Should structure or conduct drive the Pentagon’s supply strategy?

The bids for Sikorsky are in. For United Technologies CEO Greg Hayes, they’re “at least as good as what we had hoped to see.” By the rumors, they’re from Blackstone, Lockheed Martin, Textron, and Airbus. With such a heterogenous set of bidders, a range of strategic and financial considerations are driving the offers. The tax implications are daunting for United Technologies, and even strategically arduous for Textron, so a spinoff remains in the running as the best option for shareholders. But military buyers should also care about just how the structure of the rotorcraft industry could change, and what that could mean for the conduct and performance of all involved.

Sikorsky on the NYSE, as an independent entity, would change little for the buyer. The new company will need to figure out how to pay for some new corporate functions from its existing sales forecast, but as a Fortune 500 in its own right, this would be manageable. It just might not be highly profitable. Sikorsky’s low margins, after all, are what led UT to seek an exit.

Sikorsky, a Blackstone company, in the short run changes little structurally. But private equity investors are unsentimental, and generally have exit strategies too. In Sikorsky’s home state, federal Senator Chris Murphy thinks that the local “physical infrastructure and human capital are unique.” Bell, which actually started in business up there, could today say the same about Texas. Thus Sikorsky’s current cost structure, in high-wage Connecticut, will come under quick scrutiny. Perhaps the company is just to be tightened up operationally, and harvested for cash. Or would the new owners see opportunities in Sikorsky’s new technologies, as in its SB-1 and S-97 compound helicopter efforts? Pentagon procurement chief Frank Kendall professes interest in his suppliers’ independent R&D efforts, so he might care how this company is disposed. Either way, it’s possible that Blackstone will have the opportunity to demonstrate that UT was not the efficient owner of a helicopter company. Perhaps margins are low not because they are structurally low in the industry, but because management had been too attached to its old ways of doing business. It’s an hypothesis that only a multi-billion dollar bet can resolve.

A Lockheed Martin Helicopters solves some long-standing problems for Lockheed, and maybe for customers too. As Byron Callan of Capital Alpha noted, Lockheed’s interest “is not surprising, given its long-standing work on Sikorsky platforms, including the SH-60 program… and the Combat Rescue Helicopter.” As a prime contractor, Lockheed has also screwed up at least two aircraft integration programs—its presidential transport effort with Agusta and its Airborne Common Sensor with Embraer—in large part because the company’s electronics people wouldn’t or couldn’t leverage the experience of its aircraft people. (The Wall Street Journal’s 2006 story about the ACS is illuminating.) With Sikorsky inside, Lockheed next time would have an actual helicopter company to keep it in line.

A Bell-Sikorsky combination would create the largest rotorcraft company worldwide. With $10.8 billion in pro forma 2014 sales, Textron’s combined rotorcraft activities would be almost a third larger than those of today’s Airbus. The two product lines overlap only slightly, and that’s generally viewed favorably in antitrust considerations. But a Bell-Sikorsky would also consolidate most of the US military’s supply of rotorcraft in a single firm. Yes, the Pentagon will still buy its Chinooks, and half of each Osprey, from Boeing. But those are declining lines, and the Future Vertical Lift program is pretty far in the future. On the other hand, the US Army’s enthusiasm for Airbus’s low-cost Lakotas looks set to continue. It’s entirely possible that Airbus would not object to Textron’s buying Sikorsky, preferring this result to a spinoff, private-equity buyout, or vertical integration. As the Pentagon’s dependency on the Texas-and-Connecticut company would be considerable, its immediate solution to re-diversifying its supply lines could be looking closer at aircraft from Mississippi. The Coast Guard, that other military service, has been happy with its aircraft for a long time.

Of course, Airbus + Sikorsky would produce the really huge combination, with $14.9 billion in pro forma 2014 sales. The company would be over two-and-a-half times the size of Agusta Westland, the next largest under such a structure. That figure alone would draw scrutiny, and the more so because Airbus and Sikorsky’s medium-sized rotorcraft are sold to overlapping customer sets. But whatever antitrust attention must be weathered, the deal could be profoundly enticing for the buyer. Expect Airbus’s emissaries to reassure Senator Murphy and anyone else who will listen that New England is a big part of their plans. For with helicopter plants in Mississippi and Connecticut, and that new A320 jetliner plant opening in Alabama, Airbus could make a strong claim to be another BAE Systems—a European company that really needs to be accepted in the US as part of the transatlantic team.

So, against that range of corporate strategies, what should military procurement strategists want? From a spun-off and publicly-traded Sikorsky, military buyers would still get their helicopters. From a privately-owned Sikorsky, the aircraft would still flow, but Pentagon planners and others might consider asking Blackstone about its intentions. A winning bid from Lockheed Martin would still yield helicopters, and maybe fewer fiascos. A winning bid by Airbus might not survive antitrust scrutiny, but it could change Pentagon buyers’ long-run habits, and thus end European complaints about opening the American market. Any amicus brief in that case is a serious strategic choice. The hard choice, though, comes should Textron have the winning bid. While the deal is less objectionable structurally, change in the strategic conduct of the combined seller, and the quotidian conduct of American military buyers, are hard to gauge in advance. Would source selectors seek alternatives, or presume that they didn’t have any?

James Hasík is a senior fellow at the Brent Scowcroft Center on International Security.