The Little Contractor That Could
In recent days, Pentagon officials from Defense Secretary Donald H. Rumsfeld on down have raised alarms about the scary spiral of cost and complexity in new weapons of war. But as the price tag for arms pro- grams in development or production heads toward $1.5 trillion, there's at least one corner of the military-industrial complex where penny-pinching pragmatism is supplanting high-tech visions that often wind up over budget and unreliable.
Case in point: little Alliant Techsystems Inc. (ATK ), which last year battled defense titan Lockheed Martin Corp. (LMT ) for an Army contract to make mortar rounds more accurate, a deal that could be worth $500 million. In effect, Lockheed Martin, which declined comment, tried to stuff a mini-missile into a mortar. Alliant, known by its stock symbol ATK, made a dumb shell smart by slapping a "seeker" sensor on an existing mortar round so it could find a target "painted" by a laser.
The Lockheed Martins, Boeings, and Raytheons (RTN ) of the world like "doing the impossible," as Boeing Co. (BA ) puts it in its ads -- or at least trying to. The big boys need big programs to make a noticeable difference in sales. But their glitzy weapons often produce cost overruns, delays, and technical glitches. Alliant -- which makes bullets, rocket boosters, and precision weapons -- focuses on the possible and the cheap. Merrill Lynch & Co. (MER ) defense analyst Byron Callan notes the defense industry hasn't had "a Dell (DELL ) or Southwest [Airlines] (LUV ), someone who comes in with a different business model or mind-set. ATK is the closest."
Created in 1990 when Honeywell International Inc. (HON ) spun off its defense business, Edina (Minn.)-based Alliant has raked in handsome profits while saving the Pentagon millions. Buoyed by surging demand for space systems and ammo for operations in Iraq and Afghanistan, its sales for the year ended Mar. 31 rose 18%, to $2.8 billion, while income before interest, taxes, and one-time items rose 13%, to $304 million. By contrast, industry giant Lockheed Martin had 2004 sales of $35.5 billion and profits of $2.3 billion. Though its stock is up some $14, to just over 70 on June 21 from its 52-week low, Alliant is one of UBS (UBS ) defense analyst David E. Strauss's top defense picks. "It will grow faster than the larger prime contractors," he says.
So in an industry that can't seem to shoot straight, how does Alliant come off like a special-ops sniper? Some of the credit goes to the whatever-works attitude of Chairman and CEO Daniel J. Murphy, a retired vice-admiral. The company avoids leaps into complex technology; instead it incrementally improves existing gear. "We will never compete successfully with the giants in our industry by approaching solutions in the same manner as they do," says Murphy. "They'll beat us every time."
Focusing on the nitty-gritty of manufacturing has also helped turn one of Alliant's mundane operations into a gold mine. Five years ago it won a contract to run the Lake City Army Ammunition Plant in Independence, Mo., which uses some machines installed soon after then-Senator Harry S Truman helped break ground for the plant in 1940. Since then, it has slashed costs by, among other things, reducing the defect rate from 13% to 5.7%. Alliant cut the cost of a shell by 35%, saving the Army $400 million. Yearly production soared from 350 million in 2000 to 1.2 billion rounds, and profit margins jumped from 8.9% in 1998 to 12.2% in 2004. That helps bankroll research in new niches, such as high-power microwave devices that can defuse explosives by frying their circuits. On July 17, Alliant said the Air Force awarded it a $1.5 million contract to pursue these devices.
ATK's approach works for more sophisticated programs, too. The company beat out Raytheon on a contract to put advanced sensors on a Raytheon missile that targets enemy radar. ATK bought an off-the-shelf global positioning system and added an off-the-shelf seeker. Using proven parts "takes a lot of risk out of it," Murphy says. The challenge was knitting them together. The result: Two years into the $223 million contract, the program is on budget and on schedule. After the CEO pointed that out at a Lehman Brothers Inc. (LEH ) conference in February, he asked the 80 defense mavens there if they knew of a similar program that could make that boast. No one did. And ATK's business model could help it beyond the Pentagon. NASA may choose Alliant's shuttle boosters for some manned and unmanned space missions instead of the Evolved Expendable Launch Vehicle being offered by Lockheed Martin and Boeing.
To be sure, the giants aren't taking this lying down. General Dynamics Corp. (GD ), for example, is vying with ATK for the increased ammo production the Army needs. And Alliant has made missteps. Its contract to develop an electronic time fuse for mortars that illuminate an area ran into snafus. It also missed analysts' consensus for last quarter's earnings by a penny.
Even so, the company is well positioned. There's a good chance that Pentagon arms budgets will have to shrink to help slash the budget deficit and pay for overseas operations. If that happens and the brass needs something fast and cheap, don't be surprised if ATK smites the giants again in the future.
By Stan Crock in Independence, Mo.