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INSIGHT
Northrop tanker exit spells good news for Boeing
Boeing Co is poised to win a sole-source U.S. contract for aerial tankers that could provide a much-needed boost for the company, but the impact is less certain on Northrop Grumman Corp, which dropped out of the race.
Northrop walked on Monday from one of the few new U.S. defense contracts expected in coming years.
It made good on its threat to abandon a contest it said was skewed against it, surprising top Pentagon officials, supporters in Congress and some industry analysts, who believed Northrop's statements had been a tough negotiating ploy.
One senior Air Force general, upon learning Northrop would not bid, said, "You're kidding. Why not?"
Others said tankers were never core to Northrop's business and the decision underscored new Chief Executive Wes Bush's determination to boost performance and profits in more vital areas such as space, electronics and data services.
"Northrop isn't looking to greatly increase its revenues, it's looking to increase its sustained profits in core business areas," said Loren Thompson, analyst with the Virginia-based Lexington Institute.
Northrop Chief Financial Officer Jim Palmer, speaking at a J.P. Morgan investor conference on Tuesday, reiterated the company's 2010 earnings forecast, but Northrop shares closed 16 cents lower at US$64 on the New York Stock Exchange.
Boeing shares rose 55 cents, or 0.8 percent, to US$67.79.
NEEDED BOOST FOR BOEING
Unless things change dramatically, Boeing is now set to win a sole-source contract this summer to build up to 179 refueling planes for the Air Force and will be in a good position to bid for big follow-on orders in later years.
The deal will give Boeing two decades of orders for its 767 plane that was nearing the end of production, ensuring US$3 billion a year in steady revenues at a time when the Pentagon is once again trying to kill orders for Boeing's C-17 transport plane.
Rob Stallard, defense analyst with Macquarie Securities said it looked like Boeing had "round one sown up," but said there was still a chance for Northrop and its European partner EADS to sell the Air Force larger tankers in the future when it begins to replace its Boeing KC-10s.
That could provide some hope for EADS officials, who pushed Northrop until the very end to stay in the competition.
Airbus Chief Executive Tom Enders and group finance chief Hans Peter Ring held meetings in Washington last Friday to plot strategy in the event that Northrop could not be convinced.
EADS officials agonized over whether to mount a solo bid without Northrop's lobbying skills and Pentagon access, or find a new partner, but decided there simply was not time.
"We wanted to do it, but in the end we could not," a source familiar with the company's decision-making process said.
Thompson said Boeing's biggest gain was not the "tremendous amount of revenues" it could now expect from the 767, but that it had kept Airbus from establishing a production line in the United States -- at least for the time being.
"The best thing about this situation for Boeing is that it precludes the company's biggest rival Airbus from establishing a commercial beachhead in North America," he said.
PASSING UP OPPORTUNITY
"Boeing needs the tanker far more than Northrop does. The end of the C-17 would leave a large gap in Boeing's defense revenues that the tanker can fill," Macquarie's Stallard said.
In addition to facing a halt to U.S. orders for its C-17, Boeing was also hit harder than most by the Pentagon's cancellation of weapons programs over the past two years. It lost work on missile defense programs, watched its US$160 billion Future Combat Systems modernization program shrivel, and was beat out on several big contracts by rival bidders.
Yet Boeing, already under pressure to offer the government a rock-bottom price for tankers, will face additional hurdles as a sole-source provider, including the need to certify the accuracy, timeliness and completeness of its pricing data.
That could limit profits on the tanker program in future years, especially relative to the high profits of 22 percent to 25 percent it generates on the C-17 transport planes, said Jim McAleese, a Virginia-based defense consultant.
But the "shortfall in profits" will be more than compensated by the logistics and maintenance work generally expected for major aircraft programs, he said. "This is a decision that has huge upside for Boeing."
McAleese said some investors were questioning why Northrop would pass up the chance to bid for what he called "the opportunity of a lifetime," especially when there were few new programs on the horizon, except a new Air Force bomber.
Wall Street already traded Northrop at a discount of 10 to 15 percent relative to other defense companies, and this week's developments provided little incentive for change, he said.
Northrop's shipbuilding program faced performance problems, and the company recently lost a ground control contract for the Global Positioning System satellites to Raytheon Co.
But Thompson said Northrop was doing well in other sectors, including classified programs, and had opportunities in coming years to bid for work on a new submarine, an alternative Army modernization program and a long-range bomber.
"Wes Bush is trying to change the culture of his company to emphasize sustained profits rather than mere size and that means he has to take a disciplined approach to new opportunities," he said. "The tanker was not really at the core of what they do."
He said Northrop concluded the Air Force's final terms were not only skewed to favor Boeing, but even if Northrop had managed to win, the long-term fixed price nature of the contract would have capped possible profits.
--- Andrea Shalal-Esa, Reuters
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