August 19, 2020 | International, Aerospace, Naval, Land, C4ISR, Security
By: Doug Berenson and Chris Higgins
This year's Defense News Top 100 list of global defense companies coincides with a steep economic downturn created by COVID-19. Although the defense sector has faced pandemic-related business disruptions, it remains a safe haven, with most defense-oriented firms reporting only modest impact on revenues and profits. Seeing how diversified players rely on their defense units is of particular interest at a time when the commercial aviation market has all but collapsed. While many defense firms are bracing for stagnation in defense-spending growth, other markets could experience an extended downturn.
Avascent drew on the Top 100 list to examine the broader mix of market exposure among firms comprising the global defense industrial base. We segmented company revenues across more than two dozen defense and commercial end markets. This analysis provides insight into how companies with defense business leverage exposure to other markets, either as a complement or as a hedge to their defense activities.
One can think of defense companies in three categories:
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Defense/government pure-plays: Companies that focus overwhelmingly on military markets generate about 23 percent of the defense-oriented revenue on this year's list. To the extent these companies have revenue outside defense, it comes from close adjacencies in intelligence, civil space or others. Indeed, the top ranks of the Defense News Top 100 list includes numerous firms for whom defense and government comprise 85 percent or more of total revenue. Lockheed Martin, Northrop Grumman, BAE Systems, LIG Nex1, and Huntington Ingalls Industries and many others fall in this category. BAE Systems and L3Harris maintain significant positions in the commercial aviation supply chain, but these activities represent a small portion of their total revenues.
The unique demands of military and government markets — complex acquisition processes, challenging sales channels, burdensome regulatory compliance — has led many leading defense players to maximize their position across the defense product range. These frustratingly unique features of government customers have deterred many commercial technology firms from pursuing this space, a fact that the U.S. Department of Defense is struggling to reverse. Firms in this category have optimized their financial management, business development and other processes to the particular demands of government customers.
Within government markets, the different economics that characterize the sale of products and services has increasingly led to the separation between these two distinct segments. Many of the market leaders in U.S. government services, including Leidos, Booz Allen Hamilton, CACI International, SAIC and others, feature a near-exclusive focus on government customers. A range of firms providing such services continue to find business with both the government and commercial clients, to be sure, including Bechtel, Jacobs, Babcock International and KBR, to list just a few on this year's Top 100 list. But companies with a significant focus on mission-oriented requirements have increasingly focused solely on government customers.
Commercial and defense sectors: Nearly 60 percent of the defense revenue tracked in the Top 100 list comes from firms that compete in sectors that cross the defense-commercial divide. These include shipbuilders and automotive manufacturers, but the vast majority of firms serving both defense and commercial customers are focused on commercial aerospace. A range of firms recognize the unique complementarity between military and commercial aerospace technology in their business mix. Airframe primes like Boeing and Airbus are chief among these, sitting atop vast aerospace supply chains. But many other household names have sought opportunity in commercial aviation, either as airframe primes (General Dynamics via Gulfstream, Textron via Cessna) or as suppliers of avionics, structures, and other content.
Because it calculates 2019 revenue, this year's Defense News list does not count Raytheon Technologies, which was created with the merger of Raytheon Company and United Technologies Corp. in April 2020. The new “RTX” would have pro forma 2019 revenue of about $43.4 billion in defense and $33.7 billion in commercial markets; this excludes Otis (elevators) and Carrier (air conditioners), which were spun off concomitant with the Raytheon-UTC merger.
Many firms with heavy commercial market exposure now face unprecedented economic headwinds. Between March 1 and Aug. 1, 2020, stock prices for firms spanning defense and commercial aerospace declined by 33 percent, as global air travel nearly ground to a halt amid the coronavirus pandemic. By contrast, an index representing defense/government pure-plays has dropped by just 5 percent over the same period. Conglomerates were in the middle, declining about 16 percent.
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The silver lining, however, may be the ability of some companies to draw on defense-related cash flows to sustain commercial aerospace investment in preparation for an eventual upturn.
Industrial conglomerates: Finally, there are firms with a foot squarely in defense but which also pursue markets far afield, in terms of customer types and market economics.
About 18 percent of the defense revenue tracked in the Top 100 list is earned by firms with interests that have almost no technical or customer link with defense. Large Asian conglomerates — including China North Industries Group Corporation Limited, also known as NORINCO; Japan's Mitsubishi Heavy Industries; and South Korea's Hanwha — top this category in total revenue.
But several Western firms also follow this approach to varying degrees: Textron, Ball Corporation, Diehl Group and others combine widely disparate product lines in a holding company structure.
With defense versus commercial valuations relatively high, there may be competing instincts in the boardrooms of these giants. On one hand, these companies may decide to reorient their portfolio more toward defense activities by exiting underperforming industrial businesses. On the other hand, firms could elect to use defense cashflows to support the broader corporation and position the company for an economic rebound.
Trends to monitor
While defense budgets could face downward pressure in much of the world, many U.S. contractors have good predictability through 2021 because of DoD outlays already in process. It is the wider commercial economy where the real uncertainty lies.
This makes it hard to predict how many firms active in defense markets will fare over the next year, given the variety of other markets they serve.
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Over half the revenue earned by the Defense News Top 100 is generated from commercial sectors. Commercial aviation markets are likely to languish at pre-2019 levels through 2022 or later.
The outlook for other commercial markets is more heterogeneous, but challenges exist across areas like shipbuilding, automotive, industrial equipment and energy. To the extent that countries pursue infrastructure-led stimulus, some of the more diversified companies may find pockets of sunshine amid the gloom.
Doug Berenson is a managing director at Avascent, where Chris Higgins is a principal.
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By: Jen Judson WASHINGTON — The U.S. Army's interim short-range air defense system, which will urgently fill a capability gap identified a few years ago in the European theater, has crystallized. The Army had already decided the Interim Maneuver-Short-Range Air Defense system would be developed around its Stryker combat vehicle, but it has now chosen Leonardo DRS to supply a mission equipment package that will include Raytheon's Stinger vehicle missile launcher, according to Col. Chuck Worshim, program manager for cruise missile defense systems with the Army's Program Executive Office Missiles and Space, who spoke to Defense News on June 28. General Dynamics Land Systems — which produces the Stryker — will be the platform integrator for the IM-SHORAD system, he added. The Army went through a selection process through the Department of Defense Ordnance Technology Consortium to determine the best collection of vendors to build prototypes. A Boeing-GDLS team was a front-runner for an interim SHORAD mission package, unveiling before any other vendor a solution in August 2017 at the Space and Missile Defense Symposium in Huntsville, Alabama. Using an Avenger system on top of the Stryker, which was the team's solution, sought to take what was already in the Army's inventory to create a system. And a SHORAD demonstration at White Sands Missile Range, New Mexico, last September saw more possibilities for the interim solution including Rafael's Iron Dome and South Korean defense firm Hanwha's Flying Tiger. But a dark horse emerged at the Association of the U.S. Army's Global Force Symposium, also in Huntsville, in March. Leonardo DRS showed an unassuming small-scale mock-up of its concept at its booth at the symposium that featured its partner Moog's Reconfigurable Integrated-weapons Platform. The platform would provide a choice of sights, direct-fire weapons and missiles, Ed House, DRS Land Systems' business development manager, told Defense News at the show. The system would be able to integrate both Stinger and Longbow Hellfire missiles, requirements for the service's IM-SHORAD solution. It also would come equipped with a complement of direct-fire weapons and sights to include the M230 chain gun and the 7.62mm coaxial machine gun. But the solution also has non-kinetic defeat capabilities and Rada's onboard multimission hemispheric radar. And that dark horse has won the opportunity to provide the mission equipment package for the IM-SHORAD prototype program. The system will also have Hellfire rails as well as an onboard sensor, according to Worshim. The Army decided to choose DRS to provide the mission equipment package because of the flexibility of its reconfigurable turret, which allows for growth opportunities should the threat change or something else change that requires a new interceptor or another capability, Worshim said. The solution also posed less intrusion to the existing Stryker platform, he added, and provided an increased level of protection as the crew reloads ammunition, which can be done under armor. While the Avenger solution was deemed technically acceptable and met requirements, one of the reasons the Army decided against using the Avenger on Stryker as the solution was because the government felt it would require major modifications to the Stryker, according to Worshim. The Army has a desire to keep the Stryker as common across the fleet as possible, Worshim said. Boeing was also looking to the government to supply Avenger turrets, of which a limited amount of those exist readily in the service's inventory, which would have been problematic when considering the Army's goal to deliver 144 IM-SHORAD systems by fiscal 2022, he explained. Now that vendors have been selected, the Army will move into a negotiation period expected to wrap up in mid- to late July. The service expects to officially award the contract to build nine prototypes by Aug. 31, but has the intention to possibly move that date up, Worshim said. Once the contracts are solidified, DRS will provide the first mission equipment package, complete with a new digital Stinger missile launcher in February 2019. Then GDLS will fully integrate the SHORAD prototype by April 2019. The final prototypes will be delivered to the service by the first quarter of fiscal 2020. As the prototypes are coming along, the Army will conduct prototype testing to see if the systems are meeting requirements. “From there, the Army will decide if this solution truly meets requirements in this respect,” Worshim said. If the solution does meet requirements, production efforts to build 144 systems — a total of four battalions — will move forward. The Army's goal is to provide the first battery no later than the fourth quarter of 2020, but that will depend on funding. If funding is lower than expected, the Army will deliver the first platoon by about that time, according to Worshim. The service has moved from receiving a directed requirement in late February 2018 to selecting vendors for the IM-SHORAD solution in just about four months, which, Worshim noted, is moving at “lightning speed” for a typical acquisition process. The hope is the process to build an IM-SHORAD solution will be used as a model for Army procurement that incorporates the “fly before you buy” concept and creates a way to rapidly understand capabilities moving forward, he said. https://www.defensenews.com/land/2018/06/28/us-armys-interim-short-range-air-defense-solution-crystallizes/