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Frank Kendall speaks out on buybacks, consolidation

Frank Kendall is in an awkward position. He is the guy at the Pentagon with the checkbook, the under secretary for acquisition, technology and logistics. That gives him a lot of power with the defense industry, as he represents its No. 1 customer — the U.S. taxpayer.

At the same time, he has less money to spend than he used to, and even less than he expected to have. "We're sitting here under the threat of this crazy sequestration thing, which is frankly crippling to the department," he said.

It's made even worse because Congress has yet to come up with a full-year budget, meaning the Defense Department will have to operate under last year's budget, forcing Kendall to cut $20 billion in spending he'd been planning on.

"I would personally prefer to see them making capital investments, doing research and development, to get ready for the next round of defense budget increases, which is inevitably going to occur at some point." -Frank Kendall, Defense under secretary for acquisition, technology and logistics

For defense companies, that means less money coming in and less stability for predicting what the Pentagon will do. As a result, the biggest industry players have been busy adding billions of dollars to their share buyback programs to help shore up stock prices. Lockheed Martin is about to close on its acquisition of helicopter maker Sikorsky, which could portend a wave of consolidation among big players.

Kendall is not a fan of either move.

"For-profit companies are financially motivated," he said, adding that defense companies are a little different, since most of their profits come from taxpayers. Lockheed Martin is using some of those profits to add another $3 billion to its share repurchase program. Northrop Grumman announced that it plans to buy back an extra $4 billion worth of shares.

"They're free to do that," Kendall said. "I would personally prefer to see them making capital investments, doing research and development, to get ready for the next round of defense budget increases, which is inevitably going to occur at some point."

In response, Northrop Grumman spokesman Randy Belote said the company's priorities with capital are "to be investing in our business, managing the balance sheet, maintaining a competitive dividend and returning excess cash to our shareholders though share repurchases. We believe these priorities are serving our shareholders and the company as well."

Analyst Howard Rubel at Jefferies thinks Kendall is misguided. "Pentagon officials ought to take a lesson in economics to understand how the capital markets work," he said, "rather than come up with these statements that are really devoid of understanding economics."

Kendall feels it is his responsibility to weigh in. "I'm very concerned about U.S. technology superiority, and I look at the modernization programs in China in particular, and Russia. I think we have cause to be concerned," he said. "One thing that can give us a head start is the independent investments industry makes to prepare for the next round of defense budget increases."

The under secretary has ruffled feathers with a program that would require defense companies to run any R&D projects by the Pentagon first if they expect to be reimbursed down the road.

"The initial idea I had was to have sponsorship; that was seen as being like approval," he said. Now he's trying "something with a lighter touch, which is basically like, the government has to be briefed."

The reaction from the defense contractors? "Industry is mostly relieved I didn't do something worse for them," Kendall said.

Sikorsky S-97 Raider helicopter
Source: Sikorsky
Sikorsky S-97 Raider helicopter

Then there's the issue of consolidation. "It's not necessarily best for the government to have that happen," Kendall said. After Lockheed Martin got Department of Justice approval to acquire Sikorsky from United Technologies, Kendall became concerned that soon the Pentagon will only have two or three very large contractors to buy from, giving him less buying power. But there's little he can do to stop the acquisition, and that is something he'd like the change.

Kendall thinks having competition in military contracts could be considered national security, and that's a tool he'd like to have the next time two companies plan to merge.

"I'm working with my staff, and I'm working with Congress, and I'll be making some recommendations to Congress about what they might do along those lines," he said.