In ancient times, skillful warriors first made themselves invincible, and then watched for vulnerability in their opponents ... skillful warriors are able to be invincible, but they cannot cause opponents to be vulnerable.
-- Sun Tzu, The Art of War
Well, with Pentagon Sequester now in full swing, defense execs are starting to feel "vulnerable." For most of July, and on into August, we've seen below-average issuances of new contracts to the nation's leading defense contractors. Last week, only $1.5 billion in contracts went out -- about 76% below the level you'd ordinarily expect in this budget year. Clearly, money is getting tight.
Yet long-term investors know there are ways to grow profits even in a shrinking market. Because even in a shrinking market, you can still shore up your share of the market ... and sometimes even take market share from others.
And that's what Lockheed Martin (NYSE:LMT) intends to do.
A few years ago, Lockheed locked up the market for military warplanes, winning the contract to build F-35 fighter jets for the U.S. Air Force, Navy, and Marine Corps -- a $1 trillion dollar opportunity, and maybe more. According to some experts, this might be the last manned fighter jet the U.S. ever builds. And yet, although Lockheed appears to have cornered this market, its ambition doesn't stop here.
Last week, in a development that got little attention from the mainstream media, Lockheed announced a new initiative to help do for helicopters what it did with the F-35 for fighter jets -- to "offer a universal, highly adaptable and affordable mission equipment package (MEP) to meet requirements for the Joint Multi-Role/Future Vertical Lift (JMR/FVL) rotary wing program." With the U.S. Army expected to buy some 4,000 such next-gen helicopters eventually, this is already a pretty big deal. But it could be even bigger than it sounds.
According to Lockheed, MEP will be "a highly adaptable package" including "advanced avionics, sensors and weapons ... that can be applied across multiple platforms." To me, this sounds like Lockheed is trying to develop a package that can be installed on multiple helicopter systems -- to the exclusion of competing defense contractors' systems.
As Lockheed tells it, of course, its primary aim is to make military helicopters more "affordable" for its customers. But a side benefit for Lockheed -- completely unintentional, I'm sure -- is that a customer that chooses to install its MEP package of "avionics, sensors, and weapons" would most likely be unable to swap out one part of the integrated package for an offering from a rival contractor.
What it means to you
So what does this mean in practice? To start with an easy example, Lockheed has been putting TADS/PNVS electro-optical fire control systems in Boeing (NYSE:BA) Apache helicopters since 1983. Every time a helicopter contract comes up for bid, though, Lockheed has to fight for the right to make sure TADS/PNVS gets installed in it rather than, say, Raytheon's (NYSE:RTN) Multi-Spectral Targeting System, a standard on Sikorsky Seahawks.
Similar struggles arise between Lockheed's AN/AAQ-30 Target Sight System, used on the AH-1Z Cobra helicopter, and Northrop Grumman's (NYSE:NOC) AN/AAQ-37 system, used on Lockheed's own F-35. In helmet displays, Lockheed must compete with Israel's Elbit Systems (NASDAQ:ESLT).
Meanwhile, if Lockheed appears to "own the future" in helo-borne rockets, thanks to its having won the Joint Air-to-Ground Missile contract, the JAGM still isn't scheduled to even begin deployment for four more years. In the meantime, Lockheed has to try to keep people buying its venerable Hellfire missile, and not, for example, Raytheon's Maverick.
If Lockheed succeeds, this wouldn't only benefit Lockheed. If MEP becomes the standard package for military helicopters, and Hellfire is incorporated into it, well, at last report, Boeing was still receiving "fee-per-missile" residuals from its prior investment in the Lockheed-Boeing Hellfire LLC joint venture.
As for Lockheed, ideally, the company would like to lock the military into using a package including TADS/PNVS, AN/AAQ-30, the Hellfire, and its other equipment for as long as possible. This would go a long way toward making Lockheed "invincible," even in the face of defense budget cuts. Meanwhile, if the company succeeds in depriving its rivals of the ability to bid on contracts they might otherwise want ... then companies like Raytheon, Northrop, and Elbit could soon start to look "vulnerable" indeed.