Motivated by a sense of the unravelling of the European Union in the face of the clear and present danger of Russia, NATO leaders at last week's NATO summit in Warsaw affirmed for the second time their committment to spending 2% of their GDP on defense by 2020. Other manifestations of a renewed NATO included the approval of permanent NATO troops in the Baltics and Poland and the symbolic gesture of the admission of the last Balkan country, Montenegro, to the Allliance.
According to NATO figures, the 28 countries of NATO collectively spend $US 900B annually on defense with US spending of $650B comprising 72% of that amount.
In 2015, only the US (3.6%), UK, Greece, Poland and Estonia met the unanimously agreed NATO guideline that individual nations will spend at least 2% of their GDP on defense. Only six nations met the further standard that at least 20% of defense spending must go towards equipment: US (26%), Poland, UK, France, Turkey, Norway and Luxembourg.
Translating GDP% to the dollars required to meet the goal shows the potential impact of additional spending on the defense industry. In dollar terms the individual nations are underspending from the NATO guideline by a total of $109B annually. Given the 20% equipment spending minimum, there is potential for at least $21B more spending annually on hardware when and if NATO countries meet their goal.
In the face of Brexit, flat economies, the worst migration crisis since WWII and serious internal terrorist threats, meeting this financial goal will be a challenge. However, we think that European defense spending will increase because it has to. First, the Russian threat is real. Second, this is going to be a central element of policy of whoever wins the next US election. One of the few things that Hillary Clinton and Donald Trump actually agree on is that Europe must do more for itself. Domestically this will become a mainstay of future US policy and thus NATO policy regardless of the election winner in November.
NATO nations will naturally try to focus any increased spending on indigenous industry. In general, the strategy of keeping increased defense Euros and pounds at home will work with respect to shipbuilding and vehicles but not when looking at fighters and missile defense.
Fighters. The star of the Farnborough airshow is the F-35. LMT and its partners, UTX, NOC, BA, not only have the only Western fifth generation export aircraft, they also have well developed local production partnership programs with all of the key NATO buyers (UK, Norway, Turkey, Italy, Netherlands, Belgium and Denmark) that allows partners to keep some of the increased spending at home. UK industries, for example, reap ~15% of each F-35 sale. While Canada currently appears to be backsliding on its committment to buy 65 F-35s, it is now facing the loss of $930M in F35 contracts as a consequence. No matter what happens, the Canadians will be buying American, as their alternative is BA's FA-18E/F.
Missile Defense is a critical and controversial need for each of the NATO countries allies close to Russia and a likely focus of increased NATO spending. LMT is a critical partner with German MBDA on MEADS (Medium Extended Air Defense System) which is the prime European competitor to RTN's venerable Patriot radar system (uses LMT's PAC-3 missile) in this critical area. Moreover, the thirteen nations globally that already use the Patriot system are likely customers for needed upgrades to the radar, where RTN would appear to have the inside track.