HOLLYWOOD
02-15-2011, 06:39 AM
Middle east to buy $100 Billion more in Military Weaponry
America's hottest export: Weapons
http://money.cnn.com/2011/02/10/news/international/america_exports_weapons_full.fortune/index.htm
FORTUNE -- This time last year, Boeing's F-15 production line, which is housed in a beige, dreary building on the outskirts of Lambert-St. Louis International Airport, was on the verge of shutting down. The F-15 is an old jet, first designed in the 1970s to outmaneuver Soviet MiGs. It has long been surpassed by more advanced rivals, and the U.S. military hasn't bought a new one since 2001. When production slowed to a trickle a few years ago, a pair of orders from Korea and Singapore kept the line alive, barely, and it has been churning out about one F-15 a month since then. Local politicians fretted that Boeing would have to close the production line, eliminating hundreds of jobs and delivering a blow to the struggling regional economy.
Then, last summer, rumors surfaced about a deal -- a big one. The workers at the plant followed the news online, where defense publications reported on the details of the sale. The would-be buyer, they learned, was Saudi Arabia, and the proposed order was massive -- 84 planes, as well as upgrades to older jets. In October the Department of Defense, which administers sales to foreign countries, finally announced an arms package worth some $60 billion, including 70 Apache attack helicopters, also made by Boeing (BA (http://money.cnn.com/quote/quote.html?symb=BA&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/59.html?source=story_f500_link)), and the fleet of F-15s.
It was the biggest overseas arms sale in recent memory, and it extended the life of the production line through 2018. The F-15 may live even longer -- a Boeing executive says there are two other overseas buyers waiting in the wings. Dale Lauer, a 52-year-old flight mechanic, smiled slightly when I asked him what he thought about the news. "People thought this program was dead a long time ago."
Far from it. Thanks to a surge in overseas demand, the F-15 and other aging U.S. weapons systems are hotter than they've been in years. The Department of Defense last year told Congress of plans to sell up to $103 billion in weapons to overseas buyers, a staggering rise from an average of $13 billion a year between 1995 and 2005, according to Deutsche Bank analyst Myles Walton. Signed agreements have tripled since 2000.
As defense giants like Boeing, Raytheon (RTN (http://money.cnn.com/quote/quote.html?symb=RTN&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/342.html?source=story_f500_link)), and Lockheed Martin (LMT (http://money.cnn.com/quote/quote.html?symb=LMT&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/263.html?source=story_f500_link)) increasingly seek to peddle their wares to well-financed (sometimes by the U.S.) international customers, they have a surprising ally: the President. "Obama is much more favorably disposed to arms exports than any of the previous Democratic administrations," says Loren Thompson, a veteran defense consultant. Or, as Jeff Abramson, deputy director of the Arms Control Association, puts it: "There's an Obama arms bazaar going on."
Administration officials say the boom in arms exports is simply the result of healthy demand. Indeed, American-made arms are widely considered the best and most coveted weapons in the world. But the Obama team has hustled to pave the way for big sales like the Saudi deal; the President himself recently sought to secure a pending $4 billion aircraft deal with India. Obama is also backing a massive push to rewrite the rules that govern arms exports, a process that some say will reduce oversight of U.S. weapons sales.
For the administration, robust international arms sales advance domestic goals, like bolstering exports and supporting a defense workforce of more than 200,000. Weapons transfers are also a subtle yet potent form of diplomacy: By arming its allies, the U.S. can spread the burden of policing hot spots (the Middle East, the Korean peninsula). And arms exports give Obama's State and Defense departments tremendous negotiating clout with buyers.
But critics contend that supplying some nations with advanced weaponry is a risky strategy, especially as the Middle East, which is teeming with American-made arms, crackles with the sparks of regime change. While the U.S. sells weapons only to its allies, power can shift quickly -- just look at Tunisia and Egypt. Even Saudi Arabia, with its 86-year-old monarch, could see a change in leadership. When friends become foes, arms exports become a liability. The government sold dozens of F-14 fighter jets to Iran in the 1970s before the Shah was deposed. Since then the U.S. has systematically destroyed F-14 parts to keep them out of Iran's hands.
Weapons proliferation watchdogs expected the volume of exports to decline when Obama became President; instead the reverse has happened. Thompson pins the surge in large part on the recession. Production lines for Boeing's F-15, Harpoon missile, and Apache helicopter are sustained by exports, which support thousands of high-paying, highly skilled manufacturing jobs.
But Thompson also believes that the President has other motives for supporting foreign arms sales. "It's about U.S. alliances, it's about maintaining jobs, and it's about America's broader role in the world -- and what you have to do to maintain that role."
'The spigot is starting to close'
Defense contractors like Boeing are notorious for spreading their manufacturing outlets across the country to curry political favor; the Chicago-based company has facilities in more than 20 states, supported by mom-and-pop subcontractors in dozens of districts. But its heart beats in Arlington, Va., which is where it gets its lifeblood -- government spending. There, executives in crisp suits walk alongside uniformed servicemen. Many of those officers will leave the military and walk straight into corporate gigs; Boeing's head of business development for military aircraft, Lt. Gen. Jeffrey Kohler, used to run the Pentagon agency that oversees arms exports.
Although most contractors have their headquarters elsewhere, they all have offices in D.C. for a reason: The industry does 80% to 90% of its business with the Pentagon. And business recently has been good: The U.S. government has more than doubled its defense budget since 2001, to about $700 billion, almost as much as every other country in the world spends combined. In December, Congress agreed to spend $725 billion on defense in 2011.
But while defense spending continues to rise, the mood in Arlington is somber. With two wars coming to an end and a massive federal deficit, it seems inevitable that, as Pentagon comptroller Robert Hale put it, "the spigot is starting to close." Though Secretary of Defense Robert Gates has requested a slight increase in spending over the next few years, defense analysts are skeptical that the budget can go anywhere but down. Walton, the Deutsche Bank analyst, says investors are pricing in a 30% decline in weapons spending over the next decade. "We're at a procurement peak this year," says Richard Aboulafia, an aerospace analyst at the Teal Group. "There's no disguising the fact that it's at best plateauing, and most likely going to soften."
Who's buying what: 8 big arms deals (http://money.cnn.com/galleries/2011/news/international/1102/gallery.new_arms_boom.fortune?iid=EL)
In response, Boeing and its peers are following the same path as the rest of corporate America -- out of the country. Foreign arms sales, once viewed as icing on the cake, are now the focus of the industry's growth strategy. Honeywell (HON (http://money.cnn.com/quote/quote.html?symb=HON&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/11.html?source=story_f500_link)) recently created a new international sales division. (EADS, a European defense conglomerate, plans to establish a headquarters in Asia.) Many companies have set targets for international growth. Lockheed, which currently gets 14% of its revenue from outside the U.S., wants to boost that figure to 20% by 2012, and Boeing's defense division aims to grow international sales to 25% from 17% today.
Compared with multinationals like Nike (NKE (http://money.cnn.com/quote/quote.html?symb=NKE&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/2184.html?source=story_f500_link)) and Procter & Gamble (PG (http://money.cnn.com/quote/quote.html?symb=PG&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/334.html?source=story_f500_link)), both of which derive about 60% of their sales overseas, that's a small percentage. But unlike those companies, defense contractors can't simply trek over to Delhi or Dubai and start knocking on doors. Before arms makers can sell weapons abroad, they must obtain the permission of the State Department. So-called "foreign military sales" are coordinated through the Department of Defense. (The parties usually overstate the value of the goods the companies hope to sell by about 30% to 50% so that they don't have to keep going back to the Hill with new requests; the $103 billion in congressional notifications in 2010 is likely to translate into close to $50 billion to $70 billion in actual sales.)
Until recently, executives say, the defense industry shrugged at globalization. "[During] my first few years here, you could hardly get a senior person to go international," says Tom Culligan, head of Raytheon's international business. "People would say, 'I don't want to give up my weekend to go to Riyadh.'" (The workweek in Saudi Arabia begins on Saturday.)
Raytheon now derives 23% of its sales from other countries, the most of any big contractor. Analysts say that's because it sells affordable gear -- missiles, upgrades, and radar -- as opposed to jets that cost $100 million apiece. Raytheon does sell one large program, the Patriot, a radar-guided firing system that shoots down ballistic missiles. Two years ago, Culligan says, a $3.3 billion order from the United Arab Emirates enabled the company to restart the Patriot production line and add new features like radar digital processors, which, in turn, lure more international customers. The strategy is working: Raytheon's domestic revenue was up just 1% last quarter, according to its CFO, but its international sales grew 11% to 12%.
Tapping the Middle East
The countries with the biggest appetite for U.S. weapons are, conveniently, the same ones that have the money to buy them: oil-rich nations in the Middle East. Nearly 50% of foreign military sales signed between 2006 and 2009 were with Middle Eastern countries, according to the Congressional Research Service. During that time, Saudi Arabia purchased about $13 billion worth of American weapons; the UAE spent $11 billion. Iraq, poised to get rich from its own oil reserves, is a growing customer.
All major defense contractors are profiting from the region, but none more so than Boeing, which was the major beneficiary of the Saudi deal. Mark Kronenberg, Boeing's head of international business development, attributes the buying spree to a natural replacement process, just as in any other business cycle -- mainframe servers and car engines, for example. "The last time we had a period like this in the Middle East was the early '90s," he says. "Here we are, 20 years later, and they're recapitalizing.
There are other, less innocuous reasons: a weakened Iraq, the terrorist threat in Yemen, and most important, the country that defense executives call the Gulf's "dangerous neighbor" -- Iran. "You hear it almost on a daily basis. Iran is flexing its muscles, most of it through offensive capabilities," maintains Abdulkhaleq Abdulla, a political science professor at UAE University. As a result, he says, small countries like the UAE feel pressure to try to keep up with their neighbors.
Though the Obama administration is reluctant to tie the recent Saudi deal directly to Iran -- in a press conference announcing the sale, Assistant Secretary of State Andrew Shapiro dodged questions on the matter -- the connection is obvious, says Gregory Suchan, who headed the State Department's arms transfers program from 2003 through 2007. Suchan, now a consultant, says the F-15 deal was in the works as early as 2006 -- the same year that Iran said it would reject any UN efforts to halt its nuclear program.
It took years of political legwork to execute the transaction. Lobbyists had to sell the idea to Congress, which has the power to stop major defense transfers -- something it has never succeeded in doing. Only a few sales have stirred major controversy, and all were to Saudi Arabia: AWACS sentry planes in 1981, Harpoon missiles in 1986, and Joint Direct Attack Munition (JDAM) bombs in 2007.
There was also the matter of persuading Israel to play ball. For decades the U.S. has promised to ensure Israel's military edge over its neighbors, and while the government doesn't like to admit it, arms deals to other countries tend to coincide with concessions to the Israelis. In 2007, the year in which the JDAM deal was announced, the U.S. boosted its military aid to Israel by about 25% annually, to $3 billion a year. Last October, right before the announcement of the F-15 sale, Israel ordered 20 F-35 planes, Lockheed's top-of-the-line fighter jet. Diplomatic cables released by WikiLeaks dating back to the summer of 2009 describe negotiations surrounding the sale of the F-15s to Saudi Arabia; they were ultimately stripped of long-range weapons systems. When the deal was announced in late October, the pro-Israel lobby barely batted an eye.
Neither did Washington. On Nov. 10, just nine days before the end of the 30-day period in which Congress can issue a resolution to halt an arms sale, a group of House members sent Secretary of State Hillary Clinton and Defense Secretary Gates a list of questions about the sale -- a "relatively soft gesture," laments Abramson. The transaction sailed through without incident.
Interactive graphic: Up in arms (http://money.cnn.com/magazines/fortune/storysupplement/up_in_arms/?iid=EL)
America's hottest export: Weapons
http://money.cnn.com/2011/02/10/news/international/america_exports_weapons_full.fortune/index.htm
FORTUNE -- This time last year, Boeing's F-15 production line, which is housed in a beige, dreary building on the outskirts of Lambert-St. Louis International Airport, was on the verge of shutting down. The F-15 is an old jet, first designed in the 1970s to outmaneuver Soviet MiGs. It has long been surpassed by more advanced rivals, and the U.S. military hasn't bought a new one since 2001. When production slowed to a trickle a few years ago, a pair of orders from Korea and Singapore kept the line alive, barely, and it has been churning out about one F-15 a month since then. Local politicians fretted that Boeing would have to close the production line, eliminating hundreds of jobs and delivering a blow to the struggling regional economy.
Then, last summer, rumors surfaced about a deal -- a big one. The workers at the plant followed the news online, where defense publications reported on the details of the sale. The would-be buyer, they learned, was Saudi Arabia, and the proposed order was massive -- 84 planes, as well as upgrades to older jets. In October the Department of Defense, which administers sales to foreign countries, finally announced an arms package worth some $60 billion, including 70 Apache attack helicopters, also made by Boeing (BA (http://money.cnn.com/quote/quote.html?symb=BA&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/59.html?source=story_f500_link)), and the fleet of F-15s.
It was the biggest overseas arms sale in recent memory, and it extended the life of the production line through 2018. The F-15 may live even longer -- a Boeing executive says there are two other overseas buyers waiting in the wings. Dale Lauer, a 52-year-old flight mechanic, smiled slightly when I asked him what he thought about the news. "People thought this program was dead a long time ago."
Far from it. Thanks to a surge in overseas demand, the F-15 and other aging U.S. weapons systems are hotter than they've been in years. The Department of Defense last year told Congress of plans to sell up to $103 billion in weapons to overseas buyers, a staggering rise from an average of $13 billion a year between 1995 and 2005, according to Deutsche Bank analyst Myles Walton. Signed agreements have tripled since 2000.
As defense giants like Boeing, Raytheon (RTN (http://money.cnn.com/quote/quote.html?symb=RTN&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/342.html?source=story_f500_link)), and Lockheed Martin (LMT (http://money.cnn.com/quote/quote.html?symb=LMT&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/263.html?source=story_f500_link)) increasingly seek to peddle their wares to well-financed (sometimes by the U.S.) international customers, they have a surprising ally: the President. "Obama is much more favorably disposed to arms exports than any of the previous Democratic administrations," says Loren Thompson, a veteran defense consultant. Or, as Jeff Abramson, deputy director of the Arms Control Association, puts it: "There's an Obama arms bazaar going on."
Administration officials say the boom in arms exports is simply the result of healthy demand. Indeed, American-made arms are widely considered the best and most coveted weapons in the world. But the Obama team has hustled to pave the way for big sales like the Saudi deal; the President himself recently sought to secure a pending $4 billion aircraft deal with India. Obama is also backing a massive push to rewrite the rules that govern arms exports, a process that some say will reduce oversight of U.S. weapons sales.
For the administration, robust international arms sales advance domestic goals, like bolstering exports and supporting a defense workforce of more than 200,000. Weapons transfers are also a subtle yet potent form of diplomacy: By arming its allies, the U.S. can spread the burden of policing hot spots (the Middle East, the Korean peninsula). And arms exports give Obama's State and Defense departments tremendous negotiating clout with buyers.
But critics contend that supplying some nations with advanced weaponry is a risky strategy, especially as the Middle East, which is teeming with American-made arms, crackles with the sparks of regime change. While the U.S. sells weapons only to its allies, power can shift quickly -- just look at Tunisia and Egypt. Even Saudi Arabia, with its 86-year-old monarch, could see a change in leadership. When friends become foes, arms exports become a liability. The government sold dozens of F-14 fighter jets to Iran in the 1970s before the Shah was deposed. Since then the U.S. has systematically destroyed F-14 parts to keep them out of Iran's hands.
Weapons proliferation watchdogs expected the volume of exports to decline when Obama became President; instead the reverse has happened. Thompson pins the surge in large part on the recession. Production lines for Boeing's F-15, Harpoon missile, and Apache helicopter are sustained by exports, which support thousands of high-paying, highly skilled manufacturing jobs.
But Thompson also believes that the President has other motives for supporting foreign arms sales. "It's about U.S. alliances, it's about maintaining jobs, and it's about America's broader role in the world -- and what you have to do to maintain that role."
'The spigot is starting to close'
Defense contractors like Boeing are notorious for spreading their manufacturing outlets across the country to curry political favor; the Chicago-based company has facilities in more than 20 states, supported by mom-and-pop subcontractors in dozens of districts. But its heart beats in Arlington, Va., which is where it gets its lifeblood -- government spending. There, executives in crisp suits walk alongside uniformed servicemen. Many of those officers will leave the military and walk straight into corporate gigs; Boeing's head of business development for military aircraft, Lt. Gen. Jeffrey Kohler, used to run the Pentagon agency that oversees arms exports.
Although most contractors have their headquarters elsewhere, they all have offices in D.C. for a reason: The industry does 80% to 90% of its business with the Pentagon. And business recently has been good: The U.S. government has more than doubled its defense budget since 2001, to about $700 billion, almost as much as every other country in the world spends combined. In December, Congress agreed to spend $725 billion on defense in 2011.
But while defense spending continues to rise, the mood in Arlington is somber. With two wars coming to an end and a massive federal deficit, it seems inevitable that, as Pentagon comptroller Robert Hale put it, "the spigot is starting to close." Though Secretary of Defense Robert Gates has requested a slight increase in spending over the next few years, defense analysts are skeptical that the budget can go anywhere but down. Walton, the Deutsche Bank analyst, says investors are pricing in a 30% decline in weapons spending over the next decade. "We're at a procurement peak this year," says Richard Aboulafia, an aerospace analyst at the Teal Group. "There's no disguising the fact that it's at best plateauing, and most likely going to soften."
Who's buying what: 8 big arms deals (http://money.cnn.com/galleries/2011/news/international/1102/gallery.new_arms_boom.fortune?iid=EL)
In response, Boeing and its peers are following the same path as the rest of corporate America -- out of the country. Foreign arms sales, once viewed as icing on the cake, are now the focus of the industry's growth strategy. Honeywell (HON (http://money.cnn.com/quote/quote.html?symb=HON&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/11.html?source=story_f500_link)) recently created a new international sales division. (EADS, a European defense conglomerate, plans to establish a headquarters in Asia.) Many companies have set targets for international growth. Lockheed, which currently gets 14% of its revenue from outside the U.S., wants to boost that figure to 20% by 2012, and Boeing's defense division aims to grow international sales to 25% from 17% today.
Compared with multinationals like Nike (NKE (http://money.cnn.com/quote/quote.html?symb=NKE&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/2184.html?source=story_f500_link)) and Procter & Gamble (PG (http://money.cnn.com/quote/quote.html?symb=PG&source=story_quote_link), Fortune 500 (http://money.cnn.com/magazines/fortune/fortune500/2010/snapshots/334.html?source=story_f500_link)), both of which derive about 60% of their sales overseas, that's a small percentage. But unlike those companies, defense contractors can't simply trek over to Delhi or Dubai and start knocking on doors. Before arms makers can sell weapons abroad, they must obtain the permission of the State Department. So-called "foreign military sales" are coordinated through the Department of Defense. (The parties usually overstate the value of the goods the companies hope to sell by about 30% to 50% so that they don't have to keep going back to the Hill with new requests; the $103 billion in congressional notifications in 2010 is likely to translate into close to $50 billion to $70 billion in actual sales.)
Until recently, executives say, the defense industry shrugged at globalization. "[During] my first few years here, you could hardly get a senior person to go international," says Tom Culligan, head of Raytheon's international business. "People would say, 'I don't want to give up my weekend to go to Riyadh.'" (The workweek in Saudi Arabia begins on Saturday.)
Raytheon now derives 23% of its sales from other countries, the most of any big contractor. Analysts say that's because it sells affordable gear -- missiles, upgrades, and radar -- as opposed to jets that cost $100 million apiece. Raytheon does sell one large program, the Patriot, a radar-guided firing system that shoots down ballistic missiles. Two years ago, Culligan says, a $3.3 billion order from the United Arab Emirates enabled the company to restart the Patriot production line and add new features like radar digital processors, which, in turn, lure more international customers. The strategy is working: Raytheon's domestic revenue was up just 1% last quarter, according to its CFO, but its international sales grew 11% to 12%.
Tapping the Middle East
The countries with the biggest appetite for U.S. weapons are, conveniently, the same ones that have the money to buy them: oil-rich nations in the Middle East. Nearly 50% of foreign military sales signed between 2006 and 2009 were with Middle Eastern countries, according to the Congressional Research Service. During that time, Saudi Arabia purchased about $13 billion worth of American weapons; the UAE spent $11 billion. Iraq, poised to get rich from its own oil reserves, is a growing customer.
All major defense contractors are profiting from the region, but none more so than Boeing, which was the major beneficiary of the Saudi deal. Mark Kronenberg, Boeing's head of international business development, attributes the buying spree to a natural replacement process, just as in any other business cycle -- mainframe servers and car engines, for example. "The last time we had a period like this in the Middle East was the early '90s," he says. "Here we are, 20 years later, and they're recapitalizing.
There are other, less innocuous reasons: a weakened Iraq, the terrorist threat in Yemen, and most important, the country that defense executives call the Gulf's "dangerous neighbor" -- Iran. "You hear it almost on a daily basis. Iran is flexing its muscles, most of it through offensive capabilities," maintains Abdulkhaleq Abdulla, a political science professor at UAE University. As a result, he says, small countries like the UAE feel pressure to try to keep up with their neighbors.
Though the Obama administration is reluctant to tie the recent Saudi deal directly to Iran -- in a press conference announcing the sale, Assistant Secretary of State Andrew Shapiro dodged questions on the matter -- the connection is obvious, says Gregory Suchan, who headed the State Department's arms transfers program from 2003 through 2007. Suchan, now a consultant, says the F-15 deal was in the works as early as 2006 -- the same year that Iran said it would reject any UN efforts to halt its nuclear program.
It took years of political legwork to execute the transaction. Lobbyists had to sell the idea to Congress, which has the power to stop major defense transfers -- something it has never succeeded in doing. Only a few sales have stirred major controversy, and all were to Saudi Arabia: AWACS sentry planes in 1981, Harpoon missiles in 1986, and Joint Direct Attack Munition (JDAM) bombs in 2007.
There was also the matter of persuading Israel to play ball. For decades the U.S. has promised to ensure Israel's military edge over its neighbors, and while the government doesn't like to admit it, arms deals to other countries tend to coincide with concessions to the Israelis. In 2007, the year in which the JDAM deal was announced, the U.S. boosted its military aid to Israel by about 25% annually, to $3 billion a year. Last October, right before the announcement of the F-15 sale, Israel ordered 20 F-35 planes, Lockheed's top-of-the-line fighter jet. Diplomatic cables released by WikiLeaks dating back to the summer of 2009 describe negotiations surrounding the sale of the F-15s to Saudi Arabia; they were ultimately stripped of long-range weapons systems. When the deal was announced in late October, the pro-Israel lobby barely batted an eye.
Neither did Washington. On Nov. 10, just nine days before the end of the 30-day period in which Congress can issue a resolution to halt an arms sale, a group of House members sent Secretary of State Hillary Clinton and Defense Secretary Gates a list of questions about the sale -- a "relatively soft gesture," laments Abramson. The transaction sailed through without incident.
Interactive graphic: Up in arms (http://money.cnn.com/magazines/fortune/storysupplement/up_in_arms/?iid=EL)