When the US Wobbles On Iran, These Companies Suffer

The Times of Israel recently reported that Saudi Arabia and Israel are coordinating attack planning against Iran should the West (meaning the U.S.) back down and allow for unacceptable development of Iranian nuclear capability.  This situation will have major implications for investors.

Here is our assessment.

Iran will NOT attack Israel because:

  • The IRGC (Revolutionary Guard) controls the economy and has the weapons; the religious leaders do not.
  • A missile leaving Iran has to cross over at least two countries to hit Israel (see the map below).
  • In terms of an attack from the sea, Iran has 3 old Kilo (Russian) subs that would have to transit through a 25-mile choke point into the Red Sea and still have to fire over Egypt (again see the map below).

Iran doesn’t want war. What Iran really wants is a stronger negotiating position for rapprochement with the U.S. and influence in the Middle East.  

Brinksmanship is the order of the day – which means there is always risk of miscalculation. Iran is a rational  (not nice, I said rational) actor and needs an accommodation with the West from an economic perspective:  Iran’s economy is archaic and resource driven.

But pride matters and nations act like five year olds on the world stage.  Iran wants the bomb because it makes them feel big and relevant.  They also compete with Turkey (historically the Ottoman Empire ruled the Middle East) and their own history as a major empire (Persia!) whereas Saudi Arabia is the upstart with money.   By all means – throw in Shia versus Sunni, Arab versus Persian, and family/clan dynamics but, in the end, Iran’s future will be directed by the quest for money and influence, not carnage.

We don’t see an Israeli/Saudi alliance launching an attack.  The House of Al-Saud does not want a shooting war.  The Saudi population is hardly enamored with the ruling family and actually shooting at another Muslim country, even Shia, will not go down well either domestically or in the region.

Israel has lost trust in the U.S. as an ally for at least the next two years and probably longer given an increasingly isolationist bent on both sides of the aisle in the U.S’s congress.  In terms of acting alone, it’s unlike Israel would want to take a potshot against Iran, which has 10X the population and 4X the economy.

Finally, no matter the political posturing, the US is the primary military and geopolitical ally to Saudi Arabia and Israel. And the U.S. does not favor action. At the end of the day, we do provide the supply chain and fulfillment to Saudi Arabia, cash to Israel and intelligence support to both.

With this in mind, it is our view that war with Iran is unlikely. And there will be significant investment implications due to this.

U.S. defense contractors will likely get hurt.

The U.S. is “going wobbly” with consequences.  The fact that Saudi Arabia and Israel are working together is a positive potential silver lining (hey, Saudi Arabia is actually thinking about letting women drive, how progressive!!!!) but U.S. defense firms will probably pay a steep price in terms of future orders for weapons and goods from the region.

The United States represents about half of total global defense spending and in turn is in a tie with Russia for being the largest exporter of defense products and services.  Totals vary by year but roughly speaking Russia is about equal to the US, China is about 25% but growing and France and Germany are both about 10-15%.

The two biggest buyers of defense offerings are Saudi Arabia, particularly the last two years, and India.  The U.S. benefitted handsomely from the success of their weapons and systems over the years. The fact that Saudi Arabia is beginning to realize that the US is unlikely to be overly supportive of military action against Iran suggest that Saudi Arabia may start shopping elsewhere.

Saudi Arabia has the largest wallet here. Their thinking is likely the following:

  • Supply chain – can I get parts and support and to whom am I locked in contractually?
  • Needs – do I need top shelf weapons and defense items or is an older generation aircraft adequate?
  • Supporting allies – Dassault (France) makes good aircraft too, should we shop there instead?
  • Sending a message to the US – see prior comment?

Unfortunately these recent developments suggest significant incremental headwinds for U.S. defense companies like Lockheed Martin (LMT), Northrop Grumman (NOC), Raytheon (RTN), L3 Systems (LLL) and others.

These companies are already under siege in the U.S. given that “international growth” could dry up quickly.  Do not forget Boeing (BA), which is about 40% defense over time and, additionally, must compete for commercial orders with EADS, which makes aircraft that are just as good.

Bad politics can be very bad for business. And a wobbly U.S. in the Middle East will hurt profits at US defense contractors.

Respectfully submitted,

Tom Langdon

 

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