Defense Companies in Diversification Drive
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It's a fact of life right now for defense companies...military budgets are being cut here in the United States and worldwide, slashing their revenues.
This has led defense contractors off in a search for a way to cope with this new reality. In many cases, the path chosen by these firms is diversification away from military projects.
Last year saw General Dynamics (NYSE: GD) snap up Vangent, a provider of healthcare information technology to various government agencies, for $960 million in cash. Also in 2011, Lockheed Martin (NYSE: LMT) bought QTC Holdings, which provides medical evaluation services to the Department of Veterans Affairs.
This diversification strategy is really nothing new for defense firms. Many of them have established strong positions in non-military markets.
Just look at Lockheed and General Dynamics. Lockheed has built a several billion dollar IT services unit, which works with federal agencies. General Dynamics owns business jets manufacturer Gulfstream and also has an IT division.
What sectors are most likely to be targets of these aerospace and defense companies?
Those in the industry point to areas like healthcare IT, cybersecurity and energy markets as likely targets. This makes perfect sense since these are growth markets with heavy government involvement.
Take healthcare IT spending on the federal level, for example. By 2016, the Department of Veterans Affairs alone will spend over $4 billion on IT (mainly healthcare) systems, up from just over $3 billion last year.
State and local government healthcare IT spending is also a juicy market. According to software provider Deltek, over $10 billion was spent on healthcare IT by these governments last year.
Diversification alone as a strategy will not solve the industry's problems. Especially since the industry has had such a poor track record in the past with diversification. Even the number one company in the industry, Lockheed Martin, has failed in the past.
In the 1990s, it tried to move into the commercial telecommunications business with the purchase of Comsat. The attempt failed and Lockheed subsequently sold Comsat. Failed attempts like this caused Lockheed's former CEO Norm Augustine to remark more than a decade ago that the “industry's record of diversification is unblemished by success”.
Investors in the defense firms like General Dynamics, Lockheed and Northrup Grumman (NYSE: NOC) must certainly hope that the industry has learned its lesson from past missteps. Diversification for the sake of diversification will not work.
Defense companies should stick to making acquisitions in areas in “adjacent markets” and taking over companies that do a lot of government business, an area of expertise for them.
Perhaps the company furthest along this path is the one that failed spectacularly in the past – Lockheed Martin.
It has invested in projects working with smart grid technology, energy efficiency, and even ocean power. But the growth has been slow and careful, starting with a military focus and then moving on to other government agencies before finally working with utility companies.
It seems that Lockheed Martin has learned its lesson. Investors must hope that if further defense budget cuts occur, it will not forget the lesson and go out and buy another Comsat.
The Motley Fool owns shares of General Dynamics, Lockheed Martin and Northrop Grumman. tdalmoe has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.