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Reports That Next V-22 Production Contract Will See Reduced Quantities With Effect On Boeing (BA) And Bell Helicopter

|Includes: The Boeing Company (BA), TXT

The V-22 Osprey tilt rotor aircraft is a unique capability to the U.S. armed forces. Built by Boeing (NYSE:BA) and Bell, part of Textron (NYSE:TXT), in a joint venture the twin engined aircraft have seen a great deal of use in Iraq and Afghanistan since entering service in 2006 with the U.S. Air Force and Marine Corps. The system had a lengthy development timeline being cancelled more then once and then revived.

The first five year production contract saw 174 aircraft ordered and late last summer the government and contractor began entering into negotiations for the second one. That would be for a further 122 Ospreys at an estimated cost of close to $8 billion.

Now there is word that as part of the planned reductions to the defense budget over the next five years the U.S. Defense Department will cut 24 of the next batch of V-22. This would reduce the next five year contract to 98 aircraft at a cost of roughly $6.5 billion. The reports indicate that the hope is to save $1.75 billion but if 122 cost $8 billion the back of the envelope calculation would show only about $1.5 billion in savings.

Normally reducing the quantity bought over the same time period would lead to higher unit costs as there would be the loss of savings reduced with buying larger numbers of parts but it seems the Pentagon is hoping to not only cut aircraft but to negotiate a better price with Boeing-Bell. If that is possible remains to be seen. The delay in retiring the CH-46 and other aircraft the V-22 is replacing may also lead to higher operational costs for those as some will have to remain in service for a longer then originally planned timeline.

At least for the companies the program is not being eliminated or delayed. That means there will still be some revenue and earnings off of the program.

The cut will also illustrate how hard it is to reduce the budget just by slicing programs. There are enough sunk and recurring costs that savings are not directly tied to the amount of items being purchased. It is easier to eliminate whole programs which is reportedly being done with the Joint Air-to-Ground Missile (JAGM, C-27 JCA transport and the C-130 Avionics Modernization Program.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: This also appeared at Defense Procurement News.