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14 Jul 10. Captains of industry, military top brass and government ministers will this weekend gather for the biennial jamboree that is the UK’s Farnborough air show. This year, however, one big name is missing from the usual line-up of executives: Robert Stevens, chief executive of Lockheed Martin. The world’s biggest defence company is sending about half as many people as usual to the show in recognition of what Mr Stevens has described as “a new reality” facing contractors. That reality is one of sluggish economies, tighter defence budgets and governments demanding more value for money. In the US, the world’s biggest single defence market, the Pentagon is looking for $100bn of savings from personnel and procurement over the next five years. In the UK, Europe’s largest market, the government is in the midst of a review that is examining cuts to its capital budget of up to 20 per cent. Companies have already seen lucrative equipment programmes cut: last year Robert Gates, US defence secretary, cancelled 30 programmes. Investors have responded,
selling their shares and sending company valuations down.
“It is obvious the defence budget has plateaued,” said Heidi Wood, aerospace and defence analyst at Morgan Stanley in New York. “The consensus on Wall Street is that defence won’t provide attractive returns. However, while defence valuations have fallen and the plateauing has been priced in, the question is, is it a value trap? The industry group as a whole is cheap but could it get cheaper – there is no obvious catalyst for an upturn.”
The history of the defence industry’s attempts to diversify has not been a happy one, writes Jeremy Lemer. In the 1990s, which saw the last major downturn in government defence spending, many companies tried it and few succeeded. Examples include Lockheed’s attempt to move into commercial telecoms in the late 1990s when it bought Comsat for $2.6bn. In late 2001, Lockheed took a $1.7bn writedown charge and eventually sold off the company in pieces. Newport News, the builder of aircraft carriers now owned by Northrop Grumman, hit problems with commercial tankers. In 1995 the company decided to construct a line of double-hulled tankers in order to reduce its dependence on Navy contracts. Hobbled by higher-than-expected costs and weak demand for new tankers, by 1999 a run of 10 ships had been cut to six and the company had racked up losses of more than $300m.
“Somebody asked me, ‘Would you do it over?’” William Fricks, chief executive of the company said at the time. “And I said ‘no’.” Newport eventually spun off the unit.
Such episodes led Norm Augustine, a former chief executive of Lockheed and under secretary of the army, to note that the “industry’s record of diversification is unblemished by success”.
Executives insist that things have been worse, noting that today’s downturn is different from the 1990s when defence spending dropped sharply after the cold war ended. This time round, argues Mark Newman, chief executive of DRS Technologies, a defence electronics company owned by Italy’s Finmeccanica, global security threats remain and the military has a pressing need to replace worn-out kit.
“The Department of Defense’s first focus is in managing overheads as opposed to cutting programmes indiscriminately. First, they are trying to become more austere within the department and second they have gone to industry and asked them to become more competitive,” he said.
Contractors, however, know they need to adjust. Operationally, most have reduced workforces. Northrop Grumman, the US Navy’s largest shipbuilder, this week announced it is consolidating its Gulf Coast facilities and exploring strategic alternatives for its shipbuilding business.
“The consolidation will reduce future costs, increase efficiency, and address shipbuilding overcapacity,” said Wes Bush, Northrop chief executive.
In terms of new business, contractors are focusing on winning exports to emerging markets with rising sp

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