Defense Cuts Mean Work for L.A. Firm

Big questions are being asked about the future of the defense industry, how employees and companies--and Southern California’s economy--will fare as the industry shrinks. Most forecasts are gloomy.

But Whittaker Corp. thinks differently. “This is a time of real opportunity in the aerospace defense business,” says Edward Muller, Whittaker’s chief financial officer.

Los Angeles-based Whittaker, a relatively small defense contracting firm at $160 million in revenue last year, is picking up Pentagon contracts other firms are eager to leave behind. It’s a homecoming of sorts for Whittaker, a 45-year-old company that only a decade ago was a conglomerate with $1.6 billion in revenue from chemicals, health care, biotech and more.

It has sold or spun off the other businesses to concentrate on aerospace--in which it supplies pneumatic valves to aircraft manufacturers, commercial and military, and electronic systems to the Air Force.

What’s the attraction in defense? It’s an industry under severe pressure--declining Pentagon budgets are making life unbearable for many companies, prices are down, and buyers of defense companies know there’s money to be made if they can acquire at a good price and operate smartly.

Big players like the action. Lockheed is buying General Dynamics’ fighter plane operations to become the largest fighter plane maker; Martin Marietta is growing by buying General Electric’s defense business.

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And smart money is asking whether defense shares are bargains at today’s prices.

To all those questions, little Whittaker offers at least some answers. Last year, it bought three defense companies, which combined had $31 million in revenue. Whittaker paid only about $15 million for the three businesses and is confident of profit even though two of the acquisitions were in the red.

Its confidence is probably well-placed. Reductions and stretch-outs in Pentagon contracts had caused losses at tiny Dowty Avionics, an Arcadia maker of electronic submarine detectors, and Ocean Technology, a Burbank supplier of gear for Trident submarines. As contract revenue shrank, the companies’ overhead costs--pay for administrators and other essential staff--ate up profit.

But when Whittaker bought them, it transferred their production to its own plants in Simi Valley and North Hollywood--making operations more economical. But it didn’t need additional accountants and the like, so it took half or fewer of the acquired companies’ people. Thus Whittaker can perform the same work at lower costs.

“Yes, some jobs are eliminated,” says Muller, “but only some. Without the acquisition, all the jobs would have gone in the general defense downsizing”--which has eliminated more than half a million jobs nationwide.

Half a loaf is better than none, agrees William Anders, chairman of General Dynamics. Writing in Fortune magazine, Anders says that his company’s sale of the F-16 fighter operation to Lockheed, which makes the F-22, brings economies to the business and ensures jobs for at least some employees. “The goal is not to liquidate but to get critical mass in our core businesses,” Anders says.

Consolidation in the defense business will continue with companies buying operations from each other. The 1,000 or so small contracting firms in Southern California will merge with each other or larger firms, but a base of business will be maintained, and there will be aerospace jobs in the area.

“There are a lot of reasons for staying in Southern California,” says Muller, listing first the immense network of 1,000 or so vendors of highly specialized equipment and services. “And there’s the skilled help in the area; you want to be able to find people who know what they’re doing,” says Muller, because defense work on valves for aircraft is more demanding than manufacturing valves for trucks.

So, despite sharing the frustration that most business people voice with “rampant bureaucracy in the California state government,” Muller reckons the region and the aerospace industry will struggle on together--helped greatly by commercial aviation, which he sees recovering mightily in the next five years.

Several important trends come through in what Anders and Muller are saying. In the industry’s consolidation, outside companies won’t come into the defense business. It’s too risky--and not only for the buyer. Fact is, a defense business essentially is a contract with the government to produce planes or tanks or uniforms. And the government never lets you off the hook until the contract is fulfilled. If a defense contractor were to sell the business to a speculator, who couldn’t do the work and gave up, the Pentagon would come back to the original contractor and demand that obligations be fulfilled. Liabilities can be heavy.

On the other hand, defense firms probably won’t diversify. After years of talking about transferring defense skills to commercial industry, experts now concede that civilian work, such as making rail cars, won’t really make jobs for defense workers. “There’s no such thing as a dual-use tank or submarine,” says Anders.

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Taking all that into account, the stock market is according low prices to defense shares--less than half the average of the Standard & Poor’s index of 500 leading companies. Are defense stocks bargains?

They may be good investments, if you can complete a contract and turn a profit, but they’re not bargains, says Muller. It’s not a business you can pay a premium for because you can’t be sure of the long-term future.

“Defense may very well be a great business five years from now, but the changes ahead are so severe, the uncertainty is too great,” Muller says. Great risk, in other words, but perhaps also great opportunity.