Street View

Two analysts with Oppenheimer's Equity Research department weigh in on Northrop Grumman's decision not to bid on the tanker competition:

Northrop Grumman decided not to pursue the US Air Force's large aerial refueling contract, which they had won during the last competition. However, that was then and this is now and a new CEO at NOC is facing a different leadership team at the Pentagon, a different RFP (request for proposal) and contract structure. In the end, we think the decision came down to economics that left NOC with the choice to submit a token bid in the name of competition or try to compete on price with a more expensive (but more capable) aircraft, and potentially, end up with a fixed price contract that could dramatically increase the risk profile of NOC's future earnings/cash flows.

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Listening to NOC management over the past few months, and seeing the changes in leadership and incentives, we weren't entirely surprised by the move not to bid. This contract has always been a must-win for Boeing and nice-to-have for NOC. The change to fixed price (vs. prior cost-plus) further softened the risk/reward for NOC.

We expect the DoD/AF will now enter into sole-source discussions with BA over a desirable tanker. Under those discussions, we do expect the DoD to obtain better pricing, cost discovery data, which will likely get over the hurdle of a blown competition in the end.

Other alternatives include: Congress demands loosening the RFP to balance the field, the DoD deciding to GFE (government furnished equipment) commercial 767s from Boeing and compete the integration (after clearly favoring the size/performance of the 767), or a very outside chance for EADS to take a shot at the contract on their own.

We're sure that some in Washington will both cheer and jeer at the decision; however, we're of the mind that the company made its goals clear in advance (even in laying out the incentives by which they are governing themselves), stated opposition early, fully evaluated the risk/reward and got to, what we'd agree is the right answer, "No."