"Damn with faint praise, assent with civil leer,
And without sneering, teach the rest to sneer;
Willing to wound, and yet afraid to strike ..."--Alexander Pope
If you haven't heard the news yet, the government of Britain announced earlier this month that it intends to meet NATO's spending targets for members of the military alliance. Through 2020, at least, Britain will devote 2% of its gross domestic product (GDP) to defense. This is despite cutting 18,000 active-duty personnel this year and slashing its defense budget by $768 million.
So, at first glance, this seems good news. A 2%-of-GDP budget should permit Britain to spend, for example:
- $9.3 billion to build the new HMS Queen Elizabeth aircraft carrier
- perhaps $9.3 billion more to build a second carrier, tentatively titled HMS Prince of Wales
- and as much as $14.4 billion -- or more -- to outfit both carriers (and the British Air Force) with F-35A and -B stealth fighter jets from Lockheed Martin (NYSE:LMT).
What's that I hear? Faint praise?
Ballyhooing Britain's boast on its pages, British newspaper The Independent says Prime Minister David Cameron's commitment "was immediately welcomed" and indeed "praised" by U.S. government officials.
It shouldn't have been.
NATO policy urges member states to spend at least 2% of their gross national product on defense. Few European countries, however, meet this goal. Out of the 28 NATO members, only Estonia, Greece, the U.S., and the U.K. currently meet the 2% target.
The U.K. already hits the target?
You noticed that, eh? Yes, that's correct. Britain does indeed already spend 2% of its GDP on defense. In fact, according to data from the World Bank, the United Kingdom spends 2.1% of its GDP on defense. But mathematically speaking, what that really means is that in promising to hit the 2% target through 2020, the U.K. has really promised nothing more than to continue cutting its defense budget.
Just as it's been doing for five straight years.
The fact that the U.K. is now boasting of spending 2% as if it were some kind of improvement, rather than a relentless march southward, threatens to mislead those who've heard of it into thinking there's some kind of turnaround in British defense policy afoot. But that's simply not the case.
What it means for investors
Over the past several months, we've taken time to examine a handful of European defense contractors -- BAE Systems (NASDAQOTH:BAESY), Thales, and ThyssenKrupp, and the potential merger between Germany's Krauss-Maffei Wegmann and France's Nexter Systems, in particular. The reason is simply that, with a newly rambunctious Russia on the rise, local European defense firms should be first in line to profit from the rearmament of European nations such as Great Britain.
Statements such as Britain's, promising to get serious about spending what it needs to spend to keep NATO strong, tend to support this thesis. More and more often, though, the facts contradict the theory.
Simply put, European defense contractors don't earn as much profit on their sales as American defense contractors such as Lockheed Martin do. And if what we're seeing in Britain proves true elsewhere in Europe -- European defense contractors may not produce the sales numbers we'd like to see, either. Long story short, this is probably not a continent where you want to be "long" on the local defense companies.
At least, not until their governments get serious about defense.