This is the upshot of a pair of news items that have appeared on Reuters over the past week, laying the stage for an upset, and perhaps as many as two upsets, in the American space industry. But let's begin at the beginning.
A new day dawns for Raytheon
Five years ago, the U.S. Air Force awarded Raytheon an $886 million contract to develop an Operational Control System (OCX) for its new constellation of GPS III global positioning satellites. To be clear, Lockheed Martin (NYSE:LMT) and its subcontractors won the contract to build the satellites per se. Raytheon's role was to design the software run by the ground stations that control the satellites.
Problem is, they don't seem to have done a very good job of it.
In comments made public this week, Air Force Space Commander Gen. John Hyten blasted Raytheon's performance on the OCX contract as "a disaster," while his colleague Maj. Gen. Roger Teague, director of space programs for USAF's acquisitions chief, noted that the price of OCX has more than quadrupled to $3.6 billion over the five years Raytheon has attempted to build it.
General Teague seemed particularly upset that delays in completing OCX (originally expected to be complete in 2016; new expected due date: July 2022) could increase costs further. Going forward, he promised to review USAF's contract with Raytheon to ensure the company is penalized "if its performance does not improve," in Reuters' words. As a carrot, however, Teague also suggested Raytheon could still be "rewarded [for] good performance" going forward.
Precisely what kind of performance would qualify as "good" on a project that's already topped initial estimates by three times was not made clear. Meanwhile, in a separate report, Reuters noted that Raytheon rival Northrop Grumman is eyeing OCX with an eye to trying to shove Raytheon aside.
At the same time, Northrop may try to oust Lockheed Martin, too, as the incumbent builder of the GPS satellites themselves. And once again, it's a rival's fumbles that have opened the door for Northrop. According to Reuters, Lockheed Martin is already two years overdue on delivery of its first GPS III satellite.
Quoting Northrop Aerospace Systems president Tom Vice, Reuters says Northrop is "ready" to participate in a new USAF tender to build additional GPS satellites, after Lockheed Martin completes the eight-to-10 sats it's already under contract to build. Other aerospace companies are also said to be in the hunt, and a formal request for proposals on the next batch of GPS sats is expected to be issued in 2018.
What it means for investors
So, what does all of the above mean in dollars and cents? Billions of the former, and plenty of the latter.
Regarding the GPS satellites themselves, when Lockheed Martin won its original production contract for the first eight satellites in 2008, that was valued at $1.4 billion (roughly $175 million apiece). Round 2 of GPS III, however, will begin with the award of tiny $6 million (not a typo) contracts for companies to demonstrate their ability to build as many as 22 new sats. That said, by the time production begins in 2023, the actual production contract is estimated to rise as high as $5 billion -- $227 million per satellite. That's a prize worth fighting for, even if Lockheed Martin does probably have an advantage as the incumbent provider.
As for OCX, it's hard to say how much USAF might pay Northrop Grumman to complete Raytheon's work -- or how much of the $3.6 billion already sunk into the project is even salvageable. Most likely, the Pentagon will just plow ahead, hoping against hope that Raytheon will eventually finish its work (and paying them all along the way). But if the generals do finally lose faith in Raytheon, Northrop Grumman will be there, ready to pounce.
Count on it.