President-elect Donald Trump might focus on managing cost-plus defense development programs as a way to extract better deals for taxpayers, according to an adviser to Trump’s transition team.
“I see this as a deal making proposition,” former Rep. Bob Walker (R-Pa.) said at the Eilene Galloway space law symposium in Washington. “My guess is you’re going to see him do that.”
Trump’s Monday tweet calling F-35 costs out of control came on the heels of another attack against a high-profile defense program: the Air Force’s Presidential Aircraft Recapitalization (PAR), or new Air Force One, program. Walker said Trump’s Twitter call for the Air Force to cancel PAR was a declaration that the administration will not have cost-plus contracts extend out the cost of programs in unacceptable ways. Boeing [BA] is the prime contractor for PAR.
The federal government is liable for cost overruns in cost-plus contracts while the contractor is liable for overruns in fixed-cost contracts. Complex defense development programs like the F-35 are traditionally cost-plus contracts. Lockheed Martin [LMT] spokesman Michael Rein said Tuesday that the F-35 program, of which Lockheed Martin is serving as prime contractor, has been working on fixed-price contracts since the award of low-rate initial production (LRIP) lot 4 contract in fiscal year 2010. An exception is the Air Force’s KC-46 aerial refueling tanker program, which is hurting Boeing’s bottom line due to development issues.
A leading defense analyst believes it is too soon for investors to react to President-elect Donald Trump’s recent online attacks on a pair of big-budget defense programs. Byron Callan of Capital Alpha Partners in Washington said Tuesday while concerns over whether the next administration could be hostile to the defense industry are legitimate, investors should wait and see who Trump names to key second- or third-level Pentagon positions like deputy defense secretary and acquisition czar. Once those positions are filled, Callan said investors will have better information to guide investment action.
Callan said history doesn’t show that emphasis on fixed-price defense contracts necessarily brings decreased costs and improved program performance. He said there was a lot of emphasis on fixed-price contracts for development work in the late 1960s and early 1980s and that he didn’t think winners could be declared from such an effort.
“It’s just not clear from the data that fixed-price contracts have necessarily developed complex technological systems on a lower cost schedule,” Callan said.
Callan said investors could see a markdown in defense stock prices and an increase in portfolio risk if the new administration does pursue an emphasis on fixed-price contracting. It may not happen immediately, he said, but would happen when a big “blowup,” or a big writeoff on a program, takes place. Callan said a blowup gets investors to question contractor margins and cash flows and that blowups happened on the C-5, C-17 and P-7 programs.
Callan said if Trump follows through on Walker’s prediction of getting involved in deal-making for large cost-plus defense programs, it would break precedent. He said he couldn’t remember the last time over the past couple administrations where a president got involved in cost issues on specific defense programs.