You got to know when to hold 'em, know when to fold 'em
Know when to walk away, know when to run
You never count your money, when you're sittin' at the table
There'll be time enough for countin', when the dealin's done
-- Kenny Rogers, 1978
Actually, Boeing (NYSE: BA) investors had best hope Boeing did count its money -- then counted it twice -- before placing its latest bet. On Wednesday, the nation's second largest defense contractor announced a deal that could preserve its place as a profitable producer of fighter aircraft … or put it deeply in the red.
Boeing rolls the dice…
As you know, Lockheed Martin (NYSE: LMT) holds the contract to build F-35 fighter jets for the U.S. military. You've probably also heard that the F-35 could well be the last warplane the U.S. ever designs to be operated by an in-cockpit pilot. And yet, between the time when the military begins retiring older F-18 fighters, and the time F-35 production scales up to replace them, it seems a "fighter gap" will appear. Seeing an opportunity to win new funds for an old franchise, earlier this year, Boeing offered to build a few brand new F-18s for the military to bridge the gap.
…and bets on black
Yesterday, the Pentagon agreed. To fill the gap of not-yet-built-F-35s, it will acquire a mix of 124 Boeing F/A-18 Super Hornets and EA-18G Growlers from Boeing. The catch: The Pentagon wants a fixed-price contract for $5.3 billion, which poses Boeing with a bit of a gamble. According to Boeing, a fixed-price long-term contract on these planes will save taxpayers $600 million. However, a fixed-price contract also puts the onus on Boeing to squeeze out efficiencies to maintain a respectable profit margin on the contract.
Now granted, if Boeing's able to build 'em for cheaper than the $5.3 billion price tag; fine and dandy -- it can "keep the change." But if it cannot -- if it really does need more to build 'em to spec -- then this deal could turn into a money-loser for Boeing.
"Better you than me"
If Boeing's taking a gamble on this contract, though, I fear it's nothing compared to what subcontractors like Northrop Grumman (NYSE: NOC), Raytheon (NYSE: RTN), and General Electric (NYSE: GE) face. In pursuit of cost-savings, the Pentagon has urged its contractors (almost in so many words) to squeeze their subcontractors and cut costs. In other words, even if Boeing manages to maintain its profit margins on the F-18 contract, I doubt its subs will be so fortunate.
