Advice to Defense Contractors: Rethink Assumptions, Prepare for Downturn

By Sandra I. Erwin

The Pentagon’s budget so far remains safe from draconian cuts. But the rampant growth of the past decade officially is coming to an end with the release of the 2012 budget next week.
The Pentagon currently spends about $400 billion a year on goods and services, but those funds will shrink over time, analysts predict. Facing soaring personnel and health care costs, the Pentagon increasingly will be dipping into its procurement, services and modernization accounts to cover the payroll. As the pie shrinks, there will not be enough money to keep every company in business, warnedStanley Collender, managing director of Qorvis Communications.
One of Collender’s new clients is an investment bank startup — Blue Stone Capital Partners — that is predicting a wave of mergers and acquisitions in the government-contracting sector, particularly defense.
“We see a shakeout,” Collender said Feb. 10 at a news conference hosted by the Center for Strategic and Budgetary Assessments, in Washington, D.C.
“This is the right time to start an investment bank,” he said. Many firms are looking for buyers as they seek to maximize value for shareholders before company valuations drop. Others are exploring ways to diversify into commercial markets, he said. “In the contractor community, they’re not running scared but they are significantly reevaluating business prospects.”
Wall Street so far has remained skeptical about the prospect of defense budget cuts, which has kept defense industry stock prices high. That state of affairs may not last, Collender said.
Also complicating the outlook for industry is the political drama unfolding in Washington, where Tea Party lawmakers are threatening to force a government shutdown if a fiscal year 2011 budget is not signed by March 4. The government is currently operating under a continuing resolution that allows agencies to keep functioning at the 2010 budget levels.
Fears of possible shutdowns and the general state of gridlock that is paralyzing decision-making will “make it tough for contractors,” Collender said. Some firms already are laying off employees, in preparation for the financial chaos that will ensue if the budget standoff is not solved soon. “There is a better than a 50-50 chance that we’ll have a shutdown,” Collender said.
Uncertainty is the order of the day, he noted. “Industry will be in a continual ‘what do we do now?’ mode,” Collender said. “I wouldn’t be surprised if there are layoffs or furloughs.”
Even if the immediate budget crisis is resolved, he added, “I’m expecting 2012 to begin a shakeout in the aerospace sector. I’m expecting a lot more activity in mergers and acquisitions. … Profit opportunities may not last. Expect corporate restructuring to continue.” Smaller companies, particularly, may want to cash out now.
The Pentagon's senior acquisition executive, Undersecretary Ashton B. Carter,acknowledged this week that he expects the industry to consolidate. He said the Defense Department would not oppose corporate mergers or takeovers, as long as they don't involve the top six prime contractors.

Topics: Defense Contracting

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