General Dynamics looks outside its core

May 20, 2012

As military spending wanes, defense contractor General Dynamics has been buying companies outside of its traditional areas of expertise.

Its playbook, which includes buying companies that specialize in health care information technology and wireless networks, provides insight into where other companies may head, seeking greener pastures. But some have doubts about whether contractors will succeed at maneuvering into new lines of work.

Falls Church-based General Dynamics “goes where the money is, and that means that when the defense budget is increasing, it buys military contractors, but when the defense budget is softening, it buys outside defense,” said Loren Thompson, a defense industry consultant. “Most military contractors are committed to the defense business forever; GD is committed as long as it can make good returns.”

Last year, General Dynamics spent nearly $1 billion on Arlington-based Vangent, a federal contractor that specializes in health care services, and more recently, said it would buy IPW Holdings, the parent of IP Wireless, which provides network equipment for first responders and the military.

At an investors’ conference last week, Jay L. Johnson, the contractor’s chairman and chief executive, said General Dynamics seeks acquisitions that boost its core skills and also those such as Vangent that “put us in a faster market” or such as IP Wireless that “put us into an adjacency that we understand.”

“I would expect to see that continue for us,” he said. The company declined to comment for this article.

Perhaps the company’s best-known model for the recent purchases is Gulfstream, its business jet business, which Thompson said was considered an unusual acquisition when General Dynamics picked it up in 1999.

In General Dynamics’ most recent earnings report, total profit dropped nearly 9 percent, but its aerospace sector — buoyed by Gulfstream — grew its income by almost 18 percent. The company said last month that it is expecting higher aerospace margins for the year given the strong first quarter performance by Gulfstream.

Still, some analysts have their doubts about whether the company’s aggressive strategy will work.

“The history of defense contractors moving out of their realm of expertise is checkered, to put it mildly,” said Rick Whittington, an analyst at Drexel Hamilton. “It’s something that investors are watching ... and typically are not real thrilled or keen about.”

Bethesda-based Lockheed Martin, for example, bought PAE, which supports operations at embassies and base camps, in 2006 but promptly divested it in 2011, explaining that the business didn’t align with Lockheed’s strategy.

Whittington added that the profit margins of businesses outside the weapons market often can’t compare.

Still, Michael S. Lewis, director of equity research at Lazard Capital Markets, which has a business relationship with General Dynamics, said the acquisitions make sense.

“There’s so much uncertainty in the defense marketplace that the prudent decision by a management team is to see what complementary areas are out there,” he said. “I wouldn’t be surprised if we saw other companies follow suit.”

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