Wall Street and the Pentagon The Economic and Business Outlook for the Defense Market David J. Berteau July 19, 2010 Presentation to the National Contract Management Association

2  PART ONE: The Economic and Business Outlook for the Defense Market  PART TWO: The Effects of Policy on the Financial Health of the Defense Industry  PART THREE: How Does the Market View the Defense Industry? AGENDA:

3 Part One: Defense Outlays and the Federal Budget Deficit Source: OMB; CBO; analysis by CSIS Defense-Industrial Initiatives Group

4 The Near-Term Challenge: DoD Budget Authority, Including Supplementals (current US$, bn) Source: DoD Comptroller; analysis by CSIS Defense-Industrial Initiatives Group

5 Part Two: The CSIS Defense Index CSIS selected 34 companies (including legacy companies) that reflect the diversity of the industry supplying the Defense Department Revenue: ~$100m to $45bn+ Electronics to heavy metal Both products and services Companies added as data become available Benchmarked to S&P 500 and S&P 1500 Industrials – broad mix of products and services and company size

6 Operating Margins, including CSIS Defense Index (revenue weighted) *Excluding Defense ** Excluding Defense & Financials Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group

7 Cash Flow Return on Investment (CFROI), including CSIS Defense Index (revenue weighted) Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group *Excluding Defense ** Excluding Defense & Financials

8 Part Three: What Do Investors Think? Key Points: 1.Wall Street is a short-term actor with a long-term view. 2.Investors’ perception is that the defense budget has peaked and, as a result, that revenue growth for defense companies may have peaked as well. 3.Current P/E multiples have already priced in not only a significant reduction in the top-line budget but also program uncertainty. 4.Markets are concerned with U.S. fiscal austerity—deeper cuts in defense budgets? 5.Investors are concerned that DoD does not have a contingency plan to preserve critical niche capabilities.

9 Index Performance, = 100 Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group 1999=100

10 Defense Stocks Performance Parallels the Broader Market 2010 Index Performance, Year-to-Date (2010 = 100) Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group

11 Index Performance, (2010 = 100) Source: Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group

12 P/E Multiples: Price / Trailing 12M Earnings (as percentage of S&P 500 P/E) * Big 4: Lockheed Martin, Raytheon, Northrop Grumman, General Dynamics Source: Standard & Poor’s, Bloomberg, analysis by CSIS Defense-Industrial Initiatives Group

13 About CSIS At a time of new global opportunities and challenges, the Center for Strategic and International Studies (CSIS) provides strategic insights and policy solutions to decisionmakers in government, international institutions, the private sector, and civil society. A bipartisan, nonprofit organization headquartered in Washington, DC, CSIS conducts research and analysis and develops policy initiatives that look into the future and anticipate change. Founded by David M. Abshire and Admiral Arleigh Burke at the height of the Cold War, CSIS was dedicated to finding ways for America to sustain its prominence and prosperity as a force for good in the world. Since 1962, CSIS has grown to become one of the world’s preeminent international policy institutions, with more than 220 full-time staff and a large network of affiliated scholars focused on defense and security, regional stability, and transnational challenges ranging from energy and climate to global development and economic integration. Former U.S. senator Sam Nunn became chairman of the CSIS Board of Trustees in 1999, and John J. Hamre has led CSIS as its president and chief executive officer since April 2000 CSIS does not take specific policy positions; accordingly, all views expressed in this presentation should be understood to be solely those of the author(s).