Investing in the Defense Sector of Tomorrow


By Lori Ann LaRocco, CNBC Sr. Talent Producer

NEW YORK (CNBC) -- Cutbacks in defense spending have been hanging over the sector for about a year now. Wall Street waits to see when the axe will fall. But that doesn't mean investors should be sitting around waiting for it to happen.

There is always opportunity hidden in times of uncertainty. You just need to know where to look. Secure Strategy Group co-founder and former DHS Assistant Secretary Robert Liscouski and Secure Strategy Group co-founder Scott Greiper both took the time to answer my questions on where the smart money is going in the defense sector.

Secure Strategy Group is a strategic advisory firm which invests in the security and defense sector.
More from CNBC
Bernanke's Mystery: 12 Out of 13 Major Firms at Risk in 2008
Global Unrest Slams Markets
What Do You Have To Do To Get Fired By The FBI Anyway?

LL: In my column Wednesday, the National Taxpayers Union broke out their cost analysis of the State of the Union and they told me the President's cost-cutting measures on defense will save $15.6 billion. Even though there will be cuts, demand will continue for defense products. What are the technologies and services of tomorrow that will continue to grow despite these cuts?

RPL: Even with the defense drawdown, there will be more emphasis on technology -- replacing people with surveillance and sensor networks for example. It is likely that contractors will replace USG/DoD personnel -- i.e. Dept. of State/Diplomatic Security Service is taking on the role of force protection for U.S. interests and augmenting the Iraqi forces providing that protection. That will be done predominantly through contractors.

SG: We see continued demand for rapid response and reconnaissance capabilities such as UAVs, helicopters and robotics. Additionally while there will be deep cuts in future combat systems programs, we think there will be demand for legacy systems such as the Stryker and Bradley fighting vehicles, and modernization programs that can extend the life and utility of current equipment.

LL: Analysts say the tightness in the defense budget is already baked into the defense stocks. Do you think the headwind facing these stocks is as bad as the markets are projecting?

SG: We agree that the defense stocks have in large part "baked in" budget tightening/cutting, as the issue has been in the public domain for well over a year now.

However, the uncertainty of the timing, scope and details of budget reduction is what continues to impact these stocks. The bloom is clearly off the rose for the public defense stocks as we've come out of the accelerated spending cycle of the 2000s. However, uncertainty is always a market killer because it hurts the ability of portfolio managers to quantify risk. This is a variable that continues to impact defense stocks.

LL: With the budget cuts, there will be more jockeying for the government contracts. How much pricing pressure do you anticipate this will have on margins? Will they go higher? Or have they troughed?

RPL: No question this has an impact on pricing -- there has been downward pressure on labor rates for government contractors and this will increase given the prospective pay freeze in USG. Furthermore -- there is more teaming going on because the government is taking a very aggressive approach to putting out multiple award IDIQ (Indefinite delivery/indefinite quantity) contracts and further forcing competition for the work as the task orders come out.

SG: We believe that the DoD will move towards greater implementation of fixed price contracts to reduce risk. This will negatively impact margins.

-- Written by Lori Ann LaRocco of CNBC

CNBC is a world leader in business news, providing real-time financial market coverage and business information.

More from Opinion

Throwback Thursday: Intel Edition

Throwback Thursday: Intel Edition

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Wednesday Wrap-Up: GE and Facebook

Wednesday Wrap-Up: GE and Facebook

PayPal Strikes Again, Facebook, and AT&T -- 3 Tech Stories You Must Know

PayPal Strikes Again, Facebook, and AT&T -- 3 Tech Stories You Must Know