A New World Order For U.S. Arms Makers

Christmas came early this year for Raytheon Co., the maker of the celebrated Patriot missile that blasted Iraqi Scuds out of the skies during the gulf war. In mid-November, it received the White House's blessing for a $3 billion sale of 14 Patriot missile systems to Saudi Arabia. For the Lexington (Mass.) company, the deal came just in time. Declining orders for Patriots from the U. S. Army, which generates nearly 15% of the company's revenues, already have contributed to 3,300 job cuts this year.

Raytheon's plight highlights the growing dependence of U. S. defense contractors on foreign markets. Without exports, U. S. military spending cuts would likely end production of McDonnell Douglas Corp.'s F-15 fighter, General Dynamics Corp.'s M-1 Abrams tank, and other heroes of Desert Storm. Arms exports have traditionally accounted for 12% to 15% of nonnuclear U. S. arms production. But as cuts in the Pentagon's budget become more drastic, exports could easily jump to 25% of production by the end of the decade. Although overseas demand won't be enough to prevent a major restructuring of the U. S. defense industry, "foreign sales will be key to determining who shrinks and how much," says Joel L. Johnson, international vice-president of the Aerospace Industries Assn. based in Washington.

If, for example, McDonnell Douglas is forced to close down its F-15 line in St. Louis, some 7,000 employees and several thousand subcontractors will be out of work. "We see increases in foreign sales as the primary way to keep open product lines," says Tom Culligan, a McDonnell Douglas vice-president. Hard times are already forcing the company to consider selling up to 40% of its commercial airline business for $2 billion, possibly to an Asian buyer.

BIG SPENDER. It's mainly Middle East purchases that are giving U. S. arms manufacturers a boost (table). Despite the victory over Iraq and the budding Arab-Israeli peace process, the oil-rich gulf states and their neighbors remain wary of each other -- and eager to strengthen their military muscle. Over the next five years, buyers in the region will spend upwards of $50 billion on tanks, fighter planes, missiles, and other weapons, says Paul Nisbet, an aerospace industry analyst at Prudential-Bache Securities Inc. in New York. Much of it will be spent in the U. S.

The bulk of those sales could come from Saudi Arabia, the region's biggest spender. Aside from the Patriots, Riyadh is ready to plunk down more than $4 billion for 72 F-15 fighters and $1.3 billion for M-1 tanks. The United Arab Emirates is prepared to spend $5 billion on new weaponry, according to industry sources. The U. A. E. currently is discussing a possible purchase of 337 M-1 tanks and is shopping for more fighter aircraft, possibly F-15s. And Kuwait will spend billions to rebuild virtually its entire defense establishment. At the top of its wish list: 200 M-1 tanks, more Patriots, and 36 F/A-18 fighter planes. Israel, whose buying power is dictated by U. S. foreign aid, wants more Patriots and $700 million worth of surplus U. S. trucks and artillery.

But arms sales to this heated region raise political problems for President Bush, who is championing arms control in the Middle East. Except for Patriots, which are viewed as purely defensive weapons, the White House is loath to approve more big arms sales until at least next year. U. S. officials fear that such orders could torpedo the tentative Arab-Israeli peace process.

While Arab buyers quietly are making their shopping lists known, they face opposition from pro-Israeli members of Congress once they go public. Says Tony Cordesman, a national security specialist and aide to Senator John McCain (R-Ariz.): "Many of the gulf states are very reluctant to make a formal request to the U. S. because they fear having to defend it in public and in Congress."

STOCKING UP. If the backlash forces Washington to keep deals on hold, Middle East buyers may opt to do their shopping in Europe. It has happened before. In 1985, stung by Washington's refusal to sell F-15Es, Saudi Arabia signed an $8.7 billion deal with Britain that included 72 Tornado fighters and 30 Hawk jet trainers. The Arabs would prefer to buy American weaponry because of its track record during the gulf war and because they're counting on U. S. reinforcement in case of future attacks.

But the Middle East is far from the only area stocking up on U. S. weapons. East Asian countries, anxious about Washington's plans to withdraw troops from the region, are spending briskly. These prospective purchases won't get such close scrutiny in Washington. Raytheon is peddling Patriots to South Korea. Grumman Corp. is hawking regional surveillance planes to Indonesia, Malaysia, and Thailand. Grumman has also teamed up with Lockheed Corp. in an attempt to interest Japan in a longer-range surveillance plane. Even Finland is looking to upgrade its air force -- it plans to spend $2 billion on 60 planes.

Asian buyers increasingly prefer technology-sharing arrangements to off-the-shelf deals for cash. Korea, for example, has a deal to license or co-produce 120 F-16s with GD. "In the long run," warns Natalie J. Goldring, senior analyst at the Defense Budget Project, a Washington think tank, "we may be creating the next generation of competitors." But for order-starved U. S. contractors these days, any business is good business.

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