Long-standing and attentive readers (H/T History of the Americans Podcast) are no doubt aware of my occasional use of this space for professional commentary, having long ago lost the patience required for onerous editorial processes. My working life has for many years been devoted to American Seapower (hint: I want more of it), and I occasionally feel the need to opine. Those of you looking for commentary on everyday American life, and for whom yet another screed about how gooned up we are when it comes to providing for our Navy would be a form of torture, I recommend skipping this one. Those up for an analysis of an interesting but ultimately disappointing essay, stay with me.
When one’s working life is spent advocating for a larger and more powerful Navy, thoughtful friends and colleagues often forward articles or papers they consider important, sometimes purposely to agitate, and sometimes out of a good-natured sense that I might have missed it in my reading. When the same article is forwarded by several parties, it tends to raise my interest. That is the case with a piece posted at the U.S. Naval Institute website last week entitled “Shareholder Interests Are at Odds with Navy Needs: The Navy encourages shipbuilders to invest in new technology and capacity, but Wall Street sees things differently.”
Written by Martin J. Bollinger, a man with a long association with the Naval Institute and decades of experience in national security consulting, the piece asserts an interesting and on its face, unobjectionable argument; that the manner in which the American shipbuilding industry has evolved since the end of the Cold War (from privately held, stand-alone entities to divisions of larger, publicly-traded conglomerates) has resulted in a situation in which the the long-term interests of the Navy are less well-served by the short term profitability desires driven by the institutional investing class. I URGE you to read the piece before going on further with this one. Then, I commend to you an earlier piece by me in which I go deeply into the points I make more economically here.
The summary of my counter-argument is this, and readers will see it in many of my responses below: While Mr. Bollinger does a solid job of laying out both the history of the shift from private ownership to public, along with his impression of how publicly traded companies behave, he ignores the degree to which the actions of the government drove this evolution (private to public), and that the continuing failure of the government to adapt to new realities is at least as responsible for underperformance in the industry as anything the shipbuilders have done in their pursuit of investor return. In other words, Mr. Bollinger does not adequately consider the demand side of this equation, preferring to concentrate on market-driven failures on the supply side.
I realize that what I’m doing below falls into the category of book reviewer failure known as “reviewing the book I wanted to read rather than the book I read”, but Mr. Bollinger’s treatment of this subject suffers considerably from ignoring the resourcing and demand behavior of the U.S. government.
This isn’t going to be a short post, as I will cadge large portions of Mr. Bollinger’s argument (good stuff and not so good stuff) and comment on it in stream.
Call and Response
Early on, Mr. Bollinger says this:
At the same time, the shipbuilding industrial base is falling short: Programs are delayed, ships and submarines are not being delivered on time, and production capacity fails to meet needs. Navy customers are frustrated. Congress is furious.
Most of this is true. The industrial base IS falling short. Programs ARE delayed. Ships and submarines ARE NOT being delivered on time. And yes, production capacity is not meeting current demand. But why is this? He addresses this in the next paragraph:
How can this be when, not so long ago, the prodigious production capability of the shipbuilding industrial base helped the United States prevail in the first Cold War? Here is the ugly reality: The industrial base that helped win that war is gone. The industry today bears little resemblance to the one that supported the Cold War, not only in its structure, but also in what motivates its owners.
Could it be that the “prodigious production capability” cited was a reflection of the demand placed on the industrial base? Presumably, profits and efficiency mattered then too, right? So one has to assume that the industrial base we wax reminiscent about was as large and capable as it was because there was money to be made in building a large and powerful Navy. That today’s industry “bears little resemblance” to the past is no less a representation of the industrial base’s responsiveness to demand.
Moving on, here is the first paragraph that drew my attention:
Many have offered explanations for production shortfalls. The lingering challenges of COVID-19, labor shortages, and inflation certainly are relevant. But one dimension remains relatively unexplored: the underlying objectives of the shipbuilding industrial base’s current owners—the shareholders. Have their objectives evolved since the Cold War? Are they aligned with those of the Navy and Congress? If not, can the shareholders’ priorities be shifted?
While diving into investor behavior and objectives is interesting, it ignores the signals and environment that said investing community was interpreting, the context. Nowhere does Mr. Bollinger consider the possibility that production shortfalls could be the predictable result of decades of low and or inconsistent demand for ships being replaced by increasingly urgent calls to expand. That the shipbuilding industry sized itself to the demand was EXACTLY what the Navy and the government wanted when the Cold War ended and peace broke out all over. The Navy had no use for excess capacity, and it certainly was not going to pay for it. When China punctured the post-Cold War euphoria and the nation decided it might need a larger Navy (and I stress “might” need, as what seems obvious to me and others has not necessarily translated into resourcing and force level decisions) a finely-tuned shipbuilding industrial base (finely-tuned to meet anemic demand) was unable to quickly expand. That is where we are.
Mr. Bollinger gets to the heart of his argument with these words:
The naval shipbuilding industry also became divorced from the overall economy, part of a broader trend across the defense industrial base. In the 1980s, more than 70 percent of major defense programs originated from large, diversified commercial enterprises that also served defense. That number is less than 10 percent today. As late as the 1980s, about 30 of the Fortune 100 companies had large defense industrial units. Now only four do . The United States entered the novel age of the stand-alone defense specialist.
In the 1980s, only one of the major naval shipbuilders—Electric Boat—was part of a publicly traded company focused on defense. Bath Iron Works and Marinette Marine were privately owned. NASSCO and Avondale Shipbuilding were owned by their employees.
These diversified, private or employee-owned enterprises could elect to take long-term risks without pressure to meet Wall Street’s quarterly cash-flow targets.
And then this gem:
This restructuring was significant, but the ultimate effect was felt after 2008, when the post-9/11 defense-market boom became a bust. Public investors interested in long-term growth and willing to accept high risks in return for potential high rewards abandoned defense company stocks in favor of opportunities in Silicon Valley. New shareholders took their place and directed management to abandon risky growth, instead emphasizing reliable cash generation. They then took that cash to invest in growth sectors elsewhere in the economy. The appetite for risk in defense declined. Capital spending was seen as a negative. In short, investors wanted to treat the legacy U.S. defense industry as an ATM to fund their tech investments.
Essentially, Mr. Bollinger would have us believe that institutional investors walked away from a thriving shipbuilding industry to chase tech investments where they saw the prospect of long-term return.
I’m not sure what post-9/11 defense market Mr. Bollinger was looking at, but any suggestion that 9/11 resulted in a “boom” that extended to the shipbuilding industry is simply wrong. Here’s the evidence:
The plain truth of the matter is that Navy shipbuilding was on life support level acquisition profiles from FY 1993 to FY 2011, and investors could see this. These numbers were choices made by the Department of Defense, and pointing to misaligned incentives between the Navy and institutional investors reveals a shockingly naive understanding of what the goal of investing is. Does Mr. Bollinger really believe that the Cold War shipbuilding industrial base would have fared better during this nearly two decade procurement holiday? And while demand has risen of late, all one needs to do is look at the halving of demand between FY22 and FY25 followed by the whipsaw of a doubling of demand from FY26 to FY 28 (future years) to understand the reticence of investors to support capital expenditures.
Later in the essay, Mr. Bollinger looks at what the Navy’s options are, including public/private ventures and the possibility of taking an existing yard from publicly traded to private, something he refers to below as “…changing the shareholders”.
In the end, if the Navy cannot change shareholder incentives, then it might have to look at changing the shareholders.
While the concept of innovative public/private ventures is intriguing as a means to address what Mr. Bollinger accurately describes the misalignment of objectives between the government and some investors, the suggestion that private equity might emerge as a source of stability perhaps misunderstands the nature of private equity markets and the degree to which investors in this sphere are equally interested in return.
Continuing to cast about for solutions to a problem that ignores the agency of the Navy and government, Mr. Bollinger moves on to the possibility of “Bring(ing) Back Commercial Players”, answering his own question in the process:
This seems highly unlikely. Once a commercial company becomes a major defense contractor, it becomes subject to the alphabet soup of administrative processes (NISPOM, DCAA, DFARS, CAS, etc.). In addition, a large number of presidential executive orders apply only to federal contractors. For many commercial giants, the small DoD market is just not worth the effort to twist their business model to comply with these requirements. On the contrary, there is a continuing departure from defense markets of major U.S. industrial and service companies, including in the past few years Ball Corporation, Jacobs Corporation, Griffon Corporation, and Gulf Island Fabrication. In each case, the parent company divested the business operating in defense, which was then absorbed into an existing defense supplier.
and,
As the company stated in its 2023 annual report: “We continue to follow potential solicitations for [government] vessels that would be compatible with our shipyard and processes [emphasis added].”
Here, Mr. Bollinger casts a sharp eye on the business and regulatory environment that governs American shipbuilding, an environment driven almost exclusively by the U.S. Government and Department of Defense, and identifies contributors to the Byzantine world of doing business with the Department of Defense. But, presumably, it is the duty of the investing class to abide by these strictures and invest into suboptimal vehicles. I would suggest it is the duty of the federal government to remove these barriers in order to attract investment.
The final head-scratcher here is an excursion into attracting “Foreign Production Expertise”, but Mr. Bollinger ultimately de-weights this option thusly:
However, it is hard for foreign companies to bring their manufacturing expertise—and their investment capital—to the United States. Foreign companies must run a gauntlet of approvals by up to six executive branch cabinet departments, including perhaps seven units just within DoD.
Thirty paragraphs into a 34 paragraph essay that essentially lays the woes of American naval shipbuilding at the feet of rapacious capitalists, and the business environment driven by the federal government is identified as a drag on the dynamism of the industry. But then only with respect to the entry of foreign competitors. While the barriers to foreign entry are formidable indeed, the barriers to entry for U.S. firms—not to mention the everyday grind of doing business with the federal government—are considerable.
Conclusion
I am not a financier, and I am not a shipbuilder. I apologize for errors of logic and analysis I may have made in the foregoing. Mr. Bollinger does a service in highlighting some of the changes in the business environment that have contributed to the mismatch in supply side of the shipbuilding industry, but his failure to consider the demand side makes for an unsatisfying read.
For further reading, I point once again to my earlier essay that points at contributions on both the supply and demand side to our current state.
I also recommend an article written by a senior HII Executive who also happens to be a retired navy Vice Admiral who once commanded the Naval Sea Systems Command, Tom Moore. “A Path to the Force Structure the Navy Needs” is not only a wise proposal to build a larger Navy, it is exactly the direction the country should consider in order to more closely align Navy objectives with portions of the investing class. I urge the Naval Institute to take this piece from behind its paywall.
There will always be a place in a balanced portfolio for dividend paying large cap stocks, and our shipbuilders and their parent companies can and should be exactly that. Building a larger Navy will accomplish this, along with the not unimportant fact of a larger Navy. Shipbuilders are not the Magnificent Seven, and they should not be compared to them.
I’m a retired shipbuilder and this article is spot on. Several shipyards HAVE invested in capital improvements despite the fickle demand signals from the Navy, and if their quarterly financial results are disappointing they get hammered hard by the market. The next time you write about the industry, please include a picture of Ingalls for equal time. 😃
I remember the Bath Iron Work slogan as: We Build Good Ships And Make Money. We Build Good Ships If We Don't Make Money.
I have some sympathies for Mr. Bollinger's viewpoint.
I fear the only action that will identify what the nation needs from the navy is a horrible peer to peer war. Please No!