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Defense secretary's planned cuts upset investors and defense contractors

By Dana Hedgpeth
Washington Post Staff Writer
Wednesday, August 11, 2010; A14

The stock prices of several major government contractors fell Tuesday, a day after Defense Secretary Robert M. Gates said he planned to cut spending at the Pentagon.

Although it is still unclear exactly how Gates's cuts would affect individual companies, his general plan to reduce reliance on private contractors strikes at a government-services line of business that had been lucrative in recent years.

The uncertainty spooked investors. Stock in government-services companies was hit especially hard; Mantech fell 3.7 percent, and SAIC dropped 2.1 percent. But even big weapons producers felt the pain, with Northrop Grumman down 1.6 percent and Lockheed Martin off 0.7 percent.

Investors' concern "has a lot to do with Gates's move to accelerate his goal to streamline costs," said Mike Lewis, a defense industry analyst at BB&T, who follows a dozen government contractors. "There's a great deal of uncertainty of how the Pentagon will implement his mandates."

On Monday, Gates said he would cut thousands of jobs, including a 10 percent reduction annually over three years in the funding for the Pentagon's private contractors and U.S. Joint Forces Command, a major military command in Norfolk that employs 6,100 contractors, civilians and military personnel.

"The industry is nervous that there'll be an irrational response by Pentagon workers where they start slashing contracting jobs just to slash them, to meet the numbers," Lewis said. "They're concerned about how it's going to impact them. Investors are perceiving that the headwinds in defense are too significant."

Some industry experts say Gates's 10 percent cut in contractors will affect those who do such work as maintenance and upgrading of computer networks, upkeep at military bases and command posts, intelligence analysis, and cyber-security work.

"It's good news and bad news for the defense industry," said Loren Thompson, who is a consultant to several major defense contractors, including Lockheed Martin, General Dynamics and BAE. "Those who provide administrative support like contract administration, or other white-collar jobs that are service-related to support the Pentagon bureaucracy are going to be hit."

"Big hardware producers who make weapons may be winners in this because [Gates's] whole point in this is to free up money for military modernization," Thompson said.

One problem defense industry analysts point out is that Gates has struggled to get a handle on just how many contractors the Pentagon has, so the 10 percent goal is hard to size up. By one estimate, the Pentagon has 790,000 contractors, according to Winslow Wheeler, a director at the Center for Defense Information and a budget expert.

So while that number would suggest that Gates could be targeting 79,000 private-sector jobs, Wheeler said the math may not be so straightforward. "None of the money [Gates] seeks to save with these efforts would leave the defense budget; he simply wants to transfer overhead spending to other parts of DOD," Wheeler said.

For defense companies, Gates's latest round of proposed cuts comes after they have shifted their business strategies to respond to a Pentagon that had been seeking to outsource more, not less, of its bureaucracy. Many of the big weapons makers had beefed up their government-services businesses to respond to increased demand after the Sept. 11, 2001, terror attacks. Now that sector could shrink.

The defense industry's biggest trade group, the Professional Services Council, said it is concerned about how Gates came to his decisions for the cuts and called the proposed reductions "arbitrary."

"The worst case is that the full functions of work being done by contractors won't be done at all or shifted to federal employees," said Alan Chvotkin, the trade group's lobbyist. "That will clearly be a loss of jobs, a reduction in the workforce, and for some companies, it could mean they go out of business if DOD or [Joint Forces Command] is your sole source of business."

Some contractors say they have already felt the hits of Gates's previous attempts to cut costs.

Dyson Richards, executive vice president of the government contracting firm RGS, in Arlington, said his company has lost about $3 million worth of business as the Navy moved to reclaim work it had once outsourced. The two contracts were to manage a mix of complicated information technology systems. Richards said he wasn't given a clear reason the government thought it could do the work better and wasn't informed of the cost savings it would produce by insourcing the work.

"I'm torn," Richards said. "I agree in principle that we don't have the money that DOD has been spending. There is a lot of fat to be trimmed, but I don't think they're using a scalpel to decide how to do it. They're using a hatchet."

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