The U.S. Army has spent the better part of a decade trying to pick a new handgun for its soldiers. Ten years -- and one 350-page Request for Proposals -- later, it still doesn't have one.
And that makes Senator John McCain mad.
You wouldn't like him when he's angry
A little over a month ago, the senior senator from Arizona issued a report blasting the Army for its "indefensibly" long, complex, and (to date) still ineffective efforts to replace the Army's go-to sidearm, the M9 Beretta pistol.
As you'll recall, this effort only really kicked into high gear last year, when the Army announced an industry day at which potential manufacturers could show off their wares in the hopes of winning a contract to build the new handgun. Everyone who is anyone in the industry would like to win this contract, from Beretta itself to Sig Sauer, Sturm, Ruger (NYSE:RGR), newcomer Detonics Defense, and an alliance between Smith & Wesson (NASDAQ:AOBC) and General Dynamics (NYSE:GD).
Problem is, while as many as 20 teams may be lining up to bid to build the new "Modular Handgun System" (MHS), we still seem far away from picking a winner. Bids aren't due until late next month. And with the Pentagon requiring bidders to confirm their ability to manufacture handguns at the rate of 9,300 units per month, plus an additional 4.4 million rounds of ammunition for the weapons -- also per month -- it's not even certain that all the companies with the best products will be able to compete.
How big is this contract?
In total, the Pentagon plans to buy just under 500,000 MHS handguns to equip soldiers in the Army, SOCOM, and eventually all branches of the military. Perhaps the biggest surprise contained in Sen. McCain's report, though, is the program's cost.
When last I wrote about the MHS, we had this program pegged at perhaps $400 million. Military.com has estimated the contract might be worth perhaps $350 million for anywhere from 280,000 to 500,000 firearms -- $750 to $1,250 per unit. And Sen. McCain warns that as much as $50 of this cost is from requiring manufacturers to dot every i and cross every t in the overly detailed 350-page RFP.
But here's the thing: In making this estimate, we appear to have focused too intently on the cost of the MHS handgun itself -- and not added in the value of the bullets it will shoot. In addition to thousands of guns, millions of rounds of ammunition will roll off the assembly line every month -- and the same company that wins the handgun contract will be expected to produce the ammunition as well.
Thus, Sen. McCain puts the total value of the MHS at not $350 million, or even $400 million, but a whopping $1.2 billion for the winner.
What it means for investors
This makes MHS an even bigger deal than we initially thought -- and at the same time, reinforces my own thoughts about who will win the contract.
As the Senator explains: "Purchasing both handguns and ammunition from a single vendor on a single contract ... increases the risk that the Army will not select the best performing weapon, ammunition, silencer, holster and training system components available." At the same time, the decision to require one bidder to produce the best bid for both handgun and ammunition -- and to also demonstrate the ability to produce both handgun and ammunition in very large quantities within a year of start-up -- "favors larger companies over smaller ones."
Which brings me back to my initial thinking: It's going to be a big company, not a small one, that wins the $1.2 billion MHS contract. And the most likely winners are the industry pairing of Smith & Wesson (guns) with General Dynamics (guns and ammo).
As the nation's largest publicly traded manufacturer of firearms, with revenues 9% larger than those of archrival Sturm, Ruger, Smith & Wesson is obviously a leading contender for MHS. Meanwhile, General Dynamics not only makes guns, but ammo as well, producing more than 200 million rounds of small-caliber ammunition for the military annually. Indeed, General Dynamics is one of only a handful of companies -- and the only one currently known to be bidding on MHS -- capable of swallowing a 52.8 million-rounds-per-annum ammo order from the Army with hardly a burp.
If Sen. McCain is right, and the Army has in fact drafted the MHS RFP to favor "large companies over smaller ones," these are probably the two companies favored to win.