This $2 Billion Deal Could Be Worth a Lot More to General Dynamics

Rich Smith, The Motley Fool

The good news for General Dynamics (NYSE: GD) just keeps getting better.

Just five years ago the American defense contractor best known for its M1A1 Abrams tanks was laying off workers and facing an existential crisis. Decades of buying main battle tanks had left the U.S. military well-stocked with the armored beasts. However, since the collapse of the Soviet Union and the (repeated) defeats of Saddam Hussein's Iraq, the U.S. Army was running out of other tanks to shoot at! With no need to buy new tanks, the Pentagon was curtailing purchases, and General Dynamics had to consider mothballing its Lima, Ohio plant -- the last operational tank factory in the U.S. -- for want of new orders.

But then a miracle happened -- several miracles, in fact.

Tank rolling across desert

Image source: Getty Images.

First, to combat ISIS, Iraq's military (now under new management) asked Congress for permission to buy nearly 200 new Abrams MBTs in 2015. A year later the Saudis came knocking, seeking 150 tanks for their army. Then Kuwait wanted 200. And within no time at all, both Morocco and the U.S. Army itself placed orders to upgrade hundreds of Abrams tanks that they already owned.

"Tanks" for your support!

Thanks to the ever-volatile Middle East, tanks are back in demand!

And not just for operations in the Middle East. Last week we learned of yet another large order for Abrams MBTs, and this time it's the nation of Taiwan that wants to give General Dynamics its business. According to a Defense Security Cooperation Agency notification to Congress, Taiwan is asking for permission to purchase 108 M1A2T Abrams Tanks from General Dynamics, along with thousands of rounds of tank ammunition, light weapons including machine guns, and grenade launchers -- basically all the accoutrements necessary to help those tanks go "boom!" upon command. 

Taiwan's shopping list, which totals $2 billion in all, also includes orders for 14 M88A2 HERCULES tank-salvaging vehicles built by BAE Systems, and 16 M1070A1 Heavy Equipment Transporters from Oshkosh. (A related DSCA notification describes a separate request for permission to purchase 250 Stinger antiaircraft missiles from General Dynamics peer Raytheon for $223.6 million, but those won't be loaded on the tanks.) 

What it means to General Dynamics

The total value of the tank deal being negotiated with Taiwan comes to $2 billion, although not all of this cash will go to General Dynamics -- BAE Systems and Oshkosh will certainly want to be paid separately for their Hercules and HET vehicles. Still, the 108 Abrams main battle tanks stand at the heart of this deal.

Even without seeing the tank prices broken out, it seems likely General Dynamics will claim the bulk of the proceeds of this sale. Assume even just half the $2 billion price tag goes to General Dynamics, and assuming the 15.4% operating profit margin earned by the company's combat systems division (which builds the Abrams), this deal should yield in excess of $150 million in profit for General D, and perhaps much more. 

In the context of General Dynamics' $4.5 billion in annual operating profit, this is a small but not insignificant contribution to the kitty -- about 3% of one year's profits. Arguably even more important is the fact that at Lima's current production rate -- about 11 main battle tanks per month -- this sale to Taiwan promises to keep the lights on and the production lines rolling in Lima for another 10 months. 

That's 10 more months General Dynamics gets to postpone the estimated $800 million cost of winding down operations, then later having to wind them back up again once tanks come back into vogue. And it gives General Dynamics 800 million reasons to say to Taiwan, "we tank you for your support."

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.