I can explain the impact of President Obama’s new defense budget to investors in one word – mergers.
Indeed, the M&A field will remain a driving force in the defense sector for at least the next two years.
The good news for tech investors is that Obama’s focus fits with the Pentagon’s push for more high-tech breakthroughs.
But don’t gloss over information technology since it cuts through the entire supply chain.
Since World War II, the U.S. military has pursued high tech at a rapid pace.
However, that trend gained speed in recent years after the Pentagon rolled out the concept of making computers an even bigger part of our fighting forces.
You see, the top brass likes to call it “net-centric warfare.” I know it sounds complex. But it really is very simple.
Here’s the big idea: link every facet of defense to secure networks. Ideally, that means senior leaders could track every boat, bullet and bayonet on one computer screen.
Obama’s Budget Cuts in a Modern World
And now, new budget cuts mean the military must do more with less.
Today, we’re facing a new Cold War with China, while at the same time we are cutting spending and reducing troop strength.
Here’s what it all means for investors…
At least once a month, the CEO of a company with great tech realizes he needs more financial muscle to survive the leaner times.
That usually means selling to a larger firm.
So look for defense companies that have access to financing or enough cash to go on shopping sprees.
Just last month, Lockheed Martin Corp. (NYSE: LMT), revealed it bought a firm that provides autopilot and other devices for small drones.
I believe this is a shrewd purchase. After all, the military is clearly moving toward more unmanned aerial vehicles.
These UAVs come in a wide range of sizes and applications.
At one end we have the Predator drone. It’s about the size of a private jet and receives heavy use by the U.S. against Al Qaeda terrorists.
Now just shrink that down to the size of a large insect and you have the new generation of drones. In the very near future these types of drones will find wide use in surveillance missions.
A high-tech team at Wright-Patterson Air Force Base is working on micro drones that look like bugs. They fit in the palm of your hand and are designed to find the enemy in tight urban terrain.
Cyber-security will also remain an active area for the Defense Department and Homeland Security. While Obama’s budget for 2013 cuts 100,000 troops, it does emphasize cyber-operations.
Consider that on December 29 Raytheon Co. (NYSE: RTN) said it is buying a small, privately held cyber-security firm. That was the second such merger in three weeks for Raytheon.
Those two Raytheon mergers occurred just weeks after the Pentagon said it reserves the right to respond to an attack on its computers with the use of force.
Though EADS hasn’t said it will buy in the U.S., it’s a good bet the company will at least look in America as it tries to balance out the sales of its jumbo jets.
On the other hand, not all the defense mergers will turn on high tech…
Mergers & Acquisitions Drive the Sector
Just look at Force Protection. The company makes blast-resistant vehicles that saw heavy use in Iraq.
In the meantime, also look for some defense firms to diversify. Some will tap civilian markets for new sales.
Take the case of ManTech International Corp. (Nasdaq: MANT). In early January, ManTech completed the purchase a small company that moved the defense firm into health-care information technology.
Ironically, the purchase of Evolvent Technologies actually helped ManTech score new defense sales. On February 6, the firm said Evolvent became part of an Air Force program worth nearly $1 billion.
Other suppliers may simply exit some of their defense lines. That’s the case with L-3 Communications Holdings Inc. (NYSE: LLL).
Last July, L-3 said it will spin off several units and create a new publicly traded company. L-3 said shares of Engilitywill start trading in the first half of this year.
The company says it will distribute shares of Engility to L-3 shareholders as a special dividend not subject to taxes.
Thus, the defense M&A wave is part of the Era of Radical Change.
Tight U.S. budgets means the Pentagon must make even greater use of high-tech to develop the fighting force of the future.
And to cope with these shifting winds, defense firms must realign to find new sources of cash.
All of which means new opportunities for tech investors.