Pity Beretta. No sooner did the Italian arms-maker announce it's entering an updated version of its standard-issue M9A1 service pistol into the Army's Modular Handgun System competition than the Army said they didn't want it.


Beretta's M9A3 -- rejected? Photo source: Beretta.

So reported Military.com last weekend. According to the website, "by late December, it was all over for Beretta's engineering change proposal for the M9. The Army's Configuration Control Board decided not to evaluate the M9A3, according to a source familiar with the decision."

Granted, Army Public Affairs has not yet confirmed the decision, and until that "official" word comes down, Beretta still has to be considered in the running. Granted too, fans of the M9 are beginning to rally around the (Italian) flag, arguing the merits of the Army's current go-to handgun, and urging a reconsideration.

But there's no doubt: Right now, things are not looking good for Beretta.

Which naturally raises the question: If not Beretta, then who will win the $400 million MHS contract? Here's what my research leads me to believe:

Who's on first?
The front-runner in this competition, in my opinion, is almost certainly unchanged since last weekend's news: an alliance between gunsmith Smith & Wesson (SWBI 1.03%) and military munitions maker and Pentagon insider General Dynamics (GD 0.11%).

Make no mistake: Everyone who is anyone in the gun industry is angling to win this contract. In addition to bidders already discussed last week, we're now just about certain that Sig Sauer will also make a bid. And while I haven't seen confirmation of this, it's simply unimaginable that Sturm, Ruger (RGR -0.48%) wouldn't make a play as well.

Also, privately held pistol research and development shop Detonics Defense has a design that's winning high praise across the Web, and could form an alliance with one of the more established gun producers to make a bid on MHS. Meanwhile, even smaller shops, lacking capability to produce guns en masse themselves, are emerging as dark-horse candidates, bearing novel variants on the much-loved 1911 design in hopes of winning MHS.

All that said, the alliance between one of America's only two publicly traded small arms specialists (Smith & Wesson) and one of its leading ammunition providers (General Dynamics) presents a formidable opponent. As long as the Army continues to favor MHS bids that offer it both a handgun solution and a new caliber of ammunition to match, these two companies remain the ones to beat.

Can they be beat?
That depends. Over and over this past week, I've heard that the Army is looking for a truly novel design for its next handgun -- while most of the designs it's been presented are anything but novel. The winning bid in this competition is therefore likely to be the company that listens most closely to the Army's requirements, and delivers on them most closely. In particular, it appears that the winning bid will offer:

  • A steeply angled pistol grip that can accommodate hand sizes both large and small. This is essential to ensuring that the shooter can maintain control of the weapon in a stressful environment (i.e., combat), so that accuracy does not suffer.
  • Low recoil -- for the same reason.
  • A handgun that is "modular" especially in the sense that its barrel length and grip can be switched out, converting the weapon from full-size to compact for use in non-combat scenarios, such as special operations and plainclothes protective details assigned to high-value targets.
  • And ideally, a manufacturer that can "do it all." One that can offer the Army not just a gun, but ammunition for the gun, and also all the accessories that go with the gun -- everything from holsters to special sights and silencers.

What does it mean to investors?
Here at The Motley Fool, we're as interested as anyone else in keeping up with developments within the military-industrial complex -- but what we really enjoy is figuring out how this kind of news affects investors' portfolios. In that regard, the fact that so few gun manufacturers are publicly traded means that, whoever wins MHS really only matters to us if it's a winner with a ticker symbol attached to it.

For this reason, the fact that Smith & Wesson and General Dynamics appear to occupy pole position in this race is good news for investors.

How good, you ask? Well, let's consider:

The exact value of MHS is still in flux. That said, we know that the Army is currently paying about $640 per unit for its current complement of M9A1 Beretta handguns. Military.com is projecting the Army will pay "at least $350 million" for somewhere between 280,000 and 500,000 firearms -- which works out to a unit price of anywhere from $750 to $1,250 per gun. (That's a bit less than we initially estimated -- but has the virtue of being closer to what the Army is already "used" to paying, and so is probably more reflective of its expectations.)

Whatever the ultimate price, this contract does promise to add nearly a year's worth of revenues to Smith & Wesson if it wins -- and at very nice margins. Already, S&P Capital IQ calculates that S&W earns about a 20% operating profit margin off its guns. The efficiencies of producing one single model of handgun at scale for the U.S. Army could lift that margin even higher.

Meanwhile, General Dynamics, should it win alongside S&W, is earning close to 15% operating profit margins on its Combat Systems business (the division housing ammunition manufacturing). GD already produces more than 200 million rounds of small-caliber ammunition (5.56 mm, 7.62 mm, and .50 caliber) for the Army annually, though. Adding a new contract for production of 9 mm or .45 caliber ammunition -- or anything in between -- would likely give its bottom line a nice boost as well.

Just not as big a boost as Smith & Wesson would get.

Long story short: If you believe, as I do, that Smith & Wesson and General Dynamics have the best chance of winning the MHS contract, the better way to bet on that happening is to buy shares of Smith & Wesson.


Smith & Wesson's M&P45 in Dark Earth Brown. Could it replace the Beretta M9, and become America's next top handgun? Photo source: Smith & Wesson.