WASHINGTON — The Department of Defense needs better tools to analyze and react to trends in the defense industrial base and to be more agile in its approach to innovation, a top Pentagon official said Monday.
These considerations come into play both in the DoD’s response to consolidation spurred by mergers and acquisitions within the defense industrial base, and to how the Pentagon develops and incorporates technological innovation from the commercial sector, said Andre Gudger, acting dDeputy aAssistant sSecretary of dDefense for mManufacturing and iIndustrial bBase pPolicy.
"We have to have a very dynamic market with very dynamic rules that continue to evolve as fast as the technology evolves," he said. "Right now we just don't have those tools available to us under the law to go and do that and view transactions on a broader basis."
Gudger’s remarks came during a panel discussion on consolidation in the defense industrial base, as part of the Center for Strategic and International Studies’ Global Security Forum in Washington.
He noted While noting that the DoD can’t single-handedly shape the industrial base, it but can create policies that incentivize contractors to incorporate and provide innovation faster to its their DoD customer, he said.
"We have to put tools in place that allow for competition and competitive forces," he said, noting that he has open-ended discussions with both company executives and members of the appropriate congressional committees on Capitol Hill.
Denis Bovin, a senior adviser at Evercore Partners, noted said that in many ways, the DoD’s goals for the industrial base are not closely aligned with the base’s own goals.
The DoD wants great products, innovation and advanced technologies, all at low costs, he said, while the companies’ a company's main goal is to satisfy its shareholders. In general, the base is healthy, with many companies’ stocks trading at or near 52-week highs, he said, but the combined size and value of defense firms is smaller than Apple, Google or ExxonMobile individually.
For example, Google has $65 billion in cash on its balance sheet, which is roughly the value of Lockheed Martin’s entire business, Bovin he said.
"Profit margins and return on assets in the defense industrial base are much, much less than they are in lots of other industries. The market generally believes that the defense industrial base is largely composed of companies that are mature, low-growth and cyclical," he said. "They are viewed as selling a tiny volume of products to a unique and frankly somewhat difficult customer. That’s not a very attractive."
Consequently, defense companies are using dividends and share buybacks to appease investors, Bovin said.
Defense firms are re-orienting to include more commercial business, he said. As examples, he cited Raytheon’s acquisition of cyber firm WebSense and Lockheed Martin’s decision to divest its government IT business while acquiring Sikorsky Aircraft, which has both government and commercial sales.
"I predict you will see more of those kind of things happen," Bovin said.
William Lynn, former dDeputy sSecretary of dDefense and CEO of Finmeccanica North America and DRS Technologies, said noted that much of the recent consolidation that has happened recently has been among platform makers, while electronics, communications and cyber businesses have not undergone similar compression.
The DoD used to be a net exporter of innovation but now needs to reduce the barriers between commercially developed innovation and the Pentagon, he said.
"DoD needs to pull commercial developments inside the defense industrial base and operationalize those for security needs," Lynn said. "The challenge for DoD is how do you do that."
Additionally, the Pentagon needs to move beyond its Cold War supply structure and its underlying bias against foreign products, which could cost the US access to top technology, he said.
"Gone are the days when DoD could rely on homegrown products to equip our forces," Lynn said.
Defense News Editor Vago Muradian, who served as a panelist, noted that M&A merger and acquisition activity in 2015 is expected to approach $60 billion, roughly twice the total for 1999.
ThatThis goes against "this notion that we’re waiting for the M&A wave to arrive. The wave has already arrived," he said.
Email: aclevenger@defensenews.com.
Twitter: @andclev
