U.S. weapons makers prepare for decade-long downturn

FARNBOROUGH, England Tue Jul 10, 2012 4:25pm EDT

FARNBOROUGH, England (Reuters) - U.S. defense companies are trying to get creative as they gird for a decade of flat or declining military spending in Europe and the United States, eyeing more cooperation across borders, joint ventures, foreign sales and adjacent markets.

Dennis Muilenburg, president and chief executive of Boeing Co's defense division, said his company is trying to preserve current spending on research and development - and possibly increase it - by cutting jobs and closing facilities as it seeks to slash overhead costs by $2 billion to $3 billion.

He said the defense division had already cut 8,000 jobs and reduced its facilities by 10 percent. More cuts were likely in the future, he added, even if Congress manages to avert $500 billion in defense cuts that are due to begin in January, on top of $487 billion in cuts already on the books.

"We're anticipating that the defense budget downturn in both the United States and Europe is a longer-term downturn, so we expect that to be a relatively flat market for us over the next decade," Muilenburg told Reuters Insider in an interview.

Muilenburg said the defense industry was working more closely than ever with the Pentagon to drive down costs and ensure that weapons programs stayed on budget and schedule.

"We all together need to drive affordability," he told Reuters in a separate interview at the Farnborough International Air Show. "Every action that we can take on affordability ... also creates the capacity to grow for the future,"

Boeing, Lockheed Martin Corp, and other arms makers say uncertainty about the U.S. defense budget outlook is clearly dampening investment, hiring, and even merger & acquisition activities.

"There's probably more damage in the uncertainty than in the actual cuts happening," Scott Donnelly, chief executive of Textron Inc., told Reuters in an interview, adding that he did not expect a recovery in the European economy in 2013.

He said the additional cuts mandated by the Budget Control Act of 2011 were ultimately unlikely to occur, adding, "At some point, something will happen, a grand bargain on deficit reduction. I wish they'd get on with it."

FROM DEFENSE TO SECURITY

In the meantime, arms makers are looking to increased international sales and growth in areas such as unmanned vehicles, cybersecurity and even energy security, in Lockheed's case, to offset sustained pressure on U.S. and European budgets.

Cost-cutting will stay on the agenda, even if the next round of automatic cuts can be avoided, executives say, noting that is clear that the industry is heading into a sustained period of slower growth after more than a decade of sharp gains.

"We definitely see that we're not going to be on the same trajectory," Marillyn Hewson, who will take over as president and chief operating officer of Lockheed in January, told Reuters at the air show, although she added that the world was unpredictable and some dramatic event could reshuffle the deck.

Hewson said Lockheed will continue to invest in unmanned systems and cybersecurity, as well as technology advances aimed at keeping the Pentagon's current warplanes, battleships and other weapons running longer and more capably.

At the same time, she said Lockheed would continue to review possible workforce reductions on a regular basis, and would keep all options on the table, especially if the additional budget cuts were not averted.

Donnelly, echoing similar remarks earlier this week by Raytheon Co Chief Executive William Swanson, cautioned against overly pessimistic views on the weapons industry.

"Defense spending is going down ... But this is still a very large defense budget, and the needs aren't going away," he said.

Stefan Ohl, an analyst with Alix Partners in Munich, said arms makers needed to find new markets such as homeland security for products they already made.

"The trick is to make those systems transferable to other areas in order to benefit from effects of scale," he said.

General Dynamics Corp, which builds warships and tanks for the U.S. military, and EADS, Europe's largest defense company, did just that on Tuesday.

The two companies said they were forming a "long-term partnership" to compete for a big U.S. border security contract, a teaming agreement first reported by Reuters earlier this year.

SELLING TIME ON THE C-17

Partnerships and joint procurement programs will be a hallmark of future trans-Atlantic defense ties, said Michael Ryan, an official with the Pentagon's European Command, who came to the air show to meet with industry executives and cultivate more cooperative efforts.

He said NATO was evaluating its procurement needs under a new "smart defense" policy aimed at encouraging more cooperative projects, such as one that allowed 12 countries to buy hours of use on the C-17 transport plane built by Boeing, rather than each country buying its own big plane.

"When you talk about high-end capabilities, it's very difficult for any nation to afford on their own," Ryan told Reuters in an interview in the cockpit of an Air Force C-17.

He said NATO members had realized that transport, refueling and surveillance were all areas of high demand that could benefit from collaborative approaches and joint procurements.

"Collectively, we all get it now," he said, "that this is the way to do business." (Additional reporting by Paul Ingrassia and Victoria Bryan; Editing by Jan Paschal)

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