Will U.S. Defense Contractors Miss Out on This $200 Billion Weapons-Buying Bonanza?

There's an arms race afoot in Southeast Asia, but what are the chances that America's defense companies will be able to profit from it?

May 11, 2014 at 10:30AM

China's first aircraft carrier, the Liaoning (PLAN CV-16). Source: Screen grab from Google Earth.

China has an aircraft carrier -- and it's making the neighbors nervous.

In fact, if news reports are to be believed, China may soon have two, three, or even four new aircraft carriers in its fleet as early as 2020. And if that's true, it's all the more reason for countries located in uncomfortable proximity to the Asian giant to begin building up naval forces of their own.

And fortunately for investors in some of the world's biggest defense contractors who sell to them, it seems China's neighbors are doing just that -- arming themselves to the teeth.

An arms race is afoot in Southeast Asia
As the foremost military power in the world, the United States is currently the biggest market for naval weaponry. That just stands to reason. But according to the naval analysts at AMI International, the Asian-Pacific region has become the No. 2 market for ocean-going arms sales. AMI estimates that Asian and Pacific nations are set to spend $200 billion on submarines and surface warships between now and 2032. At that level, they'll account for about 25% of the global naval arms market.

Unfortunately, U.S. defense contractors will be lucky to win even a sliver of this new business.

The good news
How is that possible? After all, the U.S. boasts both of the two largest privately owned defense contractors in the world -- Lockheed Martin (NYSE:LMT), with $44.9 billion in mostly military annual revenues, and Boeing (NYSE:BA), with a defense business of more than $33 billion annually (according to data from S&P Capital IQ). Both of these firms can expect to make at least some money off the Asian arms race, equipping local navies with weapons systems such as Lockheed's F-35B stealth fighter jet, optimized for use aboard "small carrier" platforms such as South Korea's Dokdo-class landing platform helicopter ships, and Boeing's P-8A Poseidon maritime surveillance aircraft.

South Korea's ROKS Dokdo (LPH 6111) in the foreground. Photo: Wikimedia Commons.

Smaller Raytheon (NYSE:RTN), meanwhile, already gets more than 10% of its annual revenues from the Asia-Pacific region, specializing in the sale of rockets and missiles that can be launched from land, air, and sea platforms. As the region invests in ever greater numbers of coastal defense works, warships, and aircraft, Raytheon can expect millions -- if not billions -- of dollars of additional business.

The bad news
But, at the same time, the two U.S. defense contractors that you'd think would be best-positioned to benefit from a boom in naval spending -- shipbuilders General Dynamics (NYSE:GD) and Huntington Ingalls (NYSE:HII) -- may largely miss out.

According to AMI, Asian and Pacific countries are likely to spend the bulk of their anticipated $200 billion investment buying warships -- perhaps as many as 1,000 surface combatants spread across several different countries, and more than 100 new submarines over the next 20 years. This implies an average purchase price of less than $200 million per warship -- probably much less, given the high cost of the submarines alone, and of the handful of new aircraft carriers to be included in the total, which will eat up far more than their fair share of the spending.

Now here's the problem in a nutshell: As a general rule, General Dynamics and Huntington Ingalls won't even get out of bed to bid on a warship contract of under $200 million. Your average GD-brand Littoral Combat Ship costs upwards of $350 million to build (some estimates put the unit cost closer to $500 million). General Dynamics' Oliver Hazard Perry-class frigate, which cost $194 million to build back in 1978, would be worth about $683 million today in inflation-adjusted terms. And Huntington Ingalls' DDG 51-class guided missile destroyers bear price tags that stretch into the billions.

And the ships these builders specialize in, those muscular, armed-to-the-teeth nuclear-powered fast-attack submarines and aircraft carriers? They all cost even more than conventionally powered craft, and are correspondingly less likely to appear on Asian-Pacific nations' shopping lists.

Foolish takeaway
America has taken a curious path in choosing how to "upgrade" its Navy over the past few decades. Eschewing the yeoman's (or, perhaps here, midshipman's) work of building small, cheap frigates and corvettes capable of maritime patrol and "showing the flag" missions, we've instead focused on building small, expensive warships like the Littoral Combat Ship, and larger, even more expensive warships such as the Zumwalt-class superdestroyer and, of course, our megabillion-dollar aircraft carriers.

This has resulted not only in a smaller Navy for us. It's also left our two best military shipbuilders woefully short of expertise in building the kinds of budget-priced small surface combatants that will be most in demand in the coming Asian-Pacific arms race. And unless we change course soon, this may cost America's defense contractors a $200 billion revenue opportunity in Asia.


America's new nuclear-powered aircraft carrier, the USS Gerald R. Ford (CVN-78). Photo: U.S. Navy.

The invention that can still save America
It's not all bad news, though -- and America still has a few tricks up its sleeves. Case in point: The Economist compares this disruptive invention to the steam engine and the printing press. Business Insider says it's "the next trillion dollar industry." And everyone from BMW, to Nike, to the U.S. Air Force is already using it every day. Watch The Motley Fool's shocking video presentation today to discover the garage gadget that's putting an end to the Made In China era... and learn the investing strategy we've used to double our money on these 3 stocks. Click here to watch now!

Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of General Dynamics, Lockheed Martin, and Raytheon Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information