The ‘biggest risk’ to defense firms; An AI take on US-China relations; Patriot club set to grow; and more.

For years, the Pentagon’s top officials warned and warned again that budget volatility posed the greatest threat to the U.S. military. Then came the bipartisan funding deal for 2018 and 2019, which freed up time for talking about rebuilding readiness and futuristic projects like hypersonic weapons.

It was nice while it lasted. At Bernstein’s Strategic Decisions conference this week, analyst Doug Harned asked Lockheed Martin leader Marillyn Hewson, “As you look out over the next five years, is there a disruptive force that you might worry about that could pose some risk for your business? What would you see in the next five years that could be an issue?”

You know the answer, right?

“The biggest risk that we face — and we kind of face it every couple of years — in the current environment is sequestration … the budget caps,” said Hewson, Lockheed’s chairman, president and CEO. “Roughly 70 percent of our business is U.S. government. To the extent that we go back down to some budget cap after we get through FY19 — if the lawmakers don’t do something for yet another way to alleviate that budget cap, it’s a pretty significant reduction in not only the budget, but other government entities that we do business with.”

If the budget caps return in fiscal 2020 and 2021, she said, “it wouldn’t hit us immediately because we have a long-cycle business” and about a two-year backlog. Hewson said that its Pentagon and other U.S. defense contracts provide about 59 percent of the company’s revenue, with another 11 percent from NASA and other federal agencies. The remaining 30 percent is international business.

She’s not the only one talking this way; I’ve been hearing similar statements from defense executives in recent weeks. Get ready, because here we go again.

Welcome

You’ve reached the Defense One Global Business Brief by Marcus Weisgerber. As promised, you can listen to Air Force Secretary Heather Wilson on this week’s Defense One Radio podcast. As always, send your tips here and thoughts to: mweisgerber@defenseone.com or @MarcusReports. Check out the Global Business Brief archive here, and tell your friends to subscribe!

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Using AI to Predict Policy Risk

About two months ago, when fears of a U.S.-China trade war were rising, I quoted some predictions by GeoQuant, a New York research firm that uses artificial intelligence to predict policy risk. This week, I asked CEO and co-founder Mark Rosenberg what his algorithms are saying now.

In April, GeoQuant predicted U.S.-China policy risk would escalate as both sides threatened tariffs, but that tensions would stabilize within a month as trade negotiations picked up.

“We still see, relative to that, a de-escalation in U.S.-China trade risk and still see this on a lower risk path,” Rosenberg said on Wednesday. “That said, where it basically settles is still at a place that’s a lot higher than it was say in 2016.

“We’re still talking about an elevated level of trade policy risk between these two major economies, but we don’t see the recent events of the past 24 hours as bringing us back to where we were late last month in terms of speculation around a full-on trade war,” he said.

Rosenberg was alluding to the Trump administration’s declaration this week that it would press ahead with $50 billion in tariffs on Chinese imports, and Beijing’s response that it was ready for a trade war.

And GeoQuant’s daily “external security risk indicator” for South Korea?

“The risk has been de-escalating obviously with the Trump-Kim bromance that was brewing, but we saw it ... going back up around May 12,” Rosenberg said.

The firm put out a report in mid-May that cast doubt on the scheduled June 12 summit in Singapore, Rosenberg said. The AI still sees risk increasing in the months ahead.

“Even though it’s going up, it settles at a point that’s significantly lower than, say, late 2017, when North Korea was firing a missile over Japan every couple of weeks,” Rosenberg said.

Even with AI, he cautioned, it’s hard to forecast what will happen if Trump and Kim, two of the world’s most unpredictable leaders, actually meet.

“Clearly a highly unpredictable situation, and we don’t pretend to have a crystal ball or have any special information about the behavior and calculation of these two actors,” Rosenberg said. “It’s more based on where the risk was at the [recent] height of the conflict and subsequent developments.”

AEI: Pentagon’s Not Funding Its New Strategy

The American Enterprise Institute’s Mackenzie Eaglen has a new report out: “Defense Budget Peaks in 2019, Underfunding the National Defense Strategy.” That itself is no surprise; as we’ve reported, the Trump administration’s budget projections for 2019 and beyond are relatively flat. But here’s what that means for Trump’s promised military buildup, Eaglen writes: “No portion of the president’s initial plan survived contact with reality.” Two other key points:

• “For the second year in a row, the Trump administration’s budget request underfunds procurement in favor of pursuing a capability-centric modernization program, imperiling the future health of the force by underresourcing capacity and the recapitalization of legacy systems.”

• “The three-year streak of defense increases was driven largely by Congress. Policymakers should work to ensure a balanced portfolio of investment to match the defense strategy.”

Sikorsky Primed for Growth

Lockheed has been carefully building up expectations for its helicopter arm in 2018, and so Hewson was asked at the Bernstein conference, “Should we think of Sikorsky now as at a point where it will be growth business from here?” She responded simply: “Yes.”

Turkey and the F-35, Redux

Relations between Washington and Ankara keep moving south, and this isn’t going to turn them around: U.S. senators have proposed legislation that would bar Turkey from buying the F-35 fighter jet, as punishment for its imprisonment of U.S. pastor Andrew Brunson and its purchase of S-400 interceptors from Russia. If that happens, Turkey’s foreign minister said, the NATO ally would turn to Europe or even Russia for weapons.

And folks tend to forget that 10 Turkish companies build parts for the stealthy jet. From the first edition of the Global Business Brief back in July 2016:

Components made in Turkey also include center fuselages; Turkish Aerospace Industries splits the work with Northrop Grumman plants in California. And that’s not all: TAI “currently supplies production hardware that goes into every F-35 production aircraft,” according to Lockheed’s supplier website.

Sweden Could Soon Join the Patriot Club

Sweden is close to signing a $1 billion-plus deal for Raytheon Patriot missile interceptors, according to a Reuters report out of Stockholm. The deal would make the Scandinavian nation the 16th country to buy the Patriot, including newish members Poland and Romania.