Analysis: South Korea setback shows pressure on Boeing warplane orders

By Andrea Shalal-Esa

WASHINGTON (Reuters) - South Korea's decision to reopen bidding for a fighter-jet contract rather than accept Boeing Co's (NYSE:BA - News) F-15 Silent Eagle signals a wider problem for the aerospace giant: revenue from its most profitable but aging military aircraft is winding down.

At the same time, U.S. government budget cuts have dimmed the prospects of Boeing developing replacements for the higher-margin legacy aircraft, such as the F-15, acquired when it merged with McDonnell Douglas in 1997.

That suggests overall profit margins from Boeing's defense business will come under pressure in coming years. It is a situation worsened by the rock-bottom bids the company has made to build a new U.S. Air Force refueling plane and the U.S. ground-based missile defense system.

"Revenues from their legacy aircraft programs are going to ramp down to painful levels" over the next three years, said Richard Aboulafia, analyst with the Virginia-based Teal Group.

"The day of reckoning has just been accelerated a notch."

Boeing's defense business already generates the lowest profit margins of the big weapons makers, and is likely to head even lower, analysts say.

Manufacturers are relying on foreign orders to help them weather the U.S. spending downturn. But Seoul's decision to launch a fresh fighter competition, announced early Tuesday, highlights the vagaries of foreign military competitions. Once-solid orders can vanish overnight, often through no fault of the bidding company.

In the South Korean competition, Boeing had followed all the bidding rules and cemented its close, six-decade-old ties with the South Korean government and industry. Behind closed doors, some government officials were describing Boeing - the only company that came in under Seoul's 8.3 trillion won ($7.7 billion) ceiling - as the likely winner.

But military threats from North Korea ultimately prompted Seoul to insist it needed a so-called "fifth-generation" warplane with special coatings and other features that make them nearly invisible to enemy radar.

That means a likely victory for Boeing's arch-rival on the fighter front, Lockheed Martin Corp (NYSE:LMT - News), which builds the only export-grade stealthy fighter, the F-35 Joint Strike Fighter. Boeing officials say they are still exploring all their options, including a possible protest to South Korean authorities over the decision to rebid the contract.

NEW LONG-RANGE BOMBER

In some sense, the South Korean decision is an earlier loss coming home to roost. Boeing lost the competition to build the Joint Strike Fighter to Lockheed in 2001, and the Pentagon has dragged its heels about starting many other new aircraft programs in recent years.

Boeing, Lockheed and Northrop Grumman Corp (NYSE:NOC - News) have contracts under an advanced design program for a new long-range bomber, but it will many years before a winning design is chosen and that program translates into real orders.

In Brazil, where Boeing's F/A-18 Super Hornet fighter had looked favored to win a large fighter competition, disclosures of spying by the U.S. National Security Agency have triggered retaliatory measures, including a ban on fighter sale purchases from Boeing, Brazilian officials told Reuters.

"I don't think Boeing did anything wrong in either case," said Aboulafia. "These were dynamics that were out of Boeing's control."

Aboulafia said Seoul's decision did not spell disaster for Boeing given its strong order book, which still features a huge Saudi Arabian F-15 fighter order, orders from India for C-17 transport planes, and a 179-plane U.S. refueling plan deal.

Given the dearth of big new programs in recent years, Boeing now faced declining revenues from very profitable legacy aircraft programs like the F-15 and F/A-18.

Profit margins in Boeing's defense sector have been edging higher over the past few quarters but remain just under 10 percent, compared with between 12 to 13 percent at such companies as Raytheon Co (NYSE:RTN - News), Lockheed and General Dynamics Corp (NYSE:GD - News).

Loren Thompson, chief operating officer of the Virginia-based Lexington Institute, said the margin pressures were exacerbated by Boeing's aggressive bids for the Air Force tanker program and the biggest U.S. missile defense program. In both cases, Boeing's low bids saddled it with low-margin contracts.

"Boeing wants to be the principal provider of large military aircraft, like the tanker, a new bomber and various radar planes. But it hasn't won the bomber contract yet, and the Air Force hasn't moved ahead with a new radar plane," he said.

The U.S. military will likely spend more than $10 billion to buy an estimated 60 to 80 new electronic-warfare planes in the coming decades, but those orders are far from showing up on any order books, Thompson said.

Boeing is also a big provider of rotor craft for the U.S. military, and has signed two multi-year agreements for both its CH-47 Chinook program, and the V-22 tilt-rotor that it builds together with Textron Inc's (NYSE:TXT - News) Bell Helicopter unit.

But budget cuts have slowed or stalled some potential new helicopter programs, including the Air Force's drive to build a combat rescue aircraft, and the Army's plan to buy new armed reconnaissance helicopters.

"You've got a fantastic five years ahead, but after that the numbers fall off the cliff," Aboulafia said.

All of those factors left Boeing highly dependent on foreign arms sales, which were historically less reliable than big U.S. orders, Thompson said.

"International sales are a wonderful add-on for a stable domestic production line, but as a stand-alone strategy they tend to be unstable and hard to sustain," he said.

Jim McAleese, a Virginia-based defense consultant, said the South Korean decision marked a setback for Boeing's F-15 line, but a Saudi order would keep that line running through 2018.

He said the company remained the No. 1 U.S. exporter, and the top generator of foreign military sales among arms makers.

Boeing also has strong supporters in Congress, where appropriators from both the Senate and House of Representatives have already earmarked initial funding in the fiscal 2014 budget that would pave the way for 22 additional F/A-18 Super Hornet purchases in fiscal 2015.

"They have more than adequate number of orders to meet their 2014 guidance," McAleese said. "It's too early to write them off. This is just a short-term setback."

(Reporting by Andrea Shalal-Esa; Editing by Alwyn Scott and Frank McGurty)

Matches

MORE TOP STORIES TODAY

Kallis, Narine star in Knight Riders’ crushing win

Kallis, Narine star in Knight Riders’ crushing win

An all-round display saw Knight Riders thump Mumbai Indians by 41 runs in the IPL-7 opener. More »

Pietersen to miss Delhi's first game

Pietersen to miss Delhi's first game

The former England batsman will have to lead the franchise as he is out of the match against Bangalore with a finger injury. More »

Srinivasan named in fixing report: SC

Srinivasan named in fixing report: SC

The court emphasised that the tainted administrator can no longer work for the BCCI. More »

'If you do the wrong thing it will be found out'

'If you do the wrong thing it will be found out'

'Everyone knows what is right and what is wrong and if you do the wrong thing it will be found out' More »

Why I'm not looking forward to the IPL

Why I'm not looking forward to the IPL

Welcome to another season of a league that many watch but few trust. More »

Mitchell Johnson may quit T20s for Test cricket

Mitchell Johnson may quit T20s for Test cricket

Australia's Mitchell Johnson may quit limited-overs cricket to prolong his test career with an eye on the 2015 Ashes series in England, the fast bowler… More »

There's a lot going on: Fleming

There's a lot going on: Fleming

He experienced anxious moments in the lead-up to the tournament as the courts decided on whether to suspend the franchise, he said, but stressed that the… More »

Latif couldn’t work with tainted players

Latif couldn’t work with tainted players

Former Pakistan cricket captain Rashid Latif said Tuesday he turned down the job of national chief selector because he could not work with ex-players tainted… More »

We are not over-confident: Bailey

We are not over-confident: Bailey

Indian Premier League — George Bailey-led Kings XI Punjab will face Chennai Super Kings on Friday. More »

Taxing issue — BCCI hits roadblock

Taxing issue — BCCI hits roadblock

MoU between BCCI & its units to avoid double taxation delayed after a few decline to share details. More »

Big runs expected, with bat and ball

Big runs expected, with bat and ball

Royal Challengers Bangalore: Their main concern, once again, is the fast bowling More »

Black Caps pick rookie duo for West Indies

Black Caps pick rookie duo for West Indies

New Zealand selectors included two new caps in a 15-man Test squad named Tuesday to tour the West Indies, with injury-hit spinner Dan Vettori's future… More »

The stage is set for IPL-7 to start

The stage is set for IPL-7 to start

The Preview — Defending champions Mumbai Indians take on Kolkata Knight Riders More »

Srinivasan appeals to court to allow BCCI comeback

Srinivasan appeals to court to allow BCCI comeback

He was aggrieved by the allegations against him during the hearing. More »

Klinger on his exit from South Australia

Klinger on his exit from South Australia

Michael Klinger has revealed he felt compelled to leave South Australia after being told he would be only a fringe part of the Redbacks' plans for next season, and disputed the suggestion that he left… More »

India: cricket's Brazil

India: cricket's Brazil

They are tough to beat with a big talent base exposed to good facilities. (CYCSPL) More »

Delhi Daredevils say no to gifts

Delhi Daredevils say no to gifts

Franchises are doing their bit to refurbish the image of the tainted league. More »

India-Pakistan Test series likely in 2015

India-Pakistan Test series likely in 2015

The revival of Indo-Pak Test ties could take place in UAE. More »

Kohli hopes to end RCB trophy drought

Kohli hopes to end RCB trophy drought

'This time around we will hope to go few more steps ahead and actually get that trophy' More »

Gavaskar can help IPL regain glory

Gavaskar can help IPL regain glory

Apart from the foreign players a lot of behind-the-scene activity has taken place in selecting the Indian domestic players. More »

Tendulkar, Ganguly to promote soccer

Tendulkar, Ganguly to promote soccer

Leading Spanish club Atletico Madrid and former cricketers Sachin Tendulkar and Sourav Ganguly are among the owners of eight franchises of a new Indian… More »

This isn’t my first trip to India: Neesham

This isn’t my first trip to India: Neesham

Kiwi all-rounder wants to utilise the India leg to explore the country’s tourist attractions. More »

Ishant wanted to quit ODIs

Ishant wanted to quit ODIs

Says his mother made him change his mind. More »