The Insider

Credit Suisse, which co-hosted an aerospace and defense conference last week with McAleese and Associates, came away from the event with the notion that while sequestration is "highly unlikely," it's still a "rising concern," according to a just-released research note.

"While we agree the expiring Bush Tax Cuts should drive a negotiated compromise during the lame-duck session, we see increased headline risk building into the summer," the note reads. Further:

Share Downside Outweighs Upside; Boiling Frog Still Possible:  We think defense stocks are discounting zero-to-little chance of Sequestration (which adds >$500B in incremental cuts over 9 years).   We expect ultimate negotiation to yield $100B-$300B in incremental cuts.  However, the closer the end result to the lower end, the greater the chance that further cuts become necessary in the out-years (the Boiling Frog scenario).

The note also lists the companies Credit Suisse analysts had varying degrees of bullishness if sequestration did in fact take place:

* Most Bullish: BA (OP-$85): Based on our discussions, Boeing is the only company specifically preparing for a sequestration.  While it needs new orders to keep the F-18 line open beyond 2014, we see it as best positioned in the near-term.  We note universally positive commentary on Tanker progress from all relevant DoD stakeholders.

* Slightly Bullish: LMT (N-$80): We heard resounding DoD support for F-35, but customer still frustrated by cost & schedule. Int’l demand solid, but buyers laser focused on holding price.  See building confidence in ES revs and IS&GS margins.

* Developing Risk: HII (N-$30): CVN-78 (Ford) is under pressure with overrun currently estimated at >$800M; Congress pushing to zero HII’s profit, although DoD it expected this to mitigate somewhat.

* Incremental: GD (OP-$85): Gulfstream sounds great, Marine sounds good, but Combat remains challenged.  Further, we see risk for GD’s guidance for back-ended 2012 year at IS&T with GD’s expectation for combined effect of likely FY13 CR and Sequester overhang.

Check out InsideDefense.com's coverage of the Credit Suisse conference:

Hale: Costly Submarines Will Force Cuts To Other Priorities

Venlet: Navy To Test F-35C Tailhook Mods This Summer At Pax River

PEO Aircraft Carriers Working To Cut Man Hours, Cost In Future Ships

Mabus: Navy To Move 2,000 Sailors From Desk Jobs To Piers

Venlet: JSF Deferment Will Lead To Pricing Adjustments

Hale: DOD Unmoved By Senator's Warning On More Cuts

Senior Defense Officials: DOD Plans Naval Buildup In Pacific

The Pentagon late this afternoon formally announced the award of an $11.4 billion foreign military sales contract to Boeing for 84 new F-15 fighter aircraft for Saudi Arabia. The agreement to sell the F-15s to the Saudi government was struck last December.

"This particular undefinitized contract action covers development efforts for the new aircraft and retrofit as well as procurement of the 84 new production aircraft," according to a Defense Department statement. "The locations of the performance are El Segundo, CA, Ocala, FL, and Cedar Rapids, Iowa. Work is expected to be completed October 2020. ASC/WWQ, Wright-Patterson Air Force Base, OH, is the contracting activity."

Last month, InsideDefense.com reported that DOD hopes to ratchet up foreign sales of U.S. weapons, seeking new deals that could advance numerous policy aims including higher procurement rates that would aid the U.S. military as it braces for a prolonged period of fiscal belt-tightening. Further:

Acting DOD acquisition chief Frank Kendall told Wall Street investors and defense industry executives that he is working with the Pentagon's top policy official -- who guides decisions about foreign military sales in cooperation with the State Department -- to find ways to facilitate more overseas deals.

"We've always been supportive of FMS but I think we can up our game a little bit," Kendall said at an aerospace and defense conference organized by Cowen and Company, an investment bank. "And maybe in some cases take a look at taking a little bit more risk then we've been willing to take in the past."

Government-to-government sales of U.S. military equipment totaled $28.3 billion in fiscal year 2011, with Afghanistan, Taiwan and India accounting for more than 50 percent of the total, according to the Defense Security Cooperation Agency, which manages foreign sales for the Pentagon (DefenseAlert, Dec. 5).

DSCA estimates it will secure foreign military sales worth $30.5 billion this fiscal year, which ends Sept. 30, a Pentagon official told InsideDefense.com today. If realized, that estimate would reflect a 2.1 percent increase over FY-11.

The $30.5 billion "baseline" forecast does not include the $29.3 billion sale to Saudi Arabia of F-15 fighters and combat helicopters finalized in December. Once the Saudi deal -- an unusually large arms package -- is factored in, the Pentagon estimates foreign military sales in FY-12 will total $59.8 billion, a previously unreported figure.

The Pentagon is asking for congressional permission to sell $300 million worth of C-17A Globemaster engines to the United Kingdom, according to a Defense Security Cooperation Agency statement released this afternoon:

The Government of the United Kingdom (UK) has requested the possible sale of 20 F-117-PW-100 engines, engine exchange kits, support equipment, Global Positioning Systems, communications equipment, spare and repair parts, personnel training and training equipment, publications and technical documentation, U.S. Government and contractor engineering, technical, and logistics support services, and all other related elements of program support. The proposed sale supports the continued UK access to the United States Air Force/Boeing GLOBEMASTER III Sustainment Partnership program supporting the UK’s fleet of eight Boeing C-17A GLOBEMASTER III aircraft. The estimated cost is $300 million.

This proposed sale will contribute to the foreign policy and national security of the United States by helping to maintain and improve the security of a key NATO ally that has been, and continues to be, an important force for major political stability and economic progress throughout Europe.

The UK was the first foreign customer for the C-17 GLOBEMASTER III cargo aircraft. Continued sustainment of this system by the UK helps alleviate the burden placed on U.S. forces supporting NATO operations. The C-17 provides the UK with an increased force protection capability that enhances regional and global stability. The UK will have no problem absorbing these additional engines and support into its armed forces.

The Pentagon's assistant secretary for homeland defense and Americas' security affairs has been given the antiterrorism (AT) program portfolio, according to a March 1 memo issued by acting Under Secretary of Defense for Policy James Miller.

Miller's memo states that the ASD(HD&ASA) is now responsible for:

a. Serv[ing] as the principal civilian advisor to the Secretary of Defense and the USD(P) to provide overall direction and supervision for policy development, program planning and execution, and allocation of resources for DoD AT activities  . . .

b. Coordinat[ing] with the Chair of the Under Secretary of Defense for Intelligence (USD(I)) Physical Security Review Board on physical security matters that affect DoD AT planning conducted in accordance with DoDI 5200.08 and DoD 5200.08-R . . .

c. Coordinat[ing] with the Chair of the Under Secretary of Defense for Acquisition, Technology, and Logistics (USD(AT&L)) Physical Security Equipment Action Group on physical security technology development and the application of new technologies to meet AT needs in accordance with DoDI 3224.03 . . .

d. Coordinat[ing] with the CJCS to validate submissions for CCIF requests.

e. Monitor[ing] resource requirements resulting from Joint Staff Integrated Vulnerability Assessment trends in coordination with the CJCS; the USD(AT&L); the Under Secretary of Defense (Comptroller) (USD(C))/Chief Financial Officer (CFO), Department of Defense; and the Director of the Defense Threat Reduction Agency (DTRA).

Overall, the memo decrees DOD's antiterrorism policy as follows:

a. DOD Components and DoD elements and personnel shall be protected from terrorist acts through a high-priority, comprehensive AT program using an integrated systems approach.

b. The DOD AT Program is an element of [Combating Terrorism] and focuses on defensive measures used to reduce the vulnerability of individuals and property to terrorist acts, including rapid containment by local military and civilian forces. The minimum elements of an AT program shall be AT risk management, planning, training and exercises, resource application, and comprehensive program review, as defined in the Glossary. All response planning undertaken pursuant to this Instruction will be consistent to the maximum extent possible with Secretary of Homeland Security Publications. . . . As such, plans for response to a terrorist incident must be incorporated into and synchronized with incident response plans prepared in accordance with [a January 2009 DOD instruction on the Installation Emergency Management Program] to ensure continued application of AT measures throughout the incident.

c. Commanders and DOD civilian managers have the authority to enforce appropriate measures to ensure the protection of DOD elements and personnel subject to their control while pursuing mission accomplishment, and shall ensure the AT awareness and readiness of all DOD elements and personnel assigned or attached.

d. Geographic Combatant Commanders have tactical control (TACON) for force protection (FP) over all DOD personnel within their geographic areas of responsibility (AORs) as directed in Secretary of Defense Memorandum ["DOD Force Protection Responsibilities"], with the exception of DOD personnel for whom the chiefs of U.S. diplomatic missions (COMs) have security responsibility as described in [agreements with the State Department regarding the security of DOD personnel at U.S. embassies abroad].

e. The Combatant Commander Initiative Fund (CCIF) or the Combating Terrorism Readiness Initiative Fund (CbT-RIF), if funded, will be maintained as a flexible means to respond to emergent and emergency AT requirements. . . .

f. The standardized DOD methodology described in [a February 2004 "Antiterrorism Handbook"] shall be used to determine the terrorist threat to DOD personnel, facilities, and interests and to establish terrorism threat levels (TTLs).

g. DOD Components shall implement Force Protection Condition (FPCON) measures as outlined in [an October 2006 "antiterrorism standards" instruction memo] in anticipation of or in response to a terrorist threat or attack. Commanders and civilian managers at all levels must continually update risk assessments to ensure all appropriate measures are applied for the mitigation of terrorist threats.

h. DOD elements and personnel shall comply with the theater, country, and special clearance requirements in DoDD 4500.54E and the DoD Foreign Clearance Guide (References (v) and (w)) before traveling outside the United States on official travel.

i. DOD shall assist [the State Department], when feasible and normally on a reimbursable basis, in supporting efforts to protect U.S. citizens abroad in accordance with section 4805 of Reference (l) or other applicable provisions of law. DOD contract provisions shall be developed in accordance with Reference (i) and shall require that contract firms, companies, and entities obtain AOR-specific AT guidance issued by the applicable geographic Combatant Commander, and require compliance by personnel performing DoD contracts outside the United States, consistent with the terms of the contract.

j. DOD will comply with the No-Double-Standard Policy (as described in the Glossary) on the dissemination of terrorist threat information.

Following a speech he gave this morning in Louisville, KY, Defense Secretary Leon Panetta was asked about climate change and its possible effect on national security. Here's what he said, according to a Pentagon transcript:

With regards to climate change, the -- actually, what we developed at the CIA was an intelligence branch of the CIA that focused on that issue actually for intelligence purposes, because of the implications that these changes might have with regards to national security.

For example, when we incur greater droughts, when we incur areas that in fact have less rain and are incurring unusual climate impacts, it creates obviously an impact in terms of the population.  It's something we have to be aware of because that can create chaos.  We've seen that happen in Africa.  We've seen that happen in other parts of the world.  So we need to have that kind of intelligence.

In addition, because of the ice melt, there are indications of a rising ocean.  We've already seen that take place.  And there our concern is how will that impact on ports, how will that impact on facilities, how will that impact on low line levels that could be impacted by that?  So we continue to try to get intelligence on that as well.

In addition, obviously, we do look at the polar ice cap and are able through imagery to determine what's happening with polar ice cap and just how quickly is it melting and what that impact will be.  I can tell you.  As the polar ice cap melts, the national security implications are that countries like Russia and others are going to be looking for the opportunity to go into those areas and try to go after the resources in the Arctic.  They've already made claims to that effect.

So clearly as it melts, as those opportunities increase, then there are countries that are going to assert themselves, try to gain access to the resources that are there.  That also constitutes an issue that relates to national security.

So from an intelligence point of view, it's important for us to keep track of those trends.  You know, this isn't about the battle of climate change and the issues related to that.  This is about what we are seeing happen and the intelligence that flows from that.  And that is important for us to consider as we look at issues that can threaten America's national security.

A Defense Science Board report published last November said that the Pentagon must better prepare for conflict and humanitarian disasters triggered by climate change by adopting a raft of alterations to its organization, policy, force structure, facilities, training, security assistance and coordination with other agencies. As InsideDefense.com reported:

The DSB's "Task Force on Trends and Implications of Climate Change for National and International Security" calls on the Pentagon to develop a "strong climate information system database" to predict where weather patterns are likely to cause instability, according to an October report, released this week. The report focuses on the potential for climate change-related crises to affect African nations.

"Climate change will only grow in concern for the United States and its security interests," Paul Kaminski, chairman of the Defense Science Board, writes in an Oct. 4 memo forwarding the task force's recommendations to the Pentagon's acquisition executive. "This report offers guidance to the Department of Defense on how to become a leader in mitigating and adapting to its growing effects."

The task force was directed last year by Ashton Carter, then the Pentagon's top acquisition official, to conduct a sweeping assessment of the trends and implications of climate change for national and international security. Carter has since been named deputy defense secretary.

The Defense Department, according to the task force, "can play an important role by providing climate change data and warning" as well as assisting foreign militaries in understanding how dramatic weather events could impact their force structure, facilities and overall security situation.

"Climate change is likely to have the greatest impact on security through its indirect effects on conflict and vulnerability," states the report. "Climate change is more likely to be an exacerbating factor for failure to meet basic human needs and for social conflict, rather than the root cause."

The commander of U.S. Pacific Command testified this morning before the House Armed Services Committee. In his prepared testimony, Navy Adm. Robert Willard stated that U.S.-China military-to-military relations "continue to lag well behind" other bilateral engagements for three main reasons:

Differences in philosophy regarding the purpose of military-to-military relations in which China emphasizes strategic dialogue and the U.S. seeks comprehensive military contact from the strategic to tactical levels as a way to build confidence; China's tendency to suspend military-to-military [interactions] following U.S. arms sales to Taiwan and, more generally, its linkage between certain U.S. defense policies and continuous bilateral military relations; and inherent Chinese distrust of U.S. regional intentions resulting in demands that perceived impediments to the relationship be conceded before military relations can advance.

Last month, the Defense Department welcomed a new statement from the Chinese defense ministry about the potential for improved bilateral military ties. Geng Yansheng, a spokesman for China's defense ministry, was quoted Feb. 23 touting Chinese Vice President Xi Jinping's recent official visit to the United States. Xi is slated to be China's next president. As we reported:

"This visit was of great significance to guiding the development of relations between the two countries and the two militaries," Geng said, as China's official Xinhau news agency reported. Further, the Chinese spokesman underscored the potential for improved ties with the Pentagon. "We are ready to work with the U.S. side, by observing the principles of mutual respect, trust, equality and mutual benefits, to respect and take care of each other's core interests and major concerns, properly handle differences and controversial issues, cultivate strategic mutual trust and push forward China-U.S. military links in a healthy and stable way," Geng said.

"We welcome the Chinese announcement that they are ready to advance military ties with the United States," Little said today. "We believe that a reliable, stable and healthy military relationship between the two countries is one of several means to enhance the bilateral relationship, work toward common goals and candidly address our differences."