Seventeen years ago, I found myself riding the Washington Beltway through Tyson’s Corner with one very happy defense executive. He was the chief financial officer of General Dynamics, and he had just sold his company’s fighter plant in Fort Worth to Lockheed for over a billion dollars. Everybody agreed he was a genius, since the plant’s future looked very uncertain following the collapse of the Soviet Union. GD was in the midst of the biggest fire sale in the history of the defense sector, a mad dash to monetize its military units that made my friend the highest-paid CFO in America that year.
Fast forward to today, and how smart does that transaction look? For a billion dollars and change, Lockheed (now Lockheed Martin) got an asset from which it has extracted at least a hundred billion dollars in sales over the past two decades. Having successfully leveraged the design and engineering skills of the same facility to win the F-35 joint strike fighter program, it will take another hundred billion dollars out of the place over the next decade.
I don’t want to minimize all the investments in computers, tooling and workforce training that Lockheed Martin has made at Fort Worth over the years, but still — buying that plant for considerably less than two billion dollars looks like the best real-estate transaction since the Dutch got Manhattan from the Indians for a handful of trinkets. Which illustrates a persistent reality of being in the defense business: demand is so unpredictable that conditions turn on a dime, and business moves that seem real smart one year may look downright foolish the next. It isn’t just that nobody knows when the next Pearl Harbor attack will happen, but the sector is dominated by a monopsony buyer (the government) that seldom behaves like an economic rational actor. Instead, it lurches from one goal to another depending on the election cycle and other non-economic factors in a fashion that makes calling future demand levels a fool’s errand.
Take another real smart transaction, this one by General Dynamics, that occurred only two years after the Fort Worth deal. GD had settled into being a much smaller version of its former self, mainly because it could not figure out how to unload its submarine and tank units. But a new executive vice president named Nick Chabraja thought he saw some bargains in the beaten-down defense business, and mounted an improbable bid for the Bath Iron Works shipyard in Maine. Bath looked so out of the money in the post-Cold War defense environment that many observers thought it was doomed. In fact, when the wily downeast lawyer in charge of Bath had to explain to its absentee owners what it was really worth on a transactional basis, they were so shocked that they accused him of trying to defraud them of their asset. He had been barely keeping the yard afloat for years, and its balance sheet was not a pretty sight.
But Nick Chabraja saw that for all of its problems, Bath Iron Works was one of only two builders of complex surface combatants in the Western Hemisphere, and that by buying it he could probably claim half of the dozens of Aegis warships the Navy planned to buy. Since each one of those ships sold for more than the asking price for the yard, it looked like a good deal even in a sector that was very much out of favor. For less than a billion dollars, GD acquired a yard that eventually generated many tens of billions of dollars in revenues. The Navy recently decided to build all of its DDG-1000 Zumwalt-class destroyers at Bath, each one of which will cost about $3 billion. Chabraja did a number of similar deals later, so in retrospect he really was a genius. Today, GD is the most consistent performer in the sector, and investors love it.
The lesson here is that if you think you know what the future holds for the defense sector, you’re just fooling yourself. Just about the time you get used to a trend, the Berlin Wall or the World Trade Center comes down, and everything changes. So instead of trying to predict demand into the distant future, the smartest thing executives can do is look at the revenues and returns of acquisition candidates as they exist today, and then calculate a price for the property that includes some reasonable hedge against future risk. But no matter what they do to improve an acquired property, there will always be a potential for surprises in the defense marketplace that does not exist in purely commercial markets. Being in the defense business isn’t like bottling soft drinks or building houses — things can change fundamentally without any warning, sometimes to the detriment of shareholders and sometimes to their benefit.
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