Crusader redux

["Ian Murray" <seamus2001@xxxxxxxxx>]

washingtonpost.com
United Defense Pays Off for Carlyle
By Jerry Knight
Monday, May 13, 2002; Page E01


For United Defense Industries stockholders, the future payoff on their
investments comes down to this: Can the Big Guns save the Big Gun?

United Defense's gun is the Crusader, which -- if it is ever built --
will be the straightest-shooting, fastest-firing, most sophisticated
heavy howitzer in the history of warfare.

As far as Defense Secretary Donald H. Rumsfeld is concerned, the history
of war is the only place for cannons like the Crusader. He has vowed to
spike the gun, which critics say would have been the ultimate weapon of
World War II. It's the ideal way to stop a column of tanks roaring across
Europe, capable of blasting them with high explosives 10 times a minute
from 30 miles away. But tanks aren't much of a threat in Europe anymore,
though, and critics say the Crusader doesn't have much of a mission in
war as it is now waged.

Since the Bush administration took aim at the Crusader last month, shares
of United Defense have fallen from nearly $29 a share to under $22.

Without the Crusader, United Defense is worth no more than $18 to $19 a
share, calculates Credit Suisse First Boston analyst Pierre A. Chao, who
was quick to downgrade the stock when he learned that the $11 billion
project was in trouble.

Though critics say the Crusader is a weapon out of the past, it was the
weapon of the future for United Defense. The Pentagon has been paying
United Defense for years to develop the gun, and production was getting
close. Crusader contracts were one reason that United Defense's
first-quarter revenue grew 22 percent, to $356 million, and profit nearly
quadrupled, to $19 million from $5.1 million.

Losing the Crusader contract would be a major setback for investors who
bought United Defense stock after the company went public in December at
$19 a share.

But the company's biggest stockholder made a bundle on its investment in
United Defense even before the public offering, and stands to make
hundreds of millions more even if the Crusader is killed.

United Defense is controlled by the Carlyle Group, the investment firm
that symbolizes the marriage of politics and money in Washington.

The firm has hundreds of employees, partners and managing directors all
over the world. Its biggest names are former secretary of state James A.
Baker III, former defense secretary Frank C. Carlucci and former Office
of Management and Budget director Richard G. Darman. The first President
Bush is a part-time consultant and sometime ambassador for Carlyle.

The real boss is less well-known outside financial circles: William E.
Conway, who was chief financial officer at MCI Communications Corp.
before he helped found Carlyle 15 years ago.

Carlyle, the biggest investment firm based in Washington, manages more
than $12 billion for its clients and investors, many of them from the
Middle East. Like other firms in the business, Carlyle collects fees from
investors for managing their money and collects more fees from companies
it invests in. The real money, however, is made when Carlyle cashes in
its investments, selling companies it owns to the public or to other
investors.

Carlyle bought United Defense five years ago in a classic leveraged
buyout, putting up about $180 million of its own money and borrowing
another $700 million or so.

Carlyle has since taken $380 million in cash out of United Defense and
collected another $225 million by selling some of its United Defense
stock. Carlyle still owns 47 percent of United Defense, a stake worth
around $500 million.

In round numbers, Carlyle has gotten its initial investment back,
collected more than twice that much in cash, and still holds half a
billion in equity in United Defense. That is roughly a 5-for-1 payoff,
which is the kind of return that wealthy investors hope for when they
park their money with someone like Carlyle.

Carlyle proved how savvy it is when United Defense made Pentagon
contractors one of its top investment strategies, but the Crusader crisis
has forced investors to look much harder at the long-term prospects of
United Defense, which so far has not given public stockholders anything
close to the payoff Carlyle has had.

The Crusader also focuses attention on another big Carlyle bet on
defense, which the company is now trying to cash in.

That venture is called United States Marine Repair Inc., a string of dry
docks and ship-fixing facilities that depends on the Navy and other
government agencies for 90 percent of its business.

United States Marine Repair has filed a preliminary prospectus with the
Securities and Exchange Commission for an initial public offering. The
company has not yet revealed how many shares it wants to sell or at what
price. But the first draft of the documents does disclose that Carlyle
hopes for another quick payoff. The firm wants to cash in immediately by
selling part of its stake in United States Marine during the IPO.

United States Marine has acquired shipyards in Norfolk, where it is
headquartered; at Pearl Harbor in Hawaii; at Ingleside, Tex., near
Houston; and in California, at San Diego, San Francisco and San Pedro.

Work for the Navy brought in three-quarters of United States Marine's
$390 million in revenue last year. Add contracts for the Coast Guard, the
Military Sealift Command, the Maritime Administration and the Army, and
the government accounts for 91 percent of revenue.

United States Marine says it collected about 25 percent of all the money
the Navy spent with private-sector companies on ship modernization and
repair in the last fiscal year. It has won nine of the 13 multi-ship,
multi-year contracts awarded competitively by the Navy since 1997. And,
the prospectus notes, there is "significant future revenue opportunity"
in the Navy's plan to modernize its guided-missile cruisers.

Carlyle's Washington skills are even more important to United States
Marine, Pentagon reporters say. Politics plays a part in a lot of defense
contracts, and there is more politics in shipbuilding than in any other
other sector of Pentagon procurement.

Such are the underpinnings of any decision to buy a company like United
Defense or United States Marine. The question is whether Carlyle is wired
into Washington well enough to pick the right defense contractors to
invest in, or is influential enough to assure that its offspring keep
getting pieces of the Pentagon pie.

At United Defense and United States Marine, Carlyle has put together what
look like Washington dream teams or, if you are more cynical, the
personification of the military-industrial complex.

Both companies are run by former politicians, money men, industry
professionals and retired Pentagon brass.

For Carlyle, Carlucci and Conway are the key players on both companies'
boards; they're backed by other board members, mostly younger Carlyle
partners.

Carlyle recruited top defense-industry executives to run the two firms.
At United Defense, the professionals are mostly from FMC Corp., which was
one of the previous owners of the company. At United States Marine, the
management is a mix of defense industry pros and people who used to work
for the ship shops that Carlyle acquired.

The generals and admirals who round out the teams are as impressive a
list of client liaisons as you could put together. William A. Owens,
former vice chairman of the Joint Chiefs of Staff and a United States
Marine director, knows how to talk to the Navy about ships. John M.
Shalikashvili, former chairman of the Joint Chiefs of Staff and a United
Defense director, is an even stronger link to the Army on land weapons
issues.

Top Army brass want the Crusader badly enough to have gone behind the
backs of their civilian bosses to talk to Congress about preserving the
gun after Rumsfeld put it in his sights.

Political connections in Congress are the only way Carlyle can save the
Crusader now that the White House has turned its thumb down on the big
gun. The pols are more than ready to help. Within half a day after
Rumsfeld announced his intention to kill the Crusader, Rep. J.C. Watts
(R-Okla.) got language into legislation that would preserve the weapon.
You shouldn't have to ask in whose district the Crusader would be built.

Chao, the analyst, last week outlined three scenarios for the Crusader
fight:

. The White House succeeds in eliminating the weapon from the defense
budget and United Defense collects one last payment -- a contract
cancellation fee. Since military reformers have long considered the
Crusader outmoded and the White House agrees, that's probably the most
logical outcome. Remember, however, that Congress just passed a
multibillion-dollar farm bill for which no one could muster any
justification except "it's good for the people who elected me."

. The projected is canceled, but because of procedural screw-ups, United
Defense goes to court and years of costly legal battles ensue. It would
not be the first time.

. The Crusader stays in the budget, perhaps for less money. Under that
scenario, another president would learn just how difficult it is to kill
any Pentagon weapon, and the public would see yet again why President
Eisenhower first warned about the influence of the military-industrial
complex.

The betting on Wall Street seems to be that the Crusader is history. Like
Las Vegas oddsmakers, however, the stock market adjusts for every
development, so United Defense's share price is likely to remain
volatile.

The fight over the Crusader will be a real test of Carlyle's clout. The
team it's assembled at United Defense shows that Conway, Carlucci and
company know how to prepare for such battles as well as anyone in town.