America, Defenseless?

Don't say I didn't tell you so. Because I did.

Two months ago, in the course of describing Washington's latest push to slash defense spending in the face of mounting deficits, I predicted: "We're no longer talking about [the $100 billion in cuts initially proposed by Defense Secretary Gates.] … Now we're more likely talking cuts of somewhere between $100 billion and $1 trillion over the next decade."

Having already grounded Boeing's (NYSE: BA  ) Airborne Laser, plucked the feathers from Lockheed Martin's (NYSE: LMT  ) F-22 Raptor fighter jet, and sent SAIC (NYSE: SAI  ) and partners Future Combat Systems (FCS) through a time warp, the Pentagon laid out a laundry list of new projects to cut over the years to come:

  • General Electric's (NYSE: GE  ) alternate F-35 engine? Shifted into "park."
  • New aircraft carriers orders from Northrop Grumman (NYSE: NOC  ) ? In drydock.
  • General Dynamics' (NYSE: GD  ) $13.2 billion amphibious landing craft? Neither "necessary [n]or sensible."

And the slashing has only just begun.

The hits (to defense contractor revenue) keep coming
On Wednesday, some of the nation's biggest defense contractors began receiving "Dear John" letters from the Pentagon. The upshot: "We had some great times together last decade, but it's over now."

In a missive to prime contractors bidding on one part of the rump FCS overhaul -- specifically, the "Ground Combat Vehicle" (GCS) program, aimed at developing next generation-replacements for the military's force of Bradley and Stryker armored personnel carriers -- the Pentagon regretted to inform its suppliers that there's been a slight delay in awarding the contracts. Rather than picking its winners next month, as the companies (and their shareholders) had been expecting, the Pentagon canceled the competition, advised that it's rewriting the rules of the bidding, and pushed back a decision by "up to" six months.

The primary reason: Cost. When BAE Systems, SAIC, General Dynamics, and their various subcontractors submitted bids for the competition in May, the Pentagon was somewhat taken aback at the numbers contained in those bids. With Secretary of Defense Gates promising to hold increases in defense spending to just 1% per year for the foreseeable future, GCS was threatening to break the bank -- necessitating a Pentagon rethink of just what it can afford to buy for its money.

Radical rethinks…
If you think that, since the first actual GCS vehicles were never expected to enter service before 2017, a two month time-out to rethink the requirements isn't significant, think again. GCS isn't the only Pentagon project getting special attention from the number-crunchers.

A few days ago, the Navy suspended the process of awarding a 10-ship tranche of Littoral Combat Ships to either of the contractors offering to build them (General Dynamics of Lockheed.) And according to industry expert Loren Thompson of the Lexington Institute, there are further rumblings surrounding the already-awarded Joint Light Tactical Vehicle program (JLTV) -- the one I once jokingly referred to as "America's Next Top Humvee."

… and an even more radical idea: Common sense
JLTV, as you know, was born in the middle of the Iraq and Afghan wars, when Humvees were routinely running into roadside bombs in Iraq, and returning the worse for wear. The Pentagon's solution: Replace these rugged-but-lightly-armored super-jeeps with a fleet of more "survivable" armored cars. Three teams of contractors -- General Dynamics/AM General, BAE/Navistar (NYSE: NAV  ) , and BAE/Lockheed -- were chosen to compete for a contract worth as much as $70 billion.

But two years after the finalists were chosen, the Pentagon may be having a change of heart. With the Iraq War now officially stamped "Mission Accomplished," and troops due to begin leaving Afghanistan in less than a year, maybe we don't need to replace our nimble national jeep-fleet with as many as 140,000 armor-plated monsters. I mean, sure, IEDs were a problem in Iraq. But we came up with a solution -- the mine-resistant, ambush-protected vehicle (MRAP). The 10,000-plus MRAPs rushed into service in Iraq helped keep soldiers safe. Now that that war's wound down, many of these MRAPs are being shifted to where it still makes sense to use them: Afghanistan.

Well and good. But now it seems the Pentagon's wondering -- if we have all these MRAPs "over there" already, and they're doing the job, does it still make sense to replace our Humvees with armored JLTVs? When most of these Humvees will spend their lives tooling around military bases in the U.S., and never even see an IED? When the cost of the second phase of the program was set to push $20 billion?

The Foolish takeaway
As an investor myself, I sympathize with the plight of Lockheed, Navistar, and General D shareholders. Two years ago, when their companies won the JLTV race, they thought they were investing in a "sure thing." Today, with budgets tight and Pentagon beancounters acting as jumpy as a cat at an AKC convention, there's a very real risk the JLTV contract could go "poof!"

It's not fair, but it's time to face facts: Common sense is on the march at the Pentagon, and defense investors need to be ready to beat a retreat.

Are there any good values left in defense stocks today? As a matter of fact, there are. Find them here.

General Dynamics and SAIC are a Motley Fool Inside Value recommendations, but Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 27, 2010, at 7:20 PM, theHedgehog wrote:

    At what point will the technology of war tools become so widespread that war tools essentially become a commodity like computers or phones? We've already reached the breaking point in fighter design where we can't add any more G-force and have an actual human in the seat, but there isn't enough secure bandwidth available for real-time remote control of a fighter aircraft. Granted, we command an enormous capability lead over most of the world, but can it last? And, to my point: what happens to the stocks of the companies in the Military Industrial complex when war toys become commodities?

  • Report this Comment On November 23, 2010, at 10:16 PM, ilovesumm wrote:

    What good is a military that financially breaks the country?

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