A few days ago, I wrote a short column here about General Dynamics Corporation's (NYSE:GD) best contract win of 2015. It was a choice that I imagine surprised some folks -- but not as much as you're going to be surprised by my choice for General Dynamics' worst contract of the year.
But first, we need to delve into a bit of history...
Opening the umbrella
Way back in May -- May 15, 2015, to be precise -- the Pentagon announced the award of a massive IT contracting project, in which multiple vendors would be invited to bid on individual task orders under an umbrella contract. Dubbed NETCENTS-2, the contract invited 20 different companies to bid to supply the U.S. Air Force with up to $7.9 billion worth of high-tech "infrastructure, networks, systems, and operations."
General Dynamics was one of those bidders, and as the company confirmed in a press release on Sept. 28, it was successful in winning a large chunk NETCENTS-2 pot of money.
Specifically, General Dynamics Information Technology, a subgroup within GD's Information Systems and Technology division, was one of "multiple" recipients of a $920 million, worldwide "application services" contract from the Air Force. Under this contract, General Dynamics was tasked with providing USAF with "a wide range of software services including application sustainment, migration, integration, training, help desk, testing and operational support," including the task of modernizing "legacy Air Force software applications."
This contract is worth $920 million over its three-year base period, with the potential for additional funds to be added if any (or all) of four "option" years extensions were subsequently awarded.
And this is a "worst" contract why, exactly?
Now on the face of it, winning $920 million in government-guaranteed revenues probably doesn't sound like such a bad thing. But here's the thing: These revenues are flowing through General Dynamics' Information Systems and Technology division, and IS&T has historically been a pretty troubled division at General Dynamics.
To cite the most egregious example, years of ill-considered acquisitions at IS&T caused the division to take a massive charge to earnings in 2012. The charge was so big, in fact, that it pushed IS&T into a $1.3 billion loss for the year, and dragged the whole of General Dynamics into its first full-year loss in the past 25 years.
Since then, things have improved somewhat at IS&T -- but not a lot. According to S&P Capital IQ, IS&T is still both the company's largest business by revenues, but revenues last year were down 8% from 2012 levels, and they haven't improved much so far in 2015, either. Meanwhile the profits that IS&T earns on those revenues remain subpar.
Last year, General D made a paltry $785 million on $9.2 billion in this division, for a profit margin of just 8.6%. 2015 hasn't been quite asbad, with the company notching 9.9% margins at IS&T through the year's first three quarters. But even 9.9% isn't all that great when you consider that General Dynamics as a whole earns profit margins of 13.1%.
Long story short, if General Dynamics was to win $920 million worth of revenues, it couldn't have picked a much worse division to run those revenues through, than its own IS&T division. For that reason if no other, I'm calling out this contract as the worst one General Dynamics inked in 2015 -- and the one most likely to cause the company headaches in the years to come.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 308 out of more than 75,000 rated members.
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