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Raytheon Dodges Budget Ax With ‘Avatar’ 3-D Training

Raytheon Ducks Pentagon Budget Ax
Trainees are shown in a virtual scene as it would be viewed by them using "VIRTSIM" gear during a tactical training program that uses technology developed by Raytheon Co. and Motion Reality Inc. Source: Raytheon Co. via Bloomberg

Raytheon Co., the world’s biggest missile maker, is girding for slower growth in the U.S. weapons budget by training soldiers with technology from the movie “Avatar” and helping educate General Motors Co. mechanics.

Those programs are part of the Technical Services unit that led Raytheon’s first-half sales increases even as Defense Secretary Robert Gates called for ending a “gusher” of military purchases. The 11 percent gain was almost three times as much as at the division building Patriot missiles.

“In these difficult times, it’s nice to have a part of your business grow like that,” Chief Executive Officer Bill Swanson said in an interview.

Swanson, 61, has pushed to diversify the fifth-largest U.S. defense contractor as war costs and the federal deficit squeeze Pentagon outlays on arms. His aim is to grab a bigger chunk of an estimated $22 billion U.S. military training budget and win contracts for that work in countries including Saudi Arabia.

Technical Services, the smallest Raytheon division, posted a 60 percent revenue surge from 2005 to 2009, to $3.16 billion, compared with a 40 percent jump over that span for the units making missiles and related gear.

Those advances weren’t enough to prevent a 9.9 percent stock drop this year, putting Raytheon behind Lockheed Martin Corp., Boeing Co., Northrop Grumman Corp. and General Dynamics Corp., the largest U.S. defense companies. Technical Services’ profit margins trail those in Raytheon’s biggest businesses, which make Patriots and AIM 9X air-to-air missiles. Raytheon said net sales were $24.9 billion last year.

Spreading Risk

Swanson’s strategy calls for spreading the defense risk at Waltham, Massachusetts-based Raytheon among almost 8,000 programs in addition to training soldiers, air traffic controllers, astronauts and law enforcement officials.

“They offer a more cost-effective training, which is more virtual than live,” Peter Arment, a Gleacher & Co. analyst in Greenwich, Connecticut, said in a phone interview. “That positions Technical Services for growth in a slower budget environment.” He has a “buy” rating on the stock.

Gates signaled his goal of tighter weapons spending with his April 2009 decision to cap output of Lockheed’s F-22, a fighter with roots in the Cold War era. For fiscal 2011, his $549 billion budget request would be a 1.8 percent increase, short of the 2 percent to 3 percent gain after inflation that Gates said is needed to keep the military’s current strength.

Ammunition Imperiled?

Among weapons programs possibly imperiled by the savings push is the Army’s Excalibur satellite-guided artillery shell, for which Raytheon and Alliant Techsystems Inc. are the sole bidders. The Army said it is considering paring purchases by 80 percent to save as much as $1.4 billion through 2016.

Raytheon got into training when then-CEO Dennis Picard bought GM’s Hughes defense business in 1997. Lessons delivered via the Internet now reach thousands of Detroit-based GM’s Goodwrench technicians at dealerships worldwide, sharpening their skills without periodic visits to training centers.

“If you take operators off the shop floor, they’re not generating any revenue for the GMs or Chryslers,” Swanson said. “The analogy in the military world is the same.”

In 2007, a Raytheon-led team of contractors won a 10-year, $11.2 billion contract to train all combat-bound U.S. Army soldiers. The Warrior Training Alliance’s services range from facilities maintenance to leadership and cultural programming to live-fire exercises, according to Raytheon’s website.

‘Avatar’ Simulators

In March, Raytheon reached an agreement with Motion Reality Inc., developer of the 3-D technology for Hollywood blockbuster “Avatar,” to build mobile training simulators, said John Harris, president of the Technical Services unit.

The equipment will mimic the experience of being on a street in Afghanistan or Iraq, helping soldiers learn how to identify and avoid roadside bombs, Harris said in an interview.

“Depending on the circumstances, we’ll use the 3-D technology to train some soldiers,” said Keith Strubhar, a Raytheon spokesman. Others will get live training, he said.

Cai Von Rumohr, a Cowen & Co. analyst in Boston, said Raytheon’s training business is “definitely a success story.”

“The question is, is it enough?” Von Rumohr said in a phone interview. Profit margins for the unit are about 7 percent, trailing the 11 percent and 17 percent figures for the missile and defense-electronics businesses in 2009, said Von Rumohr, who rates the shares as “neutral.”

Sales Forecast

Also buffeting the company last week was the cancellation of a U.K. border-security contract, which forced Raytheon to chop the top end of its 2010 sales forecast. The U.K.’s Home Office found parts of the program were running 12 months late.

Raytheon rose 9 cents to $46.43 at 4:15 p.m. in New York Stock Exchange composite trading.

Investors selling defense stocks in anticipation of Pentagon cuts are “being too pessimistic,” Jason Gursky, a Citigroup Inc. analyst in New York, said last month in a note to investors. He recommends buying Raytheon and said the company’s portfolio is “less susceptible to large program cancellations.”

Sales in the Technical Services unit will rise 77 percent by 2012 from 2007 levels, Gursky estimated, which would be more than double the gains in any of Raytheon’s five other divisions.

Foreign militaries will be one source of growth as they seek better training tools, Harris said. Raytheon is in talks with the U.K.’s Royal Navy and the United Arab Emirates in addition to Saudi Arabia, he said.

Spending on U.S. military training may climb to $24 billion by 2015 from $22 billion even as the U.S. prepares to pull back from war zones, said Nelson Sturdivant, an analyst at Mountain View, California-based researcher Frost & Sullivan. His estimate includes education programs plus supplies such as ammunition.

“Our training needs will only increase,” Sturdivant said. “We are always training to fight.”

Download: Raytheon CEO Swanson Interview

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