Investor Insight

Plenty of news on defense budget and procurement issues was generated last week at a two-day investor conference in New York that featured a slew of senior DOD types. We brought you must-reads from the show on JSF (another here), efficiencies savings and more.

Today CreditSuisse, one of the sponsors of the event, sent out a handy summary along with its own analysis of what went down. Some highlights:

Strong Potential for Negative Topline over Next Several Budget Cycles: Some of our speakers unexpectedly migrated from the current program-of-record, which calls for 1% DoD budget growth, including a 5-year plan to redirect $101B in targeted savings (mostly O&M) to support 2-3% real growth in weapons accounts. Instead, several speakers acknowledged strong potential for eventual spending reductions of up to 15-20% over the next several budget cycles. This magnitude was referenced as historically consistent with previous downturns, but we note that those were driven by abating threat, while today’s challenge is massive deficit. The more uncertain part is timing. We expect that one or two programs will be cut in the FY’12 budget, but major top-line Base Budget reduction is unlikely while we are in a “shooting war."

Profit Margins: It is already widely known that DoD wants to better align contractor profit & risk on development programs, but Dr. Carter emphasized full-rate production margin is a key protected incentive for industry.

Scale Purchasing: General Cartwright was extremely clear that we must buy in bulk (scale) to have sufficient quantities of combat platforms. Current pattern of buying more expensive platforms in fewer quantities will leave us heavily under-equipped. He also downplayed need for exquisite solutions.

Cyber Spending Must Rise: DoD is clearly going to increase cyber funding by FY’12, or FY’13 at the latest. We were warned that defending networks takes 10x the lines of software code for every line used for cyber attack. However, given the late creation of DoD Cybercom in 2010, cyber funding may not ramp up aggressively until FY13.

Unmanned over Manned Is the Way of the Future: General Cartwright clearly favors the fiscal and operating economies of unmanned vehicles, which are developing greater cognitive ability and will soon out-process human platforms at lower cost, with reduced loss of life.