The news is out, and the winner of the $40 billion KC-X Tanker contract is all but certain. So let's all give a great big round of applause to ... Northrop Grumman (NYSE: NOC).
Not because it won the contract, of course. The opposite is true. Over the past few months, Northrop repeatedly demanded that the Pentagon modify its request for proposals (RFP) on KC-X ("Halt! Or I'll shout 'halt' again!"). In response, the Pentagon basically told Northrop to go jump in a lake, kept the terms intact, and forced Northrop to show its hand.
KC-X ... RFP ... M-O-U-S-E!
Faced with a loss of ... er, face ... if it proceeded to bid on what it had already labeled an unbiddable contract, Northrop made good on its threat yesterday and pulled out of the competition. In so doing, it almost certainly handed Boeing (NYSE: BA) a very profitable sole-source contract, eliciting cheers from subcontractors Rockwell Collins (NYSE: COL), Spirit AeroSystems (NYSE: SPR), United Technologies (NYSE: UTX), and Honeywell (NYSE: HON).
But it's not just Boeing and its aerospatial allies that have cause to rejoice today. This is really a victory for all of us: Boeing, the U.S. Air Force, taxpayers -- even Northrop.
"The first thing we do, let's [call] all the lawyers"
Six months ago, Northrop beat Boeing to win a related tanker deal -- the contract to service the existing fleet of KC-10 tankers. Because Boeing bought the company that built the planes, it had every right to expect that it would be allowed to service them, too. Instead, the Air Force gave the contract to Northrop.
By all rights, this should have booted up the by-now all-too-familiar defense contracting game. Following in the recent footsteps of contract-losing companies such as L-3 (NYSE: LLL) and BAE, Boeing would protest its contract loss to the Government Accountability Office, calling the decision flawed. Lawyers would be retained, briefs would be filed, and the process of awarding the contract would be dragged out interminably -- to the detriment of America's servicemen and -women, its taxpayers, and Northrop Grumman alike. Northrop would then, of course, retaliate on the next contract it lost to Boeing ... and on and on, ad infinitum.
This is the way the game's been played for years. But back in November, the Pentagon made a public plea to stop the insanity, so to speak, begging its contractors to play nice, make their protests "rare," and refrain from using them "frivolously."
At the time, I pointed out that the loss of KC-10 to Northrop offered Boeing a golden opportunity to do just that -- to change the "game," take the high road, decline to appeal the KC-10 award to its archrival, and let the chips fall where they may. To concede that Northrop had won KC-10 fair and square, in hopes that if or when Boeing won the larger, more lucrative KC-X contract, Northrop would do likewise. I urged: "It's time for both parties to declare a truce. Boeing should grin and bear the Air Force's decision on KC-10 today. If and when Boeing wins KC-X, Northrop should reciprocate, do the honorable thing, and not protest that decision."
Well, guess what? Boeing did just that back in November, swallowing its pride and very publicly declining to protest Northrop's KC-10 victory. And now, it looks as though Northrop is responding in kind.
You [don't] scratch my [eyes out], I [won't] scratch yours
In announcing its withdrawal from KC-X, Northrop averred: "we have substantial grounds to support a GAO or court ruling to overturn this revised source selection process." Yet, even so, "Northrop Grumman will not protest."
Sure, you can fault Northrop for taking catty sideswipes at Boeing. CEO Wes Bush made a point of calling Boeing's plane a "less capable tanker" and grumbled that he hopes Boeing gets paid "much less" than the $184 million per tanker originally budgeted for Northrop's design in the 2008 competition. But considering that Northrop just lost $40 billion in potential revenue, I think we have to make some allowance for hurt feelings (and income statements) at Northrop. But the important point is this: Just as Boeing declined to appeal KC-10, Northrop is declining to appeal KC-X.
Foolish takeaway
To me, this looks like grand news for defense investors.
Why? Sure, in the short term, losing a contract may be bad news for the loser. But consider, if frivolous appeals fall out of fashion, contract winners today will have more confidence that they will remain winners tomorrow -- and not have their victories suspended or upended by appeals, and their coffers drained by trial lawyers. Investors, too, will know that when our companies win contracts, they really have won them -- or that a "bird" in the hand won't be swiped away by Wes Bush ...
Call me a crazy optimist, call me a Fool, but I really hope this is one trend that's got legs.
Boeing's stock has more than doubled over the past year. How do you know when the train has left the station and it's too late to buy? Here's how.
