Lockheed Martin (NYSE: LMT) shareholders can breathe a little easier today, knowing that their company has just survived a near-death experience. Plagued by cost-overruns and manufacturing delays, the aerospace giant was forced to undergo Congress' version of a fill-or-kill order this week, as its F-35 fighter program joined General Dynamics' (NYSE: GD) DDG-1000 program, Boeing's (NYSE: BA) Block III Apache upgrade, and three other major Pentagon weapons programs on the legislative chopping block.
Pursuant to the requirements of the Nunn-McCurdy Act, when a program runs over its initial cost estimates by 50% or more (and all of these programs fit the bill), Congress must review the program for possible cancelation. The only way the program survives, according to the act, is if the Pentagon goes on record certifying the program's necessity, citing a lack of viable alternatives, agreeing to pay the higher costs, and confirming that it will be watching those costs like a hawk going forward. Fortunately for Lockheed, the Pentagon backed it up on every point this week, greatly improving the F-35's chances of eventually landing at an airbase near you.
How crucial is the F-35 to Lockheed? It's hard to overstate the case. According to company estimates, the F-35 Lightning II program could eventually generate in excess of $1 trillion in costs, quite a bit of which flows straight to Lockheed, over its multidecade lifespan. That would make it the world's first trillion-dollar warplane. And judging from Pentagon comments, it may also be the last manned fighter jet that America builds.
In other words, if the F-35 program survives and thrives, Lockheed's secures its revenue streams for decades to come. If it fails, if Congress kills it, the future is thrown open for competition. Potentially, and assuming the Pentagon still sees a need for manned fighter jets (as opposed to unmanned aerial vehicles) in the near future, canceling the F-35 could open the field back up to competition from Boeing and possibly even current partner Northrop Grumman (NYSE: NOC).
Little wonder, then, that Lockheed is scrambling lobbyists to contest Congress' worst fears for the program. Yesterday, the company assured Congress that estimates of the plane's rising costs are exaggerated, and that Lockheed plans to build them for much as 20% cheaper than current estimates suggest is possible. The company's so sure of itself, in fact, that it's offering to build future F-35 tranches for a fixed price, rather than the standard "cost-plus" arrangement.
Foolish takeaway
Cheaper planes, and presumably slimmer profit margins? It doesn't sound like what we want to see in a company we invest in. But when the alternative is cancelation of the contract, and loss of a trillion-dollar revenue stream ... I think we can live with it.
Agree? Disagree? Tell us why below.
