Air Force Tanker: Congress Investigates While Analysts Weigh In

AP

Northrop Grumman

The House Air and Land Forces Subcommittee is holding a hearing today on how the Air Force Tanker selection process went so wrong. Fifteen minutes into the hearing, they had to adjourn to go vote on other matters. But they'll be back.

However, the best part of the hearing, in my opinion, is going to be behind closed doors. That would include questioning of Air Force acquisition official Sue Payton, who ran the bid contest which went to Northrop Grumman/EADS . The GAO accused the Air Force of not being honest with Boeing , and now the Pentagon has taken the decision-making process away from the Air Force. I would very much like to hear her tell her side of the story, but alas, for security reasons, we won't hear it.

Before congressmen had to leave to vote, Dan Gordon, deputy general counsel at the Government Accountability Office, gave brief remarks. He explained the process they went through in evaluating Boeing's challenge. Gordon said in order to be fair, the GAO allowed all parties "to make voluminous submissions" and held hearings over five days which included eleven witnesses from the Air Force chosen by the Air Force. Boeing and Northrop Grumman were given the opportunity to have witnesses, but declined.

Gordon summarized (you can hear in the clip) that the GAO only found a flawed process, it passed no judgment on the tankers themselves.

The second clip is of Gordon on why the GAO was concerned with the Air Force giving Northrop extra credit for having a larger plane.

WHAT THE ANALYSTS ARE SAYING

Merrill Lynch: Boeing win not in the bag. The Merrill report says that while "this opens the door for a Boeing victory...the selection criteria could change to favor Northrop. By no means is a Boeing win in the bag."

Merrill does not expect a split buy. And the report says there is more at stake here than just the tanker. "A Northrop victory would allow Airbus to set up a wide body jet final assembly line in a dollar-zone region, providing much needed exposure to U.S. dollar based costs. For Boeing, the tanker allows the 767 line to stay afloat, enables the commercial 767 line to share the costs of the line with the military aircraft and also offers an offset to C-17 and F-18 sales, that are set to decline early next decade."

Oppenheimer: Northrop still may have an edge. "Comments by Gates and Young indicated that they don't see the Air Force's acquisition process as 'fatally flawed'," the Oppenheimer report says. "Instead, they'd like to leverage as much work done thus far as possible and given the Air Force selected NOC in the first go-around, we continue to view them as the favorite, though we'd be surprised to see any fully resolved contract award before late spring of 2009."

The report says when the public sees the new "rules for procurement" (RFP)--basically the specs the Air Force provides on a new tanker--Oppenheimer wouldn't be surprised if one of the bidders protests the new rules. Analysts also wouldn't be surprised if there was yet another challenge to the eventual winner. "At present, there exists little downside for either NOC or BA to protest an unfavorable outcome, which could bring us into late-spring/early summer 2009 for any final decision on the program."

Finally, Oppenheimer believes the program is worth $3-$4 a share for Boeing, $5-$6 for Northrop Grumman. "However, for BA, the win (or absence of an NOC win) is important for the potential cash-flows from the tanker but also the ability to impede any Airbus manufacturing inroads in the U.S."

Bank of America: The Bottom Line is Price.BofA analysts expect both bidders to fight to present the most affordable plane. "The upshot of this recompete is that the contractors will have to become more aggressive on the pricing of their bids: since the two offerings were similarly priced in absolute dollar terms, despite the NOC/EADS KC-30 aircraft being larger, we think that this may particularly apply to Boeing." The report adds this could help. "With the full backing of senior management, the defense bid team may now see reduced friction with the commercial business in this regard."

BofA doesn't expect Boeing to change from offering a 767 to a 777. "Given the customer desire to conclude this contest, switching horses at this late hour would be technically risky and could potentially be seen as a delaying tactic, which might not favor Boeing in the long-run."

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