The EconomistFebruary 8th 2020 Business 57A
mid the crisis over the 737 maxit is easy to forget that there is
more to Boeing than passenger jets. Its Minuteman interconti-
nental ballistic missiles, which John F. Kennedy called America’s
“ace in the hole” during the Cuban missile crisis, and the b- 52
bombers (“Big Ugly Fat Fellas”) that lumbered over Vietnam are not
just part of America’s 20th-century iconography. These pieces of
military hardware are still in use today. Boeing’s space business,
which helped put Americans on the Moon, is again trying to fly
them into orbit. With its huge commercial-aviation division in
disarray, it should fall to Boeing’s venerable defence, space and se-
curity division (known as bds) to bolster earnings and morale. Yet
it, too, appears to be suffering from neglect: subscale, long in the
tooth and in slow relative decline.
For most military contractors apart from Boeing, this is boom
time in America. Defence budgets have increased since the start of
Donald Trump’s presidency in 2017. Share prices are buoyant. Last
year revenues at Lockheed Martin, Northrop Grumman and Ray-
theon rose by more than 10% on average, largely because of snazzy
fighter-jet and missile contracts. At bdsthey fell by 1%.
The reasons for bds’s weakness were not max-related. They re-
flected a combination of factors, including the end of sales of c-17
transport aircraft and Boeing’s costly failure just before Christmas
to dock its Starliner spacecraft at the International Space Station.
Some revenue also went into Boeing’s relatively new services arm.
Few analysts cared. As Ken Herbert of Canaccord Genuity, a finan-
cial firm, notes, the maxcrisis has sucked everyone’s attention
away from other parts of the business. Still, deep-seated problems
at bdscould weigh further on Boeing’s profitability and reputation
even once it puts the maxcrisis behind it. As if he did not already
have enough on his plate, David Calhoun, Boeing’s new boss, faces
a strategic quandary.
Boeing has long proclaimed the merits of running defence and
space alongside its commercial-aircraft business. Though the
commercial side is bigger, their relative weights fluctuate in times
of trouble. Last year, for instance, as a result of the max’s ground-
ing, commercial-aviation’s share of group revenues fell from 57%
to 42%. bds’s share jumped to 34% from 26%. While the commer-
cial arm suffered a huge loss, bdsmade a decent profit. This shows
howthe structure can help smooth earnings. The company says
that bdsshowed its mettle in 2018 by winning highly contested de-
fence contracts, such as a programme to provide trainer jets to the
air force and aerial refuelling drones to the navy, which could be
highly lucrative. Moreover, the almost 50-year-old f-15 fighter jet,
one of its profitable warhorses, has been given a new lease of life.
Late last month the air force said it would buy from Boeing its first
new f-15exs.
This account masks problems. Some were long overlooked
while its passenger-jet business was booming. First, bdsis sub-
scale. Its revenues last year were less than half those of Lockheed,
and a bit smaller than those of Northrop and Raytheon. Its capital
expenditure was a sixth of an average of the three. It is decades
since Boeing won the most coveted sort of Pentagon contract, to
design and build a new military aircraft from scratch. bdshas no
role in the f-35 Joint Strike Fighter led by Lockheed, nor in Nor-
throp’s long-range stealth bomber. Both could reap huge windfalls
for their makers. Its lack of commitment to bold innovation is
reminiscent of Boeing’s fateful decision to tweak the ageing 737,
which ultimately contributed to the max’s tragic technical fail-
ures, because of pressure to keep up with Airbus, its biggest pas-
senger-jet rival.
Second, it is poor at carrying out the projects it wins. This is a
growing financial risk, because the Pentagon is offering fewer
cushy “cost-plus” contracts, where it pays contractors an agreed
premium over a project’s expenses. These are being replaced by
fixed-price deals in which the armsmakers bear more risk. Soon
after winning the trainer-jet and drone contracts in 2018, Boeing
recorded a nearly $700m loss on them, suggesting it had underes-
timated development costs. It has also booked losses of more than
$3.7bn on a long-overdue contract, potentially worth $44bn, to
provide airborne tankers to refuel planes. The air force has criti-
cised Boeing’s performance on the nine-year-old project.
Third, the maxcrisis compounds bds’s problems. Defence con-
tracts are lumpy, requiring high upfront spending for a large long-
term pay-off. While Boeing is burning cash with the max, its ability
to bid big in defence contracts is constrained. Last year the com-
pany pulled out of a contest worth at least $62bn to replace the
Minuteman-series missiles, the sort of contract that used to be its
bread and butter. Boeing insists its withdrawal had nothing to do
with the maxcrisis. Analysts speculated that the cash commit-
ment required to win this Ground-Based Strategic Deterrent con-
tract may nevertheless have played a role in its decision.Defenceless?
If the maxreturns to the skies soon, as Boeing hopes, investors’ at-
tention may turn to bigger-picture issues, including the future of
the defence business, says Seth Seifman of JPMorgan Chase, a
bank. One option is a break-up, but if nothing else, the bigger Boe-
ing is, the less likely it will be allowed to fail. bds’s main customer,
America’s Defence Department, which frets about insufficient
competition, would object to any weakening of bds. So would
many Boeing investors, who hope budgets for defence and space
will keep rising if Mr Trump is re-elected. Yet Boeing may need to
consider selective defence and space divestments, perhaps com-
bined with targeted acquisitions. It is increasingly clear to every-
one, including no doubt Mr Calhoun, that Boeing’s problems go
beyond the max. The company is misfiring on many cylinders. The
Big Ugly Fat Fella, a lovely moniker for a b-52, sounds less appeal-
ing when applied to Boeing itself. 7Schumpeter Ace in a hole
Boeing’s defence business is the next problem on the company’s horizon