For United Defense Industries stockholders, the future payoff on their investments comes down to this: Can the Big Guns save the Big Gun?
United Defense's gun is the Crusader, which -- if it is ever built -- will be the straightest-shooting, fastest-firing, most sophisticated heavy howitzer in the history of warfare.
As far as Defense Secretary Donald H. Rumsfeld is concerned, the history of war is the only place for cannons like the Crusader. He has vowed to spike the gun, which critics say would have been the ultimate weapon of World War II. It's the ideal way to stop a column of tanks roaring across Europe, capable of blasting them with high explosives 10 times a minute from 30 miles away. But tanks aren't much of a threat in Europe anymore, though, and critics say the Crusader doesn't have much of a mission in war as it is now waged.
Since the Bush administration took aim at the Crusader last month, shares of United Defense have fallen from nearly $29 a share to under $22.
Without the Crusader, United Defense is worth no more than $18 to $19 a share, calculates Credit Suisse First Boston analyst Pierre A. Chao, who was quick to downgrade the stock when he learned that the $11 billion project was in trouble.
Though critics say the Crusader is a weapon out of the past, it was the weapon of the future for United Defense. The Pentagon has been paying United Defense for years to develop the gun, and production was getting close. Crusader contracts were one reason that United Defense's first-quarter revenue grew 22 percent, to $356 million, and profit nearly quadrupled, to $19 million from $5.1 million.
Losing the Crusader contract would be a major setback for investors who bought United Defense stock after the company went public in December at $19 a share.
But the company's biggest stockholder made a bundle on its investment in United Defense even before the public offering, and stands to make hundreds of millions more even if the Crusader is killed.
United Defense is controlled by the Carlyle Group, the investment firm that symbolizes the marriage of politics and money in Washington.
The firm has hundreds of employees, partners and managing directors all over the world. Its biggest names are former secretary of state James A. Baker III, former defense secretary Frank C. Carlucci and former Office of Management and Budget director Richard G. Darman. The first President Bush is a part-time consultant and sometime ambassador for Carlyle.
The real boss is less well-known outside financial circles: William E. Conway, who was chief financial officer at MCI Communications Corp. before he helped found Carlyle 15 years ago.
Carlyle, the biggest investment firm based in Washington, manages more than $12 billion for its clients and investors, many of them from the Middle East. Like other firms in the business, Carlyle collects fees from investors for managing their money and collects more fees from companies it invests in. The real money, however, is made when Carlyle cashes in its investments, selling companies it owns to the public or to other investors.
Carlyle bought United Defense five years ago in a classic leveraged buyout, putting up about $180 million of its own money and borrowing another $700 million or so.
Carlyle has since taken $380 million in cash out of United Defense and collected another $225 million by selling some of its United Defense stock. Carlyle still owns 47 percent of United Defense, a stake worth around $500 million.
In round numbers, Carlyle has gotten its initial investment back, collected more than twice that much in cash, and still holds half a billion in equity in United Defense. That is roughly a 5-for-1 payoff, which is the kind of return that wealthy investors hope for when they park their money with someone like Carlyle.
Carlyle proved how savvy it is when United Defense made Pentagon contractors one of its top investment strategies, but the Crusader crisis has forced investors to look much harder at the long-term prospects of United Defense, which so far has not given public stockholders anything close to the payoff Carlyle has had.
The Crusader also focuses attention on another big Carlyle bet on defense, which the company is now trying to cash in.
That venture is called United States Marine Repair Inc., a string of dry docks and ship-fixing facilities that depends on the Navy and other government agencies for 90 percent of its business.
United States Marine Repair has filed a preliminary prospectus with the Securities and Exchange Commission for an initial public offering. The company has not yet revealed how many shares it wants to sell or at what price. But the first draft of the documents does disclose that Carlyle hopes for another quick payoff. The firm wants to cash in immediately by selling part of its stake in United States Marine during the IPO.
United States Marine has acquired shipyards in Norfolk, where it is headquartered; at Pearl Harbor in Hawaii; at Ingleside, Tex., near Houston; and in California, at San Diego, San Francisco and San Pedro.
Work for the Navy brought in three-quarters of United States Marine's $390 million in revenue last year. Add contracts for the Coast Guard, the Military Sealift Command, the Maritime Administration and the Army, and the government accounts for 91 percent of revenue.
United States Marine says it collected about 25 percent of all the money the Navy spent with private-sector companies on ship modernization and repair in the last fiscal year. It has won nine of the 13 multi-ship, multi-year contracts awarded competitively by the Navy since 1997. And, the prospectus notes, there is "significant future revenue opportunity" in the Navy's plan to modernize its guided-missile cruisers.
Carlyle's Washington skills are even more important to United States Marine, Pentagon reporters say. Politics plays a part in a lot of defense contracts, and there is more politics in shipbuilding than in any other other sector of Pentagon procurement.
Such are the underpinnings of any decision to buy a company like United Defense or United States Marine. The question is whether Carlyle is wired into Washington well enough to pick the right defense contractors to invest in, or is influential enough to assure that its offspring keep getting pieces of the Pentagon pie.
At United Defense and United States Marine, Carlyle has put together what look like Washington dream teams or, if you are more cynical, the personification of the military-industrial complex.
Both companies are run by former politicians, money men, industry professionals and retired Pentagon brass.
For Carlyle, Carlucci and Conway are the key players on both companies' boards; they're backed by other board members, mostly younger Carlyle partners.
Carlyle recruited top defense-industry executives to run the two firms. At United Defense, the professionals are mostly from FMC Corp., which was one of the previous owners of the company. At United States Marine, the management is a mix of defense industry pros and people who used to work for the ship shops that Carlyle acquired.
The generals and admirals who round out the teams are as impressive a list of client liaisons as you could put together. William A. Owens, former vice chairman of the Joint Chiefs of Staff and a United States Marine director, knows how to talk to the Navy about ships. John M. Shalikashvili, former chairman of the Joint Chiefs of Staff and a United Defense director, is an even stronger link to the Army on land weapons issues.
Top Army brass want the Crusader badly enough to have gone behind the backs of their civilian bosses to talk to Congress about preserving the gun after Rumsfeld put it in his sights.
Political connections in Congress are the only way Carlyle can save the Crusader now that the White House has turned its thumb down on the big gun. The pols are more than ready to help. Within half a day after Rumsfeld announced his intention to kill the Crusader, Rep. J.C. Watts (R-Okla.) got language into legislation that would preserve the weapon. You shouldn't have to ask in whose district the Crusader would be built.
Chao, the analyst, last week outlined three scenarios for the Crusader fight:
* The White House succeeds in eliminating the weapon from the defense budget and United Defense collects one last payment -- a contract cancellation fee. Since military reformers have long considered the Crusader outmoded and the White House agrees, that's probably the most logical outcome. Remember, however, that Congress just passed a multibillion-dollar farm bill for which no one could muster any justification except "it's good for the people who elected me."
* The projected is canceled, but because of procedural screw-ups, United Defense goes to court and years of costly legal battles ensue. It would not be the first time.
* The Crusader stays in the budget, perhaps for less money. Under that scenario, another president would learn just how difficult it is to kill any Pentagon weapon, and the public would see yet again why President Eisenhower first warned about the influence of the military-industrial complex.
The betting on Wall Street seems to be that the Crusader is history. Like Las Vegas oddsmakers, however, the stock market adjusts for every development, so United Defense's share price is likely to remain volatile.
The fight over the Crusader will be a real test of Carlyle's clout. The team it's assembled at United Defense shows that Conway, Carlucci and company know how to prepare for such battles as well as anyone in town.