Defense sector braces for ‘self-amputation’
By: Austin Wright
December 26, 2012 04:04 PM EST
Sequestration or not, the defense industry is bracing for a bad decade.
Contractors are hoarding cash. Top firms are eyeing potential mergers. And old alliances are cracking. Even senior Republicans on the House and Senate Armed Services Committees acknowledge a shrinking military is inevitable as the U.S. withdraws from Afghanistan after more than a decade of war.
Chuck Hagel’s rise to the top of President Barack Obama’s shortlist to succeed Leon Panetta as Defense secretary is the latest sign the White House is preparing for a big drawdown — beyond the $487 billion reduction in Pentagon spending already on the table.
Hagel, a former Republican senator from Nebraska, has said the Simpson-Bowles deficit-reduction plan should act as a starting point in negotiations to rein in the federal deficit. The plan, designed to produce a balanced budget by 2015, would require steep cuts in military spending, calling for an end to such big-ticket programs as the Joint Light Tactical Vehicle, the V-22 Osprey and the Marine Corps variant of the F-35 Lightning II.
Against this backdrop, military commanders and industry executives are positioning themselves to survive the coming “period of austerity,” as Marine Commandant Gen. James Amos has described it, which could result in mergers, layoffs and other cost-cutting measures.
“I’m going to have to make some really hard calls,” Amos said in an interview in his Pentagon office, explaining that further cuts could force him to cancel or scale back major weapons programs, such as the JLTV. “I don’t know if I’m going to be able to afford that,” Amos said of the service’s plan to buy 5,500 of the tactical vehicles. “The juice might not be worth the squeeze.”
Defense insiders are cautiously optimistic Congress will act to avert sequestration, which would reduce Pentagon spending by about $55 billion during the current fiscal year. For them, the real problem is what comes next.
“There are few companies, if any, planning for a full-year sequester,” said defense consultant James McAleese.
But a deal to stave off the automatic spending reductions is almost certain to include defense cuts of its own, he said. And that’s only the beginning. “This confrontation is going to be happening either every year or every other year,” he warned.
The president’s latest deficit-reduction plan would slash the defense budget by another $100 billion over 10 years. And McAleese said he views that number as a floor, not a ceiling. “The market’s expectation is that the compromise would be $15 [billion] to $20 billion,” he explained, referring to cuts carried out each year over a decade.
Loren Thompson, another prominent defense consultant, said the end result will be reduced orders for weapons and procurement programs stretched over longer periods of time.
“We appear to be at the beginning of a long downward trend,” Thompson said. “You don’t need sequestration in order for that trend to unfold, but you will definitely need some sort of new threat in order for it to stop.”
Meanwhile, a defense lobbyist and former Republican appropriations aide said he expects Congress to slash defense spending by $100 billion to $300 billion over the next decade, as opposed to the $500 billion mandated under sequestration.
“I don’t know the answer, and I don’t think anyone knows yet,” said the lobbyist, who spoke on the condition of anonymity. “At what point are the numbers so high that you kill a big system?”
Outside Washington, large defense contractors are stockpiling enough cash to see them through winter, according to McAleese. “It’s almost certain that we’re going to have a sequester compromise — the only question is the timing and the magnitude,” he said. “The body language of the contractors strongly suggests that a deal will happen by March 2013.”
Contractors such as Lockheed Martin and Boeing are hiking their quarterly dividends to assuage nervous investors. Some companies have already announced plans to downsize. Northrop Grumman is eliminating as many as 350 Maryland-based jobs. And SAIC, a Virginia-based science and engineering firm, has said it will lay off 700 workers.
Still others are scanning the field for merger opportunities.
The European aerospace company EADS, for instance, is “still in pursuit” of the business strategy that led to its failed attempt to form a combined company with BAE Systems, according to EADS North America CEO Sean O’Keefe, who discussed the proposed merger with POLITICO in his Herndon, Va., office.
“It would have created the largest, best-balanced aerospace company in the world,” O’Keefe said of the prospective deal, which collapsed in October.
But insiders view the merger attempt as a preview of deals to come. For instance, the consulting firm Booz & Company said that “large strategic moves could begin in 2013.”
In a blunt assessment of the defense sector, Booz warned of steep spending cuts that could uproot an industry still stuck in a Cold War-era mentality.
“Tackling the fiscal situation — both in the U.S. and globally — will require that defense spending be reduced further,” wrote analysts Erich Fischer and Marty Bollinger. “It is hard to overstate the extent of the downturn.”
Survival in such an environment, they said, will require “self-amputation.”
“Don’t underestimate the challenge that the current environment brings,” the analysts cautioned. “Among the biggest regrets of leadership during the last downturn were not acting quickly enough and not making hard personnel decisions early.”
On Capitol Hill, longtime defense hawks are increasingly open to the idea of a smaller military. Earlier this month, Sen. Lindsey Graham said he’d be willing to accept “$100 to $150 billion” in additional defense cuts — as long as they’re paired with entitlement reforms and an end to the “Iranian nuclear threat.”
“I am willing to give yet again,” the South Carolina Republican said at a luncheon hosted by the Weekly Standard and Concerned Veterans for America. “But I have to see how this movie ends on the financial side.”
And, Rep. Mac Thornberry, the vice chairman of the House Armed Services Committee, recently acknowledged that additional defense cuts would probably be part of any deal to avert the fiscal cliff. “I’m not for any more defense cuts, and I’m also not for raising taxes,” the Texas Republican said at a luncheon hosted by POLITICO Pro. “I suspect I’m not going to get my way.”
According to McAleese, it’s all part of a natural — and largely unavoidable — cycle.
“Between periods of war and peace, there’s usually about a decade-long slope,” he said.