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One year ago -- almost to the day! -- I penned a short piece here posing the puzzler: "Did Boeing Just Win the Tanker Contract?" Sadly, today I regret to say I'm being forced to ask the opposite.
Nearly a decade into its epic struggle with Northrop Grumman (NYSE: NOC ) , Boeing (NYSE: BA ) stood on the brink of victory in the contest to build the Pentagon's KC-X aerial refueling vehicle. Archrival Northrop had just cried "Uncle!," demanding that the government rewrite requirements to build America's next-generation flying gas station -- or Northrop would refuse to bid.
And as it turned out, that's just what happened. The Pentagon stood firm. Northrop bowed out. Boeing's win looked like a lock -- until Northrop's partner on the KC-X bid, EADS, kicked over the gaming board. Calling a mulligan on the contest (pardon the mixed metaphors), EADS announced it would go it alone on KC-X. With everything stacked against it -- unfavorable exchange rates, a lack of local partners, a Capitol Hill full of obstreperous senators -- it seemed a fool's errand (small "f"), but EADS gritted its teeth, pulled together a bid, and submitted it.
And now, it seems they've won.
Boeing's bad news day
As you may have heard, the KC-X contract contest ran into another in its series of snafus last month, when a Pentagon clerk mistakenly sent to Boeing a package of documents intended for EADS, and to EADS a packet destined for Boeing. Speculation up until now has centered on whether the mix-up might give EADS grounds for appeal of a seemingly certain award to Boeing. But according to multiple press reports Tuesday, litigating against a poor loser might be the least of Boeing's worries. The more urgent concern: It appears Boeing will lose KC-X.
What are the odds?
Within the documents revealed to Boeing is the astonishing revelation that Boeing's version of KC-X -- the one Boeing and team members Spirit AeroSystems (NYSE: SPR ) , Rockwell Collins (NYSE: COL ) , United Technologies (NYSE: UTX ) , and Honeywell (NYSE: HON ) have ballyhooed as superior to EADS' A330-based craft in so many newspaper advertisements -- may not in fact be as good a plane as the A330 at all. Based on its examination of both planes' specs, the Pentagon appears to have concluded that EADS's plane beats Boeing on "mission effectiveness." That could be good news for General Electric (NYSE: GE ) , which had been tapped to build the engines for last-known iteration of EADS' plane -- but it's clearly bad news for Boeing.
Granted, it's also only one of the three criteria on which the Pentagon is grading both parties' planes. Problem is, on the other two criteria:
- Boeing's pretty sure the Pentagon is underestimating the cost of retrofitting airbases to accommodate EADS's larger A330-based tanker ...
- ... even as it also underestimates the cost of keeping the A330-based tanker filled up with jet fuel in future years.
Strike one, strike two, and now strike three
Result: Already operating at a price-disadvantage due to the relative Euro weakness/dollar strength we're seeing in currency markets lately, Boeing was already pretty sure EADS would underprice on its offering. Now, based on what it read in the mis-mailed documents, Boeing believes it's losing the quality argument as well.
What's it mean to you?
As I say, sources tell us that this is how Boeing is reading this news -- but what's it mean to you, the investor? You'll no doubt be shocked to hear this, but I think it means surprisingly little. The price of the planes, their relative quality -- all of this is actually irrelevant to what happens next, because at its heart, the KC-X award has become an international political football.
Consider this: Say the Pentagon rumors are correct. EADS has the better plane and the cheaper plane. I still think a combination of the struggling U.S. economy, overwhelming Congressional support for Boeing's bid, and national security concerns over farming out our tanker fleet to foreign subcontractors gives Boeing the win here.
But raise your hand if you think EADS will take that decision lying down.
I mean, yes, Boeing has extended an olive branch and bowed to Pentagon pressure to stop challenging defense contract awards. It declined to challenge the award of a contract to service Boeing-built KC-10 tankers when Northrop won it last year. But EADS has given no indication it has any such compunctions. How much you want to bet they'll balk at delaying the provision of refueling tankers to America's Air Force -- tankers we've been waiting a decade for already -- when $35 billion worth of revenues are at stake?
Granted, there's always the chance EADS will win, and Boeing's commitment to fair play and the finality of contract awards will be put to the test once more. Even then, I think it's a toss-up whether we get our tankers any time soon. The temptation to litigate a $35 billion contract in an environment of declining defense spending may be too great for even Boeing to resist.
Long story short: Absent a political compromise between Europe and the U.S., between Boeing and EADS, I see this contract as dead in the water. The merits of the actual planes just aren't relevant anymore.
Now it's time for you to tell us what you think about the KC-X controversy. Should EADS be allowed to win this one in the interests of getting planes in the air? Do we dare allow a foreign planemaker to have a stranglehold over the fuel that keeps America's strategic bombers aloft? Scroll down and sound off!