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Northrop Grumman (NOC)
Northrop Duking It Out with Boeing Over $40bn Deal
Northrop Grumman, the nation's third largest defense contractor, is in the middle of an all out brawl with rival Boeing over a $40 billion contract for refueling aircraft. The Los Angeles-based company would be hard-pressed to think of a sweeter prize, but the fervor over who gets the contract is pitting American-made versus European aircraft efficiency and is igniting government debate over whether the project is even needed. With so much riding on the deal, what are the odds that Northrop will come out from the shadow of long-time partner Lockheed Martin (LMT: Charts, News, Offers) and land the big deal?
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The biggest prize on the horizon is a $40 billion contract to provide the U.S. government with 179 refueling p***s. Many of the current refueling aircraft are decades-old, and the replacement of these p***s is seen as a necessity when it comes to the U.S. role in international conflicts. While the United States has a number of military bases abroad, the possibility of those bases being closed by unfriendly governments means that a viable alternative must be found to ensure that military aircraft are able to be refueled in a timely manner. In addition, the military's use of "long arm" fighting, which involves attacking strategic targets behind the front line, as well as the need for forward air support for troops on the ground means that having mid-air refueling capabilities results in more sorties being flown without an aircraft returning to base.
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The big battle between Northrop and Boeing (BA: Charts, News, Offers) is getting fairly dirty. Boeing, currently the second largest defense contractor, is touting that its version of the refueling aircraft is made in America, which means more jobs for Americans and increased safety of sensitive military secrets. Northrop has partnered with European defense contractor EADS, and has also indicated that it will build much of its aircraft in the United States. Both claim their aircraft's superiority in terms of capacity, durability and range. The design for Nortrop's version is based on the Airbus A330, and considering the constant battle between Airbus and Boeing over superiority in the commercial airline industry it can be expected that similar rancor would spill over into defense. The Boeing design is based on its 767 aircraft.
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Company executives and investors alike are looking toward the November elections with at least some trepidation. Defense spending has been boosted to astronomical highs over the course of the Bush administration, and the prospect of not receiving substantially lucrative government defense contracts is the sort of thing that keeps defense contractors up at night. How big is this worry? It is unlikely that defense spending will be significantly downgraded in the short run, since the U.S. military is engaged in several conflicts and will not be able to readily cut back on them due to the potential of an international political fallout. Cutting troop funding, which would include equipment, is a politically sensitive landmine. Few politicians would openly call for large cuts to defense spending if it gave the impression that the troops themselves didn't matter.
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Because the current administration's time in the White House is rapidly winding down, coming up with a winner in the refueling aircraft bidding war is a major priority. Considering that Boeing already supplies the government with over 500 KC-135 Stratotankers, Northrup is facing an uphill battle when it comes to convincing the Pentagon to buck the trend. Luckily for Northrop, Boeing has already run into heavy criticism for its role in a 1996 aircraft leasing agreement worth $23 billion, and saw its CFO plead guilty to essentially bribing an Air Force contract negotiator in 2004. The major hurdle is that such a big ticket item carries a lot of nationalistic baggage, and for many government officials and taxpayers giving $40 billion to European companies is a tough pill to swallow.
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Because the stakes are so high, any award given to a competitor will undoubtedly be challenged by rivals, meaning that it could be months or years before any new aircraft roll out. Investors simply can't celebrate until the first jet rolls of the assembly line. Luckily for Northrop it isn't placing all of its chips in on this bet. The company inked a $1 billion shipping contract back in December and is expecting 2008 earnings to be in line with its previous expectations.
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