Diversification is Key to Defense Contractors Maintaining Revenue as Raytheon Illustrates

The U.S. defense market has been dominated by five major companies since the late Nineties. Boeing (BA), Lockheed Martin (LMT), Raytheon (RTN), General Dynamics (GD), and Northrop Grumman (NOC) emerged from the large scale mergers and acquisitions as the “Peace Dividend” caused contraction in the defense budget and the U.S. industrial base at the same time. In 2009 these five companies had total revenue of almost $40 billion to the U.S. defense establishment.

One of the advantages that these companies have over other defense contractors is that they offered diversified products. These include non-military aerospace systems such as Boeing’s civil airliners or GD’s Gulfstream Aerospace as well as other government customers such as the Department of Homeland Security or Health and Human Services or in Northrop’s case the Commonwealth of Virginia.

This means that in times of decreased government spending on defense or other items they can use their commercial product lines to balance out those declines in revenue in earnings. They also can by spreading their defense products into R&D, hardware and services also achieve the same effect. Raytheon is a recent example of this.

Their recent earnings report was down partly due to the cancellation of an IT contract by the United Kingdom’s government. This required the company to take a charge against the cancellation. One would think that this might make the British government take a harsher look at further dealings with Raytheon due to their failure on that contract. Raytheon though does have an advantage in that they have an installed base of equipment and systems throughout the British military that need support.

This meant that a few days ago the company received a contract worth almost $140 million to support self defense gun systems mounted on Royal Navy ships. ) The Close–In Weapon System (CIWS) used by the U.S. Navy and many allies features a 20mm Gatling gun with on-mount radar and tracking systems that allows it to detect, track and engage missiles and aircraft. Raytheon will upgrade the system for improved capability and also to make it similar to the ones being used now by the U.S.

So at the same time that the U.K. government is cancelling a contract and trying to resolve the financial impact of that with the Massachusetts’ based company they are also buying further services and hardware from it. This disconnect is caused by the fact that Raytheon makes the CIWS and the government must deal with them on maintenance, repair and other work. Raytheon by having a broad base of products and services is able to keep customers and continue to generate revenue and earnings.

This means that defense contractors are able to ride out periods of decline in spending or issues with one or another contract and while there may not be that growth that some analysts like there will be steady revenue and in some cases dividends as their stock prices hold their value.

Photo from surfaceforce’s flickr photostream.

Article first published as Raytheon Illustrates Diversification is Key in Defense Contracting Maintaining Revenue on Technorati.

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