Lockheed Martin (NYSE:LMT) is one of the prime contractors for the US Navy's Littoral Combat Ship (LCS) (Freedom class) with Austal and General Dynamics (NYSE:GD) being the other prime contractor for the competing version, the Independence class (a/k/a the weird looking trimaran one). Right now, the US Navy has decided to simultaneously procure equal numbers of both classes of ships but we believe that eventually the dual procurement strategy will be stopped and Lockheed's Freedom class ship will be procured in greater numbers. Additionally we believe that Lockheed's version has much greater potential for international sales as well. Before we go into why, we have to understand a few things about the LCS.The LCS in Its Current Configuration is Next to Useless
The Littoral Combat Ship or LCS was developed to replace and augment the Navy's Oliver Hazard Perry class frigates. It was envisioned that the LCS would serve as a flexible multi-role platform that could be used for a variety of missions, chief among which was combating the proliferation of small, fast attack craft among possible aggressor states. The LCS was designed to be cheap to build and cheap to crew and maintain. Unfortunately, as currently being procured by the US Navy, the ships are next to useless and suffer from three major flaws.
No Long Range Standoff Surface Attack Capability
The LCS has no standoff surface attack capability other than whatever their two MH-60 helicopters can carry. The ships were originally going to use the XM501 NLOS-LS also referred to as Netfires PAM system but that was canceled. (Netfires LLC was the joint venture between Lockheed and Raytheon that was developing the missile and PAM stands for Precision Attack Munition.) The missile system would have been able to deliver a 15lb warhead out to 25 miles. Instead the Navy replaced it with… nothing.
Newer versions of the LCS may carry either the Griffin missile system which has a 5 mile range and a 13lb warhead or a modified version of the AGM-114 Hellfire missile with a 5 mile range but larger 18lb warhead.
To understand just how much of a problem this is take a look at the Chinese Type 022 patrol boat. It's a 220 ton (versus the 3500 ton LCS) boat which is armed with the C-802 anti-ship missile which has a range of 75 to 112 miles. North Korea and Iran also operate a number of patrol boats and fast attack craft armed with versions of the C-802 or the older Silkworm anti-ship missile system. The LCS is hopelessly outclassed by the very types of vessels it's meant to defend against.
No Air Defense Capability
Perhaps an even more glaring weakness of the LCS is that the ships have no air defense capability. The LCS is equipped with just one Mk-49 RIM-116 missile launcher for point defense (5.6mi range). This means that LCS ships would need to be deployed alongside other assets such as air-defense capable cruisers or destroyers if a theater had any serious airborne threats. Instead of being a smaller, cheaper, and easier to deploy ship the LCS becomes a burden by virtue of its need for an air defense capable escort. The need to be escorted almost everywhere makes the LCS more of a liability than an asset.
Inadequate Crew Size
The ships are crewed by just 50 sailors plus an aviation complement and whatever additional crew are added with the specific mission package(s) fitted with the ship. While the ships were designed to be highly automated and run by few people, other critical tasks still require significant manpower. There are many reports that there are simply not enough people on board to perform the necessary maintenance on the ships. Even more critically there are serious concerns that the ship's damage control would be severely compromised in a combat situation by the low crew levels. Indeed, a recent GAO report questioned the damage control capability of the LCS which such low crew levels.Lockheed has the Solution Thanks to Saudi Arabia
Lockheed Martin obviously realizes the limitations of the ship and has proposed numerous improvements. Starting with LCS-17 the US Navy has accepted some of the improvements. The new flight of ships will be designated FF and include upgraded armor, radar systems, countermeasures, and some increases in firepower. But the ships are still lacking.
Enter Saudi Arabia. In October 2015 Saudi Arabia requested the sale of four modified Freedom class ships in a deal worth up to $11.25B. The modified ships will feature two 8 cell Mk 41 VLS systems which can carry 16 SM-2 or 62 ESSMs total, a 76MM main gun (compared to the LCS existing 57mm gun), Harpoon Block II anti-ship missiles, torpedoes, and the SeaRAM point defense system. The Aegis combat system was available but Saudi Arabia elected to use the TRS-4D AESA air search radar for cost reasons. If the sale goes through Lockheed will now have a fully functional, fully armed, ready to kick butt ship rolling off the slipway and ready to sell to other customers including the US Navy.
We believe it's highly likely that the version of the LCS sold to the Saudis will eventually be the ship the US Navy procures. It's just too good to overlook and the with the Saudis bearing the cost of working out the kinks in the first few examples it will be a mature platform by the time the US Navy is ready to revisit its LCS procurement plans. It's going to get increasingly harder for the Navy to justify buying less effective versions of the LCS when there is a better cost effective version sitting there available for order.Not the first Time This Has Happened
This wouldn't be the first time the Navy has ended up with the version of a ship designed originally for someone else. The "Ayatollah class" or Kidd class destroyers were heavily modified Spruance class destroyers originally designed for Iran. As with Saudi Arabia's version of the LCS, the Kidds were much more heavily armed with much greater air defense capability due to their intended multi use role in the Iranian Navy. Because of the Iranian Revolution the sale never went through and the Navy ended up buying the ships.Issues with the Independence Class
What about the Independence class LCS produced by Austal and General Dynamics (NYSE:GD)? Where does that fit into everything? Well we think the competing design suffers from a few flaws that make it unlikely to be chosen by any international customers and also make it less appealing.
First the Independence class has an all aluminum design (as opposed to the freedom class' steel hull/aluminum superstructure design). The all aluminum design makes the ship more susceptible to combat damage and less survivable. It's also been known to be more maintenance intensive and the Navy has had problems with electrolysis/galvanic corrosion damaging the hull necessitating significant repair work.
Second, and perhaps most importantly is that the ships are not capable of accepting full length missiles if fitted with the Mk 41 VLS system. This means the ships would not be capable of carrying the SM-3 anti-ballistic missile interceptor and the tomahawk cruise missile and would instead be limited to just the SM-2 and ESSM missiles. This is not likely an issue for the US Navy as the LCS was never envisioned to provide ballistic missile defense or long range multi-role standoff attack capability. The issue would however be huge for international customers who would be looking at the ships to fulfill a much broader range of roles in their smaller navies.Summary
In Fiscal 2014 Lockheed had $45.6B in net sales. So, selling upgraded Freedom class ships at perhaps $450-$600M a pop (the per unit cost for the Saudi order is likely higher due to the inclusion of initial design and testing work which wouldn't be needed for subsequent orders) represents an opportunity that could have an appreciable effect on LMT's future. Indeed, the modified version of the LCS is going to be extremely competitive internationally due to its size, crew requirements, and price point. Indeed, the market for the Navy's backbone Arleigh Burke class destroyer is limited to just a few rich nations (Japan operates a class of ships based on the Arleigh Burke) due to the ship's cost. The Lockheed LCS is one of the first US Navy ships in a long time to have broad potential for export and represents yet another growth area for Lockheed in an era of stagnant (or slow growing) defense budgets.
Disclosure: I am/we are long LMT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.