Maybe I'm just old, but I remember when Britain actually had a military. When it stood shoulder-to-shoulder with the U.S. Army and Marine Corps in the liberation of Kuwait. Or earlier, when it faced down aggression in South America, defended its citizens, and reclaimed its stolen territory in the Falkland Islands.
But like I said, I'm old. That world doesn't exist anymore.
Royal Air Force, royal figurehead
England began as a monarchy, I'm told, and it's still nominally so. Dubbed the "royal family," this monarchy is basically a figurehead -- a ceremonial institution that doesn't really do much anymore. And that's fine. What's less fine is what we recently learned about that other "royal" institution -- the Royal Air Force.
According to a report just out on DefenseNews.com, the same economic crisis that's threatening to reduce defense spending in the U.S. is about to absolutely decimate defense spending in Merry Olde England. Across the pond, the Ministry of Defense is about to embark on a round of spending cuts that will reduce the size of the RAF to a grand total of six fast-attack jet-fighter squadrons.
Six. Viewed in isolation, that doesn't mean much, so let me give you some context: In the waning days of the Cold War, as Britain stood on the front lines of the war against Communism, just a short ICBM-hop from oblivion, the RAF boasted a force of 33 fast-jet squadrons. Thirteen years later, when the Royal Marines rolled into Iraq, the planes giving them ground support belonged to an RAF barely half the size of its Cold War-era forbears -- 17 squadrons in all.
Already, this force has shrunk to a bare dozen squadrons, and by decade's end, says Air Vice-Marshal Greg Bagwell, commander of the RAF's air combat group, "We are heading for five Typhoon squadrons and one JSF squadron. … It will be a six-squadron world."
And … ?
By this point you're probably thinking this is disturbing news, but what does it have to do with investing? Well, a few months back, I penned a column on the subject of U.S. defense cuts. I argued that whatever your views on the military, and spending thereon, it's inarguable that there are certain functions only the military can perform: protecting international shipping lanes, shooing Somali pirates away from oil tankers, and combating international terrorism.
I further noted that if the U.S. cuts back on defense spending and as a result is less able to cross items off the international "honey-do" list, then someone else must. China's interested in expanding the role it plays abroad. Russia's military, and its arms-export industry, are resurgent. But my real hope was that Europe might finally do its share of the global security chores. I argued that even if Boeing (NYSE: BA) and Textron (NYSE: TXT) saw their Pentagon sales slip, we could still hope Europe would step up its arms buying and that these stocks could still remain good investments.
Ahh …
Yes. Now you see we're I'm going with this. At the time, frequent commenter AnotherNavyFool suggested I was overoptimistic:
I have worked with too many Europeans to think they … have what it takes to take up the slack (except for England, maybe). That and they are dealing with their own economic issues. Same with Japan. They are still gunshy from military rule in WWII -- as are many Asian countries who are not anxious to see them with a large military.
It seems AnotherNavyFool was right. Whether from lack of will or simple lack of funds, the U.K. is declining to "stand up as the U.S. stands down." It's retiring Harriers, mothballing carriers -- and cutting (gutting?) the RAF by 80%. All of which means we need to revise our expectations for defense stocks.
Bangs for bucks
Make no mistake: Britain knows what it's doing. It recognizes the risks. As Vice-Marshal Bagwell put it this week: "Am I happy to be down at that number [eight squadrons] next April? No, it worries the hell out of me because it's a small combat air force."
So the UK's focusing on what it can afford. In particular, knowing that unmanned aerial vehicles are cheaper to buy and fly than manned fighter jets, Britain is doubling the size of its Reaper UAV fleet. This bodes relatively well for companies that cater to such cut-price arms -- first and foremost General Atomics, which builds the Reaper, but also Honeywell (NYSE: HON), which makes the engines, and Lockheed Martin (NYSE: LMT) and Raytheon (NYSE: RTN), which make the munitions it carries.
But still, supplying cheaper weapons promises smaller revenue streams for these stalwarts. Small UAV gains for Raytheon or Lockheed are outweighed by cancelled F-35 fighter orders and the revenue gains that come with those more expensive jets.
Better bets in a shrinking defense-budget world might be smaller companies with more room to grow from the we-hope-less-is-more trend. L-3 Communications (NYSE: LLL), for example, is pitching its King Air turboprop surveillance plane as a low-cost alternative to pricier fighter jets. iRobot (Nasdaq: IRBT) and its PackBots are another obvious robots-are-cheaper-than-people play -- as is Britain's homegrown iRobot competitor, QinetiQ (London-listed under ticker "QQ").
That's my read on the situation, at least. What's yours? Tell us about it below.
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