Don't look now, but the U.S. Navy's highest profile warship may soon be toast -- a victim of Pentagon cost-cutting.
It's a pretty ship, no doubt. But for years, the Navy's Littoral Combat Ship has been bedeviled by reports of production delays and cost overruns. Originally expected to cost just $220 million apiece (in FY2005 dollars), the cost quickly ballooned to as high as $500 million (again, in 2005 dollars, worth more than today's).
Cost cutting ensued, bringing expenses (somewhat) under control. But even so, current budget estimates suggest that each LCS built by military contractors General Dynamics (NYSE:GD) and Lockheed Martin (NYSE:LMT) will cost taxpayers at least $450 million ($380 million in FY2005 money) -- 73% over their initial budget.
So ... what do we get for our money, and how much money are we talking about?
According to a July 2013 Congressional Research Service report, estimates of each ship's cost vary from $440 million to as high as $528 million, depending on the year the ship is to be built (factoring in the effects of inflation), the rate at which they are produced (faster production of more ships is more efficient and saves money), and other variables. Fiscal 2014 budgets put the price tag at $448 million each for the four ships to begun that year.
But a better way to look at this may be the total cost of the program, reflected in the following chart.
Meanwhile, defense officials are staring at an estimated $52 billion in spending cuts they may have to implement at the end of this month. Cutting short the LCS building program would go a long way toward covering those cuts, and paying for future years' spending reductions as well.
How deep to cut, and how far will it go?
The $80 billion-plus price tag you see up above, after all, is the cost to build the 52 LCSes that the Navy wants to build, and had planned to build, before sequester struck. Now, budget cutters in Congress are suggesting we might be better off building the LCSes we've contracted to have General Dynamics and Lockheed Martin build (20), plus the four already built -- making for a nice, round two-dozen-ship fleet -- and calling it quits after that.
How much could taxpayers save by gutting the LCS program? You might think "54%" -- 52 divided by the 28 ships-that-won't be built. But in fact, the savings could well be less than that. Contractors would still want to recoup their R&D costs, for one thing. Costs won't be spread out across as many vessels, either, preventing production efficiencies. By my calculations, we'll probably end up saving about half the estimated cost to get less than half the ships we expected -- and we'll still spend in excess of $40 billion over the fleet's lifetime.
Who's out of pocket?
Which companies will suffer from curtailing the LCS program? Lockheed and General Dynamics, most obviously. As the builders of the sea frames, and the primary contractors doing operational support and maintenance over the vessels' life-cycles, they've got the most to lose -- probably tens of billions of dollars in lost revenue. But they won't be the only losers.
Northrop Grumman (NYSE:NOC) has already won tens of millions of dollars to consult on how to integrate "mission packages" into the LCS. Northrop, General Dynamics, Raytheon (NYSE:RTN), and other big builders of equipment for outfitting warships would all lose as the budget for building mission modules (weapons systems going into building each mission package) gets slashed by more than $3 billion.
And who's going to be OK?
Other companies might fare better, despite the cuts. Cubic (NYSE:CUB), for example, has won nearly $300 million in contracts to build instructional course-ware for operating the vessels already. Those instructional materials will be needed no matter how many LCSes are ultimately built.
Plans to focus the fleet on minesweeping missions means companies who focus on producing that mission package might not get hurt as badly as, for example, makers of weapons for sub-hunting, coastal bombardment, and air defense. (And fortuitously, one of the companies building robotic submarines for minesweeping is ... General Dynamics.)
The LCS was designed to replace three classes of warships with just one, whose "mission packages" could be swapped out to transform a single LCS, in the space of four days, into whatever kind of warship it needed to be: Cyclone (PC-1) class patrol craft, Oliver Hazard Perry (FFG-7) class frigate, or Avenger (MCM-1) class minesweeper.
Plans to gut the program, and refocus the LCS on just one mission, could end up giving the LCS the dubious distinction of making it the world's most expensive minesweeper.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Cubic and owns shares of General Dynamics, Lockheed Martin, Northrop Grumman, and Raytheon. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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