Pentagon’s woes are Sikorsky’s woes

The Sikorsky HH-60 helicopter, a derivative of UH-60 Black Hawk

Washington – Restrictions on Pentagon spending and uncertainty over federal government budgets are key reasons the company is considering selling or spinning off Sikorsky Aircraft, United Technology CEO Greg Hayes said.

“Defense spending is going to be the governor of growth for them,” Hayes told CNBC. “As much as I like doing business with the DOD, there is huge uncertainty, as well as the margin cap.”

About 70 percent of Sikorsky’s sales are to the defense department. Unlike commercial sales, the amount of profit a company can make in a military sale is limited.

“The government looks at your books and decides how much profit you can earn,” said Senior Defense Analyst Rob Levinson of Bloomberg Government. “You can’t just charge whatever you want.”

As far as Sikorsky is concerned, Hayes said, “it has a very solid future, but a very different future because of the DOD.”

Hayes highlighted Sikorsky’s contract to make a new presidential helicopter and, in partnership with Lockheed Martin, a new combat search and rescue helicopter for the Air Force. But analysts said the Pentagon demand for Sikorsky helicopters has decreased and is slated to slump further in the future.

Loren Thompson, a defense analyst with the Lexington Institute, a Washington-area think tank, said, “Sikorsky’s problem is its somewhat unpredictable government customer.”

Under budget duress, the Pentagon is shrinking the Army, Sikorsky’s best customer. The Defense Department is chafing under budget caps — and if those caps are broached, across-the-board spending cuts will be implemented. That’s hurt procurement.

Thompson said important defense programs Sikorsky was counting on never materialized.

One was the Army’s plan for a new Armed Aerial Scout helicopter, which fell victim to budget cuts.

“It simply disappeared,” Thompson said.

Sikorsky also lost a contract to supply Afghan troops with helicopters to a Russian manufacturer.

Citing budget problems, the Navy nearly canceled an order for 29 Sikorsky Sea Hawks last year. The fact the Navy would have had to pay a $250 million termination fee to Sikorsky helped change its mind and preserve the order.

Sales of Sikorsky’s famed UH60 Black Hawks to the Army are scheduled to dwindle. President Obama’s 2016 budget, which is likely to be trimmed by Congress, calls for 94 UH60 Black Hawks, another 60 in 2017, and 72 in 2018. But then numbers drop. The Army said it would only purchase 37 helicopters in 2019 and 38 in 2020.

“Pentagon spending is cyclical,” Levinson said. “How long was (UTC) going to wait for things to change again?”

Although the prospect of an outright sale of Sikorsky is still on the table –UTC said it would make a decision by June and carry out that decision by the end of the year – analysts see a spinoff of the company as more likely, and that has been the scenario most often mentioned by Hayes.

“They will probably spin it out because it’s a bad time to sell in the helicopter business,” said George Ferguson, Senior Aerospace Defense analyst at Bloomberg Intelligence.

Not only are military sales down, but the commercial market is also faltering, Ferguson said.

One major non-defense purchaser of helicopters is the oil industry, which has cut back on production – and the purchase of helicopters – because of the sharp drop in the price of oil.

Ferguson said expensive planes like the F-35, whose engines are built by another UTC company in Connecticut, Pratt & Whitney, and construction of nuclear subs, like the ones built by Electric Boat in Groton, are priorities for the Pentagon, eating up its budget and leaving little room for helicopters.

Hayes said one reason Sikorsky doesn’t fit well in the UTC portfolio is that it produces “platforms” not “systems.” A platform is the finished product, like a helicopter. Meanwhile Pratt & Whitney, Otis, Carrier and UTC Aerospace Systems make systems that are installed in other companies’ completed products.

But Ferguson said Hayes’ concerns about keeping a stellar UTC margin is the main reason he’s looking to change the company’s relationship with Sikorsky.

“Since (Hayes) is just coming in, he has a shot to get rid of it as a legacy of a predecessor and improve the budget margin,” Ferguson said.

Sikorsky has been a UTC company for 86 years. Hayes’ predecessor, Louis Chenevert sold many UTC businesses, including rocket engines and fuel cells, but he never shed a franchise like Sikorsky.