While defense contracting companies are already faced with a weakened demand from the federal government due to budgetary cuts, they are also contending with the profit motives of investors.
Investors are increasing pressure on military contractors to increase shareholder returns, even if it means abandoning long-term strategies that could make companies more resilient in the long term, wrote Loren Thompson Chief Operating Officer at the Lexington Institute.
Earlier this month, longtime corporate raider Carl Icahn disclosed that he had purchased a 9.5 percent stake in Oshkosh Corporation, the military truck manufacturer. While his motives are not known, the move is the latest in a series of hostile shareholder actions against military contractors that could significantly reshape the defense sector, Thompson said.
Last November, Relational Investors pressured ITT Corporation to sell its military electronics unit to enhance shareholder value. The company responded in January by announcing it would split into three companies. Earlier this year, Relational Investors also launched a hostile takeover of L-3 Communications.
The interest by non-traditional investors in the defense sector began in 2009, when investor dissatisfaction with inconsistent profits led to Northrop Grumman CEO being replaced. The new CEO made numerous moves to enhance shareholder value including selling a chunk of the company’s technical services portfolio, withdrawing from a risky joint venture on aerial refueling tankers, exiting the naval shipbuilding business, and adjusting performance metrics.
“In such periods of discontinuity, it is easier to convince shareholders that current management teams aren’t doing their jobs well, that strategies need to change, and that major strategic moves should be contemplated,” Thompson wrote. “The problem, though, is that the sector’s fortunes are being driven mainly by factors beyond its control, like receding military threats and a ballooning federal debt.”
However, Thompson warns that continued consolidation and other moves could “dismember” the defense sector during a prolonged downturn. At some point the government should probably step in to protect what’s left of the defense industrial base he says. “But until that day arrives, the defense sector could be headed for a prolonged period of what economist Joseph Schumpeter called ‘creative destruction.”