And the hits (to Force Protection's (Nasdaq: FRPT ) stock price) just keep on coming.
The big defense news of the week broke yesterday, as armored vehicle specialist General Dynamics (NYSE: GD ) reported its latest contract win in the military's much-vaunted MRAP (mine resistant ambush protected) program. Toward the end of the trading day, General D issued a press release confirming a story that The Associated Press had run the previous evening. To wit, its Canadian subsidiary, General Dynamics Land Systems-Canada, has won a contract to produce 600 RG-31 "Category II MRAP" vehicles for the U.S. Marine Corps, for a total contract price of $338.7 million.
The way I see it, there are not one, but several angles to this story. Let's go over them in order.
Told you so
First, the obligatory "I told you so" moment. As stunned as the market apparently was by General Dynamics' latest contract win, we predicted just such a development nearly two months ago in a piece entitled: "No Love for Force Protection." Quoting at length:
No sooner had Force Protection announced its own win, than sometimes-partner, sometimes-foe General Dynamics ... announced an MRAP win of its own -- and this is a party to which Force Protection was not invited.
The order was small -- just 44 RG-31 Mk5 (pronounced "Mark Five") Chargers for a purchase price of $19.9 million. Even so, the fact that General D managed to land this order on its own, apparently without help from Force Protection, seems to put the lie to another theory prevailing on the Internet chat boards: That General Dynamics "needs" Force Protection in order to win MRAP orders and get its own slice of the pie.
... (The) announcement revealed that General D's Land Systems-Canada subsidiary would "provide program management" (which sounds like pretty high-margin -- and low fixed-cost -- work to me) on the Charger contract. The actual building of the vehicles will be conducted by its partner on the project, Demmer Corporation and Britain's BAE Systems.
While hardly a mortal threat to Force Protection's business, the complicated MRAP-building relationships swirling around General Dynamics suggest that many parties will be collaborating to build MRAPS, each taking a share of the profits. That means Force Protection will have to do a lot more sharing of revenues than its investors may have bargained for.
So to sum up, the first point we need to make is that the thesis is playing out as predicted. BAE Systems has purchased Armor Holdings, which also makes MRAPs. Both of these players are working with General D to make even more MRAPs.
Whither Force Protection?
Meanwhile, Force Protection appears to be getting pushed to the sidelines of the MRAP game. No sooner had investors learned that they wouldn't own the entire MRAP market, than they began reasoning, "Well, maybe other companies can make Category I MRAPs, but surely Force Protection will get the lion's share of Category II contracts?"
Actually, surely not. General Dynamics' latest contract win was for just such Category II vehicles. The vehicle discussed in the USMC's latest contract award, the RG-31 Mk5E, appears to be a heavier version of the RG-31 Mk5 Charger to which the June contract related. In one stroke, Force Protection lost its second monopoly.
Granted, Force Protection can still get a piece of the MRAP pie. General Dynamics appears to be nothing if not willing to cooperate with any and all companies, be they "competitors" like BAE and Armor Holdings, or "partners" like Force Protection. But those investors who expected Force Protection to profit mightily by using its partners' factories (Force Protection has partnership deals in place with both General D and Armor Holdings) will need to rethink their assumptions.
Consider: If you were in General Dynamics' shoes, would you rather use your production capacity to build your own MRAPs, and keep all the profits, or would you "share and share alike?" I know what I'd do. I'd only agree to let my partners use my production capacity when they agree to give me the bulk of the profit margins accruing from the vehicles produced. I fear that's what's in store for Force Protection as well.
Speaking of profit margins, did anyone notice the price that General D is getting for its Cat II Chargers? $338.7 million for 600 vehicles works out to a hair under $565,000 per Charger. Now, I wouldn't have known this but for the fact that I began investigating Force Protection's own contract awards several months ago -- but it looks to this Fool like General D gave the Marines a pretty steep discount to win this Cat II contract. According to my figures, Force Protection had been getting in the neighborhood of $750,000 for its Cat II vehicles as recently as one year ago.
This raises several possibilities (which, rest assured, we'll be investigating further going forward):
- Either the USMC is beginning to extract significant price concessions from its MRAP suppliers; or
- General Dynamics has found a way to build MRAPs cheaper than Force Protection can manage; or else
- General Dynamics is playing hardball, low-balling its estimates in order to grab market share at its rivals-cum-partners' expense.
Whichever theory you adhere to -- or even all three! -- it sure doesn't sound good for Force Protection. Or for the remaining independent players in this game, BAE, Ceradyne (Nasdaq: CRDN ) , Oshkosh (NYSE: OSK ) , and Navistar.
Does Force Protection have an ace in the hole that could turn the entire scenario described above upside down -- and make the stock a long-term winner against all odds? The lads at Motley Fool Rule Breakers think so. Take a free 30-day trial to the service, read their write-up on the company, and find out what Force Protection has up its sleeve.