Lockheed Martin (NYSE:LMT) built the F-16 -- so why would you hire anyone else to upgrade it?

Crazy as it sounds, though, Korea did just that. Looking for someone to perform $1.7 billion worth of upgrades on its fleet of 134 "Korean version" F-16s (dubbed KF-16s) last year, Korea tapped BAE Systems (NASDAQOTH:BAESY) to do the work. It seemed all but certain that Britain would swoop in and steal away a contract that should have been Lockheed's by right.

But as it turns out ... Lockheed Martin just might swipe this contract right back.

Republic of Korea Air Force KF-16s at take-off from Kunsan Air Base. Photo: Flickr

Storm clouds on the horizon
For weeks now, word has been leaking out of Korea about BAE's contract being in danger, as Korean officials complained of rising costs. With work already under way, Korea was seeing prices beginning to spike -- to as much as $750 million beyond BAE's original bid price. Thus, there was a real risk that this "$1.7 billion" contract would soon morph into a $2.5 billion monster.

In a move to head off this risk, Korea's Defense Acquisition Program Administration (DAPA) raised the possibility last week that it might term these price hikes a "breach of contract," entitling it to strip BAE of the contract and hand it to another contractor, such as Lockheed Martin.

And in fact, that's just how things have played out. On Wednesday this week, DefenseNews.com reported that BAE's KF-16 upgrades contract has been "officially canceled" by the U.S. Pentagon. (Formulated as a "foreign military sales" contract, the upgrades work was officially given to BAE by the Pentagon, acting as intermediary between Korea and the contractor.)

For the time being, Korea is still calling it only a contract "suspension." But already, Korea's DAPA has begun negotiations with Lockheed to take over the work.

What it means to Lockheed Martin -- and to investors
While Lockheed's recapture of the KF-16 upgrades contract is not yet 100% certain, it does hold at least the potential to give the defense contractor -- and its investors -- a sizable windfall.

According to BAE, Phase 1 of the contract, which included developing plans to upgrade the fighters' avionics, beginning the collecting of necessary parts, and beginning the construction of facilities to perform the upgrades and test the systems when complete, is already being completed. But as we pointed out back in December, Phase 1 was valued at only $200 million.

Even if Phase 1 work were substantially complete, therefore, that would still leave anywhere from $1.5 billion -- to potentially as much as $2.3 billion under BAE's new-and-"improved" price estimate -- up for grabs by Lockheed Martin. And with Lockheed still earning respectable 7.2% profit margins on its business, that could easily translate into anywhere from $108 million to $165 million in extra profits for Lockheed.

That's enough money to add $0.34 to $0.52 per share to Lockheed's profits -- and maybe even enough to give the company an "earnings beat" next quarter.