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A Dynamic Defense Duo Teams Up to Drop Bombs

As government budget cuts take effect, investors are keeping a close eye on new military contracts. Apparently, defense-funding desperation can make for strange bedfellows: Longtime foes Boeing (NYSE: BA) and Lockheed Martin (NYSE: LMT) are now pairing up to snag a potentially juicy bid.

Rivals team up
Boeing's stock price has been on a tear this year, up more than 70%, and it continues to flirt with record highs today. It's trading higher because of potential growth in its commercial aircraft segment, and it recently posted a strong third-quarter earnings report. But bearish investors often worry that Boeing's defense segment will decline as the Pentagon tightens its purse strings.

That search for dependable revenue may explain why Boeing will team up with Lockheed Martin to compete for a U.S. Air Force long-range strike bomber program. Boeing will act as the prime contractor, while Lockheed Martin will be the primary teammate. Together, the two companies say they'll be able to produce unique and affordable solutions that wouldn't be possible if they acted alone.

"Building on decades of manned and unmanned weapon systems experience, we're proud to bring our collection of technologies, capabilities and resources to affordably design, develop, produce and sustain the bomber program," said Orlando Carvalho, executive vice president of Lockheed Martin Aeronautics. "We're confident that our team will meet the well-defined system requirements and deliver a world-class next generation Long-Range Strike Bomber to the U.S. Air Force within the budget and timeframe required." 

Boeing's F-15 was passed over by South Korea initially. Photo Credit: Boeing

While that's a unique example, the two companies continually face off for military contracts. Late in September, Boeing and Lockheed Martin competed for South Korea's $7.7 billion 60 fighter jet contract. While Boeing came in as the only bid under South Korea's initial budget, it was still turned down – a slap in the face, almost. Now that South Korea has reopened bidding, Lockheed Martin seems to be the new front-runner.

To put a value or importance of this event, consider how the $7.7 billion contract compares to Boeing's defense segment, and Lockheed's overall business: $33 billion and $47 billion in revenue, respectively, in 2012. 

Boeing is also working on the U.S. Air Force refueling tanker project, the KC-46A, which will initially replace 179 of the military's 400 KC-135 tankers. The first 18 aircraft are expected to be delivered by 2017; if Boeing executes well, it could receive the entire contract, whcih would be worth upwards of $75 billion -- a huge potential win going forward. 

As the government cuts its budget by up to $1 trillion over the next nine years, competition will certainly heat up for available contracts. Boeing's Defense, Space and Security segment currently makes up nearly 40% of its company revenues, while Lockheed Martin focuses on defense as its main source of revenue. As a result, Lockheed will feel much more pressure on its business as a whole.

Meanwhile, Boeing's commercial aircraft is expected to have tremendous growth opportunities as the global fleet grows over the next two decades. It recently raised its 20-year forecast of commercial aircraft demand to a total value of $4.8 trillion. Boeing also has a very large backlog of orders valued at $415 billion, which will provide revenue security if the decline in its defense business is more drastic than anticipated.

Investors rarely enjoy that kind of safety -- and in this unlikely defense pairing, that may make Boeing a better bet than its new partner.

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9/26/2016 2:48 PM
BA $130.88 Down -0.90 -0.68%
Boeing CAPS Rating: ****
LMT $245.57 Down -0.27 -0.11%
Lockheed Martin CAPS Rating: ****