A Sink-or-Swim Moment for Combat Vehicles Industry

In less than a decade, BAE Systems went from niche player to major powerhouse in the ground armaments industry. A series of multibillion-dollar corporate acquisitions — Alvis Vickers in 2004, United Defense in 2005 and Armor Holdings in 2007 — turned BAE into the world's largest manufacturer of combat vehicles and ground war systems.

Now the company faces a dramatic downturn that could end up being steeper than the historic down cycles of the defense business. Combat and tactical vehicle production has quickly gone from boom to bust after the end of two wars and massive budget cuts that will hit the Army harder than the other branches of the U.S. military.

BAE Systems Land & Armaments is positioned to weather the budget storm, as long as it wins new contracts over the coming years andavoids the shutdown of its Bradley Fighting Vehicle assembly line in York, Penn., says Loren Thompson, industry consultant and chief operating officer of the Lexington Institute.

For companies that depend heavily on combat vehicle work, such as BAE Systems and General Dynamics Land Systems, there is light at the end of the tunnel. But it could be a very long tunnel, Thompson says. “There's future, but there's a near-term gap of four to five years when demand is so low that it's hard to preserve the skills.”

Winning a production contract for the Army’s new infantry combat vehicle that would replace the Bradley could turn BAE’s ground-systems fortunes around. But the program is on shaky ground.

Senate appropriators slashed its funding for fiscal year 2014 as they objected to the Army’s request to spend $480 million on 12 prototypes. Army officials, meanwhile, have hinted the program could be delayed by several years if sequestration continues in 2014.

“Without that program, the outlook for heavy armor production is pretty bleak,” Thompson says.

BAE’s land business today has less tolerance for setbacks than it did in 2009, when it lost two major contracts: a $1 billion deal to produce 2,200 armored trucks for the Marine Corps and an Army competition to build 23,000 medium trucks. In the latter program, BAE had been the incumbent since it acquired Armor Holdings.

Besides competing for the Army’s new infantry combat vehicle, BAE will be going up against GDLS for a contract to build the Army’s armored multi-purpose vehicle that would replace nearly 3,000 aging M113 infantry carriers. Army leaders have said they intend to support the program, but also have warned about the possible impact of sequestration.

In this uncertain climate, investors are shunning the combat vehicles sector, says Thompson. Even if BAE wanted to sell Land & Armaments, it would command too low a price to satisfy corporate shareholders, he says.

“As the business outlook for combat vehicles has softened, BAE Systems is not likely to get a price for Land & Armaments that matches its long-term value,” says Thompson. “Combat vehicles are looked upon unfavorably by investors. … It is not a good time to be selling.”

In a recentForbes.com article, Thompson notes that the BAE Systems has been scoring wins in other sectors of the defense business. The company’s Support Solutions unit, he writes, has “become a buffer against the possibility of declining sales in the company’s military-hardware business, increasing revenues at a time when demand for combat systems is expected to soften.”

It is possible for Land & Armaments to turn things around over the next 10 years, says Thompson, particularly if BAE can capture a share of the Marine Corps’ new amphibious vehicle work. “The Marines are determined to get a new amphibious combat vehicle,” he says. Commandant Gen. James Amos has said he is committed, and “will throw JLTV [the joint light tactical vehicle] and everything else overboard in order to have the amphibious combat vehicle,” Thompson says. Again, the program schedule could be problematic for a company that needs work now. The ACV would not go into full-rate production until 2022.

BAE’s best hope in the immediate future lies with Congress, where Pennsylvania lawmakers are fighting to keep Pentagon funds flowing to the Bradley facility in York, despite an increasingly anti-spending mood on Capitol Hill.

Sens. Pat Toomey, R-Penn., and Bob Casey, D-Penn., recently wrote a letter to Army Secretary John McHugh asking for the service to maintain funding for Bradley Fighting Vehicle manufacturing.

The Army’s 2014 request includes $288 million for Bradley modernization. But the Army’s plan is to stop the work between 2015 and 2018. The senators want to reverse that decision. "Halting the modernization of the Bradley Fighting Vehicle could adversely affect the industrial base,” the letter says.

The stakes could not be higher for BAE, says Thompson. If the Bradley plant is shut down for three years, it would lead to its demise, he says. During a recent visit, Thompson noticed that some of the workstations at the facility already are idle. “There isn't enough workload to keep employees engaged. The workforce is about half of what it was five years ago.” If the work at York slips much further, he says, it will be difficult to maintain the skills to build a ground combat vehicle or an amphibious combat vehicle.

BAE cannot afford to keep the plant going on its own dime if the Army cuts off funding, says Thompson. He notes that BAE pays the highest dividend in the defense industry and a money-losing operation would be hard to absorb.

BAE executives have been pleading the case that is often made in these situations: It would be more costly to the government to shut down and reopen the line three years later than it would be to keep it open, even with a reduced workload. Army officials defend their decision as a necessary move to cut costs in the face of declining budgets. They also contend that closing down the BAE plant temporarily should not cause any risk to the force, as the Army owns a large fleet of more than 3,000 Bradleys, most of which have low mileage and have been updated with new weapons and electronics.

BAE officials estimate it would cost the Army $750 million to shut down and restart the Bradley production line in 2017.

BAE declined to comment on any hypothetical scenarios regarding the future of Land & Armaments. Company spokeswoman Stephanie Serkhoshian said BAE continues to “evaluate and pursue opportunities that further our corporate strategy. With that in mind, we constantly assess evolving customer and program requirements, available resources and the market environment."

Topics: Armaments, Business Trends, Combat Vehicles, Defense Contracting