Russia is on the march in Eastern Europe, and Poland is nervous.
Earlier this year, Poland announced multiple -- and massive -- defense contract awards in an effort to beef up its military to meet the threat from the East. About $3.4 billion to purchase 50 combat helicopters from Airbus (NASDAQOTH:EADSY). Perhaps $7 billion more to build a Patriot "missile shield" from Raytheon (NYSE:RTN). Billions of dollars more spent buying everything from German Leopard tanks to Finnish APCs to drones from who knows where.
And now it's all at risk.
In one of the more confusing defense policy statements in recent memory, Poland's new Prime Minister announced last month that Russia is Poland's "enemy." To defend against this enemy, the incoming Law & Justice party plans to grow Poland's army by 50%, secure permanent bases of NATO troops on its soil, accelerate the modernization of its military, and increase annual defense spending to 2% of GDP -- or more.And the first step in doing all of this will be... to cancel Poland's two biggest defense contracts.
A Polish sausage of a defense policy
With Poland's GDP recently clocked at $548 billion per annum, Poland is fully capable of supporting the levels of military spending it's promised to commit. Two percent of that sum works out to about $11 billion in annual spending, putting Poland's entire $43.3 billion defense spending wish list within reach in less than four years. The question now, though, is who will share in the loot.
Last month, Polish Defense Minister Antoni Macierewicz announced plans to "repeat" the competition that had hired Airbus to supply 50 Super Cougar transport helicopters to its military. A more accurate translation might be to "cancel and start all over again."
This is bad news for Airbus, whose struggling defense unit could dearly use the extra business. According to data from S&P Capital IQ, last year, both revenue and profits at Airbus helicopters declined 9%, while Airbus defense and space earnings were down a staggering 45%. Depending on how they're allocated, revenues from the Polish helicopter contract could have more than made up the shortfall in defense -- or replaced the decline in helicopters more than four times over. On the other hand, Airbus' loss could turn into a windfall for someone like Lockheed Martin (NYSE:LMT), which recently purchased Sikorsky, Airbus helicopters' archrival, and can be expected to bid aggressively for the Polish contract.
At the same time, Macierewicz dismissed Poland's missile shield contract with Raytheon as "practically non-existent," based on a "much higher" price than Poland wanted to pay, with delivery taking "much longer" than expected. That all sounds very bad for Raytheon -- and for Lockheed Martin, too, as it builds a good chunk of every Patriot system in cooperation with Raytheon. But the news may not be as bad as it sounds.
In what optimists can interpret as a hopeful note, Macierewicz at least didn't call for a "repeat" of the Polish Shield contract. Instead, he said that Poland will seek "honest, fair, and effective talks with our American partners."
The upshot for investors
The fact that Poland still considers Raytheon a "partner" suggests that the Polish Shield contract isn't quite as "non-existent" as the Defense Minister first intimated. But it does mean that Raytheon needs to make a serious effort to get the ball rolling on this project, lest it lose out on a $7 billion opportunity.
A bit of smart negotiating right now could turn Poland's rearmament into a pair of big wins for Raytheon and for Lockheed Martin -- both.
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