US military spending under the gun: Part 1

By Maureen Aylward

With military spending under pressure in the US, and a possible directive for a $400 billion cut in defense spending by 2023, how is the aeronautics and defense (A&D) industry responding? Our Zintro experts explain the current thinking in the industry.

Tim Letzkus, an international and domestic aerospace and defense expert, sees the sector responding to soft domestic demand by employing historical strategies in a downturn: shed workers, ramp up acquisition activity, and turn to international markets. “The aerospace and defense response to the current and potential future budget downdraft is already well underway,” he says. “We are seeing layoffs in soft program areas, specifically those associated with terminated or unfunded space programs.”

For example, Letzkus says that recently Boeing’s Defense and Space sector shed 225 space unit employees. Lockheed Martin, the most vulnerable space contractor among the major players, according to Letzkus, cut about 7.5 percent of its space employees. “We’re likely to see more layoffs as funding for programs like missile defense and armored vehicles dries up because of Congressional budget slashing. It would not be surprising to see the industry as a whole shed some 8 to 10 percent of its employment base over the next 12 to 18 months,” explains Letzkus.

Letzkus says that companies will respond through strategic acquisitions in an attempt to sustain growth. “While US military leadership has made it clear it will frown upon further consolidation among major companies, it is actually encouraging mid-tier acquisition activity,” he says. “In several speeches this year, the Pentagon’s Ashton Carter said the Department of Defense would approve first tier supplier acquisitions by major A&D companies and support consolidation amongst first and second tier suppliers. Moreover, major A&D companies have the available cash for acquisitions.”

According to Bluestone Capital Partners, the top 15 US-domiciled A&D companies are sitting on some $35 billion in cash. While most European firms are cash strapped, the majors – EADS and BAE Systems – are also cash rich. EADS, for example, has more than $15 billion in cash on its books. Furthermore, resurgent equity firms have made a strong move into the sector.

Letzkus says the A&D industry will look overseas to sell its products and services. “According to a recent Los Angeles Times article, A&D firms will sell some $46 billion in weapons systems and services in 2011, a nearly 50 percent increase over 2010’s $30.1 billion,” Letzkus reports. “Companies have gone on record about growing their international market share. For example, Boeing’s Defense and Space sector has indicated it expects to grow its international business to 25 percent of total sales over the next five years. Current international revenue is somewhere in the 12to 15 percent range. Raytheon and Lockheed have made similar pronouncements along with a parcel of tier one suppliers.”

Letzkus says the budget cuts will affect a wide spectrum of major US defense programs. These will include vehicle programs, missile defense, and smaller hardware programs. “Middle East service and logistics support will dry up by the end of FY12 creating more financial pressure on defense firms,” he says. What will survive the Congressional budget cutters? Programs will include the F-35 and its derivatives; Army helicopters; command, control, communications, computing and intelligence (C4I); surveillance, including many drone programs; and cyber security.”

Luis Figueroa, PhD, a technology consultant, says that given the challenging US fiscal environment there will be cuts in Department of Defense Science and Technology (S&T) programs. However, while the overall S&T budget is decreasing in 2012, there will be selective areas of opportunity.

Figueroa outlined areas based on the Department of Defense Quadrennial Review, the 2012 Program Acquisition Costs by Weapon System, and the House Armed Services Committee  NDAA FOR 2012, which, in summary, state that protection against weapons of mass destruction will continue to see emphasis, including nuclear, chemical, and biological. “There will be additional emphasis on protection against newer threats, such as cyber and electromagnetic pulse attacks. The technologies will be extended to include protection of not only the military infrastructure, but also the civilian one,” says Figueroa. “The increasing vulnerability of the US to either malicious electromagnetic attacks or naturally occurring ones as publicly disclosed by The National EMP Commission in 2008 led to the introduction of The Shield Act (HR 668). This provides protection to civilian electrical infrastructure and, if passed by Congress, would lead to new research and development opportunities.”

Figueroa says there will be continued emphasis on providing technology enabling operationally responsive space (ORS) and space-based infrared sensing capabilities. “There will be less emphasis on conventional aeronautics technology associated with piloted aircraft, but increased emphasis for technology associated with robotic/autonomous vehicles, including vehicles that are used in space, air, ocean, and land,” says Figueroa. “In the autonomous vehicle area, there will be increased emphasis in micro-autonomous vehicles.” In addition, Figueroa says that the increasing limits on non-renewable resources such as petroleum-based fuels will focus research on the development of alternative fuels with smaller environmental footprints.

Garret Schneider, PhD, a senior aerospace engineer, says one obvious source for major cuts is in high-ticket acquisition programs begins with the Navy’s littoral shipbuilding programs. “A&D companies will indeed be facing layoffs if these programs get cut; however, a possible move to alleviate this impact would be for the companies to position themselves for what should be a refurbishment of war-weary materiel,” Schneider says. “Another potential major impact may be a reduction in R&D spending. This could result in less industry-conducted research as the Department of Defense laboratories keep programs in-house to maintain staffs and capabilities.”

Beau Norgeot, a business development expert in the defense industry, says that despite all of the budget cuts, both current and proposed, there is still a lot of money being spent in new programs. “Unmanned systems of all types are seeing increased demand and attention. Logistics and C4ISR systems continue to be strong areas of focus because they allow for greater efficiency and cost savings throughout the entire organization,” says Norgeot. “The companies that are struggling right now seem to be those that have relied heavily on a single contract for revenue. Overall, the companies that will survive are actively innovating and aggressively pricing. Even with a $400 billion cut in defense spending, the US defense industry will continue to be a huge market with great potential for those that have something valuable to offer.”

By Maureen Aylward

What do you think?

If you have a question or comment about the aerospace and defense industry, we would like to hear it. Click here. Would you be interested in signing up to be a Zintro expert and generate free leads for your business? Click here.