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REUTERS, Washington - A new wave of defense industry mergers and the increasing propensity of companies to protest contract losses signal the post-9/11 surge in US defense spending is finally coming to an end.
The US defense budget, which accounts for half the world's military spending, ramped up dramatically this decade but is now likely to plateau, albeit at a high level, according to defense analysts.
Michele Flournoy, president of the Center for a New American Security, predicted a period of "belt-tightening" for the U.S. defense industry in coming years. She said procurement spending had not grown at quite the same pace as overall defense budgets, given rising personnel and health care costs.
The U.S. military is expected to reduce its presence in Iraq regardless of whether the Republicans or Democrats win the 2008 presidential election. That means an end to the supplemental war budgets that have pumped extra funds into myriad weapons programs in recent years.
"The post-9/11 days of a blank check for defense are coming to an end," Flournoy said, noting that slower growth or stagnation in spending could fuel industry consolidation.
Italy's Finmeccanica SpA (SIFI.MI: Quote, Profile, Research) agreed this week to buy U.S. defense contractor DRS Technologies Inc (DRS.N: Quote, Profile, Research) for $3.94 billion. It is the latest effort by European defense companies to increase their foothold in the U.S. market.
"If indeed companies find themselves with a hole in their bookings, they will have to identify options to close that gap, which may include strategic acquisitions," said defense industry consultant Jim McAleese.
Communications equipment maker Harris Corp (HRS.N: Quote, Profile, Research) has also started exploring strategic options that may lead to its eventual sale, the Wall Street Journal reported last week.
Potential bidders could include Lockheed Martin Corp (LMT.N: Quote, Profile, Research), Boeing Co (BA.N: Quote, Profile, Research), Northrop Grumman Corp (NOC.N: Quote, Profile, Research) and General Dynamics Corp (GD.N: Quote, Profile, Research), the four biggest U.S. defense contractors, according to defense analyst Loren Thompson of the private Lexington Institute. The Journal also named Raytheon Co (RTN.N: Quote, Profile, Research), the No. 5 contractor in fiscal 2006, and Britain's BAE Systems Plc (BAES.L: Quote, Profile, Research), ranked No. 8, as possible bidders.
Analysts said Harris may be motivated by other factors than an expected drop in orders since it does a great deal of classified work for the U.S. government, which is likely to continue to increase, and its sales have also been buoyed by rising foreign demand for Harris tactical radios.
LAST BUSH BUDGET PUSH
Standard & Poor's Aerospace and Defense index almost trebled from the start of the U.S. -led invasion of Iraq in March 2003 to its lifetime peak in October last year, followed by sharp declines as the markets were roiled by credit worries.
Most defense companies have clawed back some of those losses, as investors look for companies well placed to withstand an economic downturn.
McAleese said officials in the Bush administration are keen to accelerate big military programs and move them into production in 2010 before a new White House is able to shape its first real budget for fiscal 2011.
The newly-elected president must deliver a fiscal 2010 budget proposal to Congress just weeks after taking office early next year, which means largely relying on a budget plan drafted in the final months of the Bush administration. The government's fiscal year begins on October 1.
"Contractors are going to be living for the next several years on the programs that they are able to win over the next year," McAleese said. Companies that lose big contracts are also more likely to "fight to the death" or protest awards to rival bidders, he said.
Lockheed last week appealed its loss of a multibillion dollar Navy contract for new unmanned surveillance planes to Northrop. And Boeing has aggressively sought to overturn a $35 billion aerial tanker program that went to Northrop partnered with Europe's EADS (EAD.PA: Quote, Profile, Research).
"The default setting now for defense contractors is that whenever a big award is lost, you automatically protest unless nobody expected you to win in the first place," Thompson said.
Protests have also increased in recent years because there are fewer defense contracts to win, they are generally worth more than in the past, and the Government Accountability Office has upheld more protests, according to analysts.
The trend might be also be a sign of flagging confidence in the defense procurement system.
"People have lost faith in the ability of the defense acquisition system to make good decisions," Thompson said.
Contract protests are also relatively easy and inexpensive to mount, and there were no real disincentives to filing such appeals, said one former defense industry executive, speaking on condition of anonymity.
In addition to fighting hard for contracts to develop new weapons, defense companies are also likely to step up their efforts to lobby for upgrades to older weapons systems that they already control, McAleese said.
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