“NATIONAL DEFENSE MAGAZINE”
“The competition for the $100 billion Air Force long-range strike bomber program includes three of the Pentagon’s top contractors. The contest pits Northrop Grumman against a Boeing-Lockheed Martin team. Big programmatic decisions — like selecting a prime contractor for the F-35 in 2001 and now one for the bomber — unleash market forces that the Pentagon cannot control.
Whoever loses the bomber is likely to come under pressure from investors to make a big move — to either merge with a competitor or acquire a piece of one, predicts aerospace industry analyst Richard Aboulafia, vice president of the Teal Group. “It’s a fascinating horserace … and the outcome could precipitate a big merger or acquisition,” Aboulafia told executives at a recent meeting of the National Aeronautic Association.
Only Lockheed Martin can afford to lose the bomber contract and still have certainty that it will remain a combat aircraft prime contractor, as it will be producing the F-35 joint strike fighter for decades. But Boeing’s and Northrop Grumman’s future as a combat aircraft prime depends on winning the bomber. “If you are not Lockheed, you’d better win this one,” Aboulafia said.
Under one scenario, if Northrop wins, Boeing could seek to acquire if not the entire company, maybe Northrop’s aerospace unit that would have the bomber contract and also builds sizeable components of the F-35. Aboulafia believes this would be the only option for Boeing to remain a combat aircraft prime contractor if it does not win the bomber deal. If Northrop loses, its investors might conclude that it is more lucrative to break up the company and spin off the aerospace division.
But Carter could face challenges to that policy in the near future as defense contractors weigh their options in a tight market. There is growing speculation that such a test might come in 2015 or 2016, following the award of a major Air Force contract to build a new stealth bomber.
Whoever loses the bomber is likely to come under pressure from investors to make a big move — to either merge with a competitor or acquire a piece of one, predicts aerospace industry analyst Richard Aboulafia, vice president of the Teal Group.
The Air Force said it plans to make an award some time in 2015. It has budgeted nearly $14 billion for long-range strike bomber research-and-development work through 2020, and procurement would begin some time in the next decade. Additional funding is said to be tucked in the Pentagon’s classified “black” budget.
For the companies, the contest is a matter of long-term survival because the bomber is the only combat aircraft program up for grabs that is likely to go into production in the next decade.
Although the Pentagon has drawn a hard line on prime contractor mergers, there might be cases when it might have to reconsider, Aboulafia said. Since the last big wave of industry consolidation in the 1990s, the market has changed dramatically, including the definition of what constitutes a prime contractor. If Northrop doesn’t win the bomber, even if the company is financially healthy and successful, its days as a military airframe prime would be numbered, said Aboulafia. “Does that mean it can sell one or more of its units?” The Pentagon might not be able to make a strong enough case to stop a sale, he said.
“The money you spend is the only real leverage you have,” he said of the Defense Department. “This is a changing environment in terms of investor expectations and company structure. Maybe we’ve forgotten that people do expect either growth or a compelling story to invest their cash.” The companies that are left out of the bomber program will feel pressure from investors, he added. “How do you make your case to Wall Street? An acquisition might be the way forward.”
If the government doesn’t have enough work to keep prime contractors in business independently, it is not clear how it can dictate which units a company can sell, said Aboulafia. “That sounds problematic.”
During his time as chief weapons buyer and deputy secretary of defense, Carter stood firmly behind the idea that market competition is essential to ensure innovation and protect the Defense Department from becoming dependent on monopolies.
Carter told the Senate Armed Services Committee that he continues to believe that the Pentagon should carefully review the implications of industry consolidation before allowing mergers. “I support the review of each proposed merger, acquisition, and teaming arrangement on its particular merits, in the context of each individual market and the changing dynamics of that market,” Carter said in written answers to committee questions submitted before his Feb. 4 confirmation hearing.
“I believe the government must be alert for consolidations that eliminate competition or cause market distortions that are not in the department’s best interest,” Carter said. “During my time as the undersecretary of defense for acquisition, technology and logistics and the deputy secretary, the department took steps to improve and preserve competition in defense procurements, and I would support the creation or continuation of competitive opportunities.”
For military aircraft manufacturers that want to be viable beyond the coming decade, the bomber is the only game in town. The Air Force has plans to buy a trainer aircraft, and both Boeing and Northrop have announced their intent to develop clean-sheet designs for the competition. The Air Force, however, has said it might choose to buy an existing airplane rather than a new design.
If the Air Force sticks with its goal of buying 80 to 100 bombers, the program could be worth more than $100 billion. The Air Force has championed the bomber as one of its top three acquisition priorities.
In his statement to the Senate Armed Services Committee, Carter said he would support the program. The Air Force, he wrote, “requires a new generation of stealthy, long-range strike aircraft that can operate at great distances, carry substantial payloads, and operate in and around contested airspace.”