CSIS held an event this morning on the “The Acquisition Implications of the DoD Strategic Guidance and the FY2013 Budget.”  The speaker was Frank Kendal, the Acting Undersecretary of Defense, AT&L (Acquisition, Technology & Logistics).  Kendall set force of vision of acquisition changes he would like to see through, assuming he is confirmed as the Undersecretary of Defense, AT&L.  Since he is the in effect the chief weapons buyer for the Pentagon, his views are important for investors to consider.

Kendall does not see a major departure from initiatives set forth under “Better Buying” (focus on cost and competition) that had been introduced by Dr. Ashton Carter.  This shouldn’t be a surprise as Kendall has been his Deputy, but there are a few changes that appeared noteworthy.

• Kendall wants to change the culture of acquisition—Dr. Carter didn’t appear to want to tackle culture, in our view.  A better trained acquisition work force is a key to this.  Cultural change has to identify risk and affordability issues early, embrace recognition within DoD that the defense industry is part of its force structure, and use metrics to challenge conventional wisdom regarding acquisition practices and policies.  Another change is for military acquisition officials to adopt “sound capital planning” and realize the implications of the new budget environment.
• He stated that it was “acquisition malpractice” for the F-35 program to have been put in production before testing was completed.  Design tools and simulations did not capture issues that are now emerging in the flight test program.  To us, this isn’t necessarily bad for the F-35 program as FY13-17 budget changes will reflect this shift.  But it may suggest more measured growth on future programs such as Long Range Strike bomber and the SSBN(X).
• Kendall did not believe the U.S. was about to take another “procurement holiday” and defense cuts won’t be as steep as the Cold War drawdown, though he admitted to being a “little nervous” about sequester.
• He wants to make more use of incentives to influence industry behavior.  DoD will pay for performance.  But underperforming programs are more likely to face cancellation.
• Data has shown that undefinitized production contracts are not a source of cost growth, but for development programs, this is an issue.  Fixed price contracts in LRIP also should not be an issue, based on data he’s looked at.
• No surprise, but some services are doing better than others at managing acquisition programs and that some contractors perform better than others.

Mass Refi Campaign Continues, Now Harnessed By Obama, Senate Dems
While Hill passage of the President’s mass refi proposal is doubtful, Obama’s exhortations seem timed to coincide with GOP nominating events in hard-hit FL, NV, and MI. Senate Dems, for their part, will offer amens in a Thursday hearing.

Mortgage Servicing Settlement (Again, But This Time Really) Imminent
With a deadline for participation looming later today, investors may finally be on the verge of seeing whether a legal agreement between the largest mortgage servicers, feds, and state attorneys general meets expectations or includes large regional banks.

Derivatives: House Hearing on Legislation to Modify Extra-Territorial Impact
The extraordinary overseas application of the new derivatives regime in Dodd-Frank could have negative impacts on the largest U.S. banks, and any legislation to lessen its extra-territorial impact could provide significant relief.

Election 2012

Romney Train Heads to CO and MN
We think our “red stock thesis” should remain viable to investors (for now), after back-to-back Romney victories. Doubts are nevertheless becoming more pronounced amid the improving economy, Mitt’s gaffes, and the GOP candidates’ food fight.

Other notes today from Capital Alpha…

Healthcare – Kim Monk and Rob Smith

Bipartisan MLR Broker Bill Finally Introduced in the Senate
Despite bipartisan support, legislation to exempt brokers from MLR (medical loss ratio) requirements faces fairly long odds in 2012.

Doc Fee Offsets: Members Struggle with Using War Savings for Full Fix
House-Senate negotiators haven’t made progress on what health offsets to use for a doc fee patch, as broader discussion on using war spend down “savings” for a full fix intensify.

FDA on Hill to Talk Generic User Fee Deal
A House FDA user fee hearing will likely highlight generic and brand pharma’s split on paying for foreign facility manufacturing inspections. Also, Senate HELP should unveil its drug user fee bill this week.

ESRX-MHS Merger: Letter to FTC Urges Careful Consideration
Senate Judiciary Chairman Herb Kohl (D-WI) was the sole signature on the letter, which is unlikely to change the outcome of the FTC’s anti-trust evaluation. We’re hearing a decision will come by month’s end.

Defense – Byron Callan

Another Week Where FY13 Budget Details Could Be Dribbled Out
We see DoD efforts to confer with Congress and hold press briefings before the formal release of the FY13 budget as a tactic to emphasize the pain of sequestration.

No Quick Deal on Removing Near-Term Sequester Risk
We remain skeptical that either House or Senate versions of a bill to change sequestration by making cuts to the federal workforce has a chance and so sequestration risk remains.

Week Ahead – Hearings and conferences abound
HASC and House Energy and Commerce Committee are holding hearings with defense implications. CSIS, NDIA, Cowen, and AUVSI are holding conferences this week.

Taxes – James Lucier

Corporate Tax Reform Proposal Due Out February 13
The White House will release a corporate tax reform proposal in tandem with the President’s Budget on Februrary 13. Rules will be tightened for multinational corporations, while the overall rate will go down.

Telecom – Robert Kaminski

Verizon-SpectrumCo/Cox: Congressional Hearings Soon, Importance Overstated
Verizon’s cable company spectrum purchases are receiving Congressional attention, but we don’t think this changes the regulatory outlook.

Extended commentary…

Financials

Mass Refi Campaign Continues, Now Harnessed By Obama, Senate Dems
Amid no signs of House GOP receptivity toward his State-of-the-Union  proposal to allow expedited FHA refinancing of otherwise ineligible single-family mortgages not held by Fannie or Freddie, President Obama devoted his Saturday radio address to the issue and the Senate Banking Committee will host a related Thursday, February 9, hearing, entitled “State of the Housing Market: Removing Barriers to Economic Recovery.” In addition to testimony from Moody’s Economist Mark Zandi, the senators will hear from principal mass refi proponent Chris Mayer of Columbia Business School.

Mortgage Servicing Settlement (Again, But This Time Really) Imminent
Uncommitted state AGs reportedly have until this evening to decide whether or not to join the long-in-the making $20-$25 billion mortgage servicing agreement that would provide legal immunity in exchange for servicers’ commitments to change future practices, pay modest cash sums, and guarantee some $17 billion in principal reductions and other loan restructurings that could help as many as 1 million homeowners. Meanwhile, though the deal will have a monitor (NC head banking supervisor Joe Smith) and the lenders will be forced to pony up cash if their soft refinancing commitments go unfulfilled (per the Huffington Post, byproducts of distrust lingering from the ineffectual implementation of a 2008 Countrywide agreement), still uncertain is the extent of participation among servicers outside the big five and the degree to which legal insulation might include false claims or misrepresentation relating to loans purchased or insured by the GSEs and FHA.

Derivatives: House Hearing on Legislation to Modify Extra-Territorial Impact
On Wednesday, the House Financial Services Subcommittee on Capital Markets will hold a hearing on legislation to amend Title VII of Dodd-Frank, which authorizes the CFTC to regulate swap transactions contracted outside of the U.S. if they have a significant connection or effect upon U.S. commerce. The largest U.S. firms conduct a large percentage of their derivatives business in London or Asia, and the application of the new clearing, trading, reporting or business conduct rules in those jurisdictions could create important compliance and competitiveness challenges. While it’s unlikely that legislation to resolve these potential problems would pass the Senate this year, passage in the House would pressure the CFTC to moderate the application of its final rules abroad.

Elections

Romney Train Heads to CO and MN
Having sustained momentum with a win in Saturday’s Nevada GOP caucuses, Mitt Romney is now expected to play similarly strong hands in Minnesota, Colorado and a nonbinding “beauty contest” in Missouri on Tuesday, February 7, ahead of the Arizona and Michigan primaries on February 28 and Super Tuesday contests (in 10 states) on March 6. Nevertheless, low turnout in the early events  has raised concerns about GOP voters’ enthusiasm, while doubts on Romney’s electability have risen amid Newt Gingrich’s  attacks on his conservatism and with each new self-inflicted (“I don’t care about the poor. . .”) wound. Meanwhile, the spread out primary calendar and proportional allocation of delegates (rather than winner take all)  in many states suggest that the nominating phase could go on for months – or at least through April 2, when Gingrich has based his unlikely strategy on winning the Texas primary. Separately, though Obama’s reelect prospects have seemed to improve with the firmer January employment report, other indicators, like consumer sentiment, betray continued vulnerability.

Taxes – James Lucier

Corporate Tax Reform Proposal Due Out February 13
The President outlined some tax reform ideas in his January 24 State of the Union Speech. There would be some form of “basic minimum tax” for multinational corporations, tax penalties for moving jobs overseas, and an array of incentives for corporate good behavior that would seem to go against the momentum for tax simplification on the Hill. Yet it remains to be seen how much in the President’s proposal is really new:  he has proposed changes to deferral and other international tax breaks in all three of his previous budgets, just as he has called for higher taxes on oil companies and clean energy tax breaks. The level of detail provided may be less than a formal legislative proposal.

Download the Capital Alpha Telecom Scorecard Today
The Telecom Scorecard is our monthly “at-a-glance” update on Washington telecom policy issues, released at the beginning of each month.  High-impact investment stories we are watch in this edition include Verizon-SpectrumCo/Cox, LightSquared, and DISH. We track these and six other issues in the Capital Alpha Telecom Scorecard.
You can download the February 2012 edition of the Capital Alpha Telecom Scorecard here.

Highlights of other research by Capital Alpha Partners this week are below.  Download a PDF of this report here for full commentary.

Healthcare – Kim Monk and Rob Smith

Bipartisan MLR Broker Bill Finally Introduced in the Senate
Despite bipartisan support, legislation to exempt brokers from MLR (medical loss ratio) requirements faces fairly long odds in 2012.

Doc Fee Offsets: Members Struggle with Using War Savings for Full Fix
House-Senate negotiators haven’t made progress on what health offsets to use for a doc fee patch, as broader discussion on using war spend down “savings” for a full fix intensify.

FDA on Hill to Talk Generic User Fee Deal
A House FDA user fee hearing will likely highlight generic and brand pharma’s split on paying for foreign facility manufacturing inspections. Also, Senate HELP should unveil its drug user fee bill this week.

ESRX-MHS Merger: Letter to FTC Urges Careful Consideration
Senate Judiciary Chairman Herb Kohl (D-WI) was the sole signature on the letter, which is unlikely to change the outcome of the FTC’s anti-trust evaluation. We’re hearing a decision will come by month’s end.

Defense – Byron Callan

Another Week Where FY13 Budget Details Could Be Dribbled Out
We see DoD efforts to confer with Congress and hold press briefings before the formal release of the FY13 budget as a tactic to emphasize the pain of sequestration.

No Quick Deal on Removing Near-Term Sequester Risk
We remain skeptical that either House or Senate versions of a bill to change sequestration by making cuts to the federal workforce has a chance and so sequestration risk remains.

Week Ahead – Hearings and conferences abound
HASC and House Energy and Commerce Committee are holding hearings with defense implications. CSIS, NDIA, Cowen, and AUVSI are holding conferences this week.

Financials – Charles Gabriel and Joseph Engelhard

Mass Refi Campaign Continues, Now Harnessed By Obama, Senate Dems
While Hill passage of the President’s mass refi proposal is doubtful, Obama’s exhortations seem timed to coincide with GOP nominating events in hard-hit FL, NV, and MI. Senate Dems, for their part, will offer amens in a Thursday hearing.

Mortgage Servicing Settlement (Again, But This Time Really) Imminent
With a deadline for participation looming later today, investors may finally be on the verge of seeing whether a legal agreement between the largest mortgage servicers, feds, and state attorneys general meets expectations or includes large regional banks.

Derivatives: House Hearing on Legislation to Modify Extra-Territorial Impact
The extraordinary overseas application of the new derivatives regime in Dodd-Frank could have negative impacts on the largest U.S. banks, and any legislation to lessen its extra-territorial impact could provide significant relief.

Taxes – James Lucier

Corporate Tax Reform Proposal Due Out Februrary 13
The White House will release a corporate tax reform proposal in tandem with the President’s Budget on Februrary 13. Rules will be tightened for multinational corporations, while the overall rate will go down.

Election 2012 – Charles Gabriel

Romney Train Heads to AZ and MN
We think our “red stock thesis” should remain viable to investors (for now), after back-to-back Romney victories. Doubts are nevertheless becoming more pronounced amid the improving economy, Mitt’s gaffes, and the GOP candidates’ food fight.

• Bipartisan MLR Broker Bill Finally Introduced in the Senate
• Doc Fee Offsets: Members Struggle with Using War Savings for Full Fix
• FDA on Hill to Talk Generic User Fee Deal
• ESRX-MHS Merger: Letter to FTC Urges Careful Consideration

Defense

• Another Week Where FY13 Budget Details Could Be Dribbled Out
• No Quick Deal on Removing Near-Term Sequester Risk
• Week Ahead – Hearings and conferences abound

Financials

• Mass Refi Campaign Continues, Now Harnessed By Obama, Senate Dems
• Mortgage Servicing Settlement (Again, But This Time Really) Imminent
• Derivatives: House Hearing on Legislation to Modify Extra-Territorial Impact

Taxes

• Corporate Tax Reform Proposal Due Out Februrary 13

Telecom

• Verizon-SpectrumCo/Cox: Congressional Hearings Soon, Importance Overstated

Election 2012

• Romney Train Heads to AZ and MN

Detailed commentary:

Healthcare – Kim Monk and Rob Smith

Bipartisan MLR Broker Bill Finally Introduced in the Senate
Late last week, a bipartisan group of senators introduced the “Access to Independent Health Insurance Advisers Act of 2012” (S. 2068). Cosponsors include Democratic Sens. Mary Landrieu (LA) and Ben Nelson (ME) and Republican Sens. Lisa Murkowski (AK) and Johnny Isakson (GA). Under the ACA, insurers would have to spend 80 percent of premium dollars on medical care (85% in the large group market). With their fees counting as administrative expenses, brokers are getting squeezed. The new Senate bill is somewhat narrower than the House version sponsored by Rep. Mike Rogers (R-MI). For instance, broker fees cannot be excluded from large group plans, and states can’t request an MLR waiver for the small group market as they can under the House bill. Although the Senate bill is bipartisan and the House bill has 168 co-sponsors, it faces long odds this year when Republicans aren’t interested in incremental improvements to a law they wish to repeal, and Democrats can’t risk reopening the debate on health reform.

Doc Fee Offsets: Members Struggle with Using War Savings for Full Fix
The House-Senate conference committee on the Medicare doc fee patch/payroll extension bill meets again this Tuesday. Negotiators have made little progress so far, and there is a broader discussion brewing on whether to tap ~$600 billion in “savings” from the Iraq and Afghanistan war draw down to help pay for a full ~$316 billion/10 year doc fee fix, as we covered Friday. Although some key members’ opposition to using the somewhat gimmicky war money appears to be softening somewhat, we think it will be a very hard sell to House Republicans. We continue to believe a 10 month, ~$17 billion patch with only very targeted health offsets is the most likely outcome. The House Ways and Means Subcommittee on Health is holding a hearing on the Medicare physician payment system at 10 am on Tuesday, Feburary 7.

FDA on Hill to Talk Generic User Fee Deal
FDA chief Hamburg will be in the House Energy and Commerce Committee again Thursday (webcast, 10am ET) to discuss the generic drug industry-FDA deal to establish new generic user fees. We’re particularly interested in generics’ agreement to devote a portion of their fees to FDA foreign drug production facility inspections, which branded companies have resisted. We’re hearing the Senate drug user fee package will contain some risk-based foreign inspection requirements, which will likely have hefty CBO scores. We will be watching to see whether the inspection fees generics have agreed to will be enough to cover the inspection costs and how/whether brands plan to help cover their cost. The Senate HELP committee should unveil its drug user fee bill this week.

ESRX-MHS Merger: Letter to FTC Urges Careful Consideration
Senate Judiciary Subcommittee on Antitrust Chairman Herb Kohl (D-WI) last week sent a letter to the Federal Trade Commission (FTC) raising concerns with the pending Express Scripts – Medco deal. Kohl states the “merger presents serious competition concerns which should be examined carefully by the FTC.” However, as we’ve said all along, Congress has no real role in the FTC’s antitrust evaluations. It’s also very notable that Kohl was the only committee member to sign the letter. Past ESRX-MHS Congressional hearings have revealed a similar lack of agreement among members on the merger, and we suspect Kohl’s missive is a last gasp attempt to influence the FTC’s independent process. We’re hearing the FTC will announce a decision on the merger within the next three weeks.

Defense – Byron Callan

Another Week Where FY13 Budget Details Could Be Dribbled Out
The roll out of the FY13 DoD budget and plan has been quite different from prior budget releases.  DoD leadership spent hours with Congress last week on the plans.  There have been two press briefings by the Air Force and one by the Army.  We think the aim here is to get Congress to understand the impact of the first tranche of cuts under the Budget Control Act with the unstated implication of how difficult another $250 billion for FY13-17 would be under sequestration.  The BRAC proposals in particular, as well as loss of Air Force squadrons that affect bases in a number of states, are painful at the state and local level. For more, see our Sunday evening Week Ahead in Defense note.

No Quick Deal on Removing Near-Term Sequester Risk
Last week, several Republican Senators introduced the “Down Payment to Protect National Security Act of 2012.” The Senate bill proposes budget savings of $110 billion by extending a federal pay freeze to June 2014 and restricting federal hiring to two persons for every three that leaves until the total size of the federal workforce is reduced by 5%. The bill is similar in spirit to H.R. 3662, which was introduced last December.  The House bill called for hiring one person for every three that leaves employment and differed in treatment of discretionary spending accounts.  We continue to expect that the time is not ripe for either House or Senate versions of offsetting cuts that would remove sequestration’s risk for 2013.

Week Ahead – Hearings and conferences abound
Acting Under Secretary of Defense, AT&L, Mr. Frank Kendall is speaking at a Feb. 6 CSIS event on “Acquisition Implications of DoD Strategic Guidance.”  HASC is holding a hearing of ”DoD Contracting and Regulatory Issues on Feb. 6.”  NDIA is holding its annual Tactical Wheeled Vehicle conference in Monterey, CA on Feb. 6-7.  Cowen is holding its annual aerospace/defense conference in New York on Feb. 8-9.  AUVSI is holding its “Unmanned Systems Program Review 2012″ on Feb. 7-9.  On Feb 8, the House Energy and Commerce Committee is holding a hearing on “Cybersecurity and the Private Sector”.  The monthly Treasury statement, which includes defense outlays, is to be released at 2PM on February 10.

Financials – Charles Gabriel and Joseph Engelhard

Mass Refi Campaign Continues, Now Harnessed By Obama, Senate Dems
Amid no signs of House GOP receptivity toward his State-of-the-Union  proposal to allow expedited FHA refinancing of otherwise ineligible single-family mortgages not held by Fannie or Freddie, President Obama devoted his Saturday radio address to the issue and the Senate Banking Committee will host a related Thursday, February 9, hearing, entitled “State of the Housing Market: Removing Barriers to Economic Recovery.” In addition to testimony from Moody’s Economist Mark Zandi, the senators will hear from principal mass refi proponent Chris Mayer of Columbia Business School.

Mortgage Servicing Settlement (Again, But This Time Really) Imminent
With a deadline for participation looming later today, investors may finally be on the verge of seeing whether a legal agreement between the largest mortgage servicers, feds, and state attorneys general meets expectations or includes large regional banks.

Uncommitted state AGs reportedly have until this evening to decide whether or not to join the long-in-the making $20-$25 billion mortgage servicing agreement that would provide legal immunity in exchange for servicers’ commitments to change future practices, pay modest cash sums, and guarantee some $17 billion in principal reductions and other loan restructurings that could help as many as 1 million homeowners. Meanwhile, though the deal will have a monitor (NC head banking supervisor Joe Smith) and the lenders will be forced to pony up cash if their soft refinancing commitments go unfulfilled (per the Huffington Post, byproducts of distrust lingering from the ineffectual implementation
of a 2008 Countrywide agreement), still uncertain is the extent of participation among servicers outside the big five and the degree to which legal insulation might include false claims or misrepresentation relating to loans purchased or insured by the GSEs and FHA.

Derivatives: House Hearing on Legislation to Modify Extra-Territorial Impact
On Wednesday, the House Financial Services Subcommittee on Capital Markets will hold a hearing on legislation to amend Title VII of Dodd-Frank, which authorizes the CFTC to regulate swap transactions contracted outside of the U.S. if they have a significant connection or effect upon U.S. commerce. The largest U.S. firms conduct a large percentage of their derivatives business in London or Asia, and the application of the new clearing, trading, reporting or business conduct rules in those jurisdictions could create important compliance and competitiveness challenges. While it’s unlikely that legislation to resolve these potential problems would pass the Senate this year, passage in the House would pressure the CFTC to moderate the application of its final rules abroad.

Taxes – James Lucier

Corporate Tax Reform Proposal Due Out Februrary 13
The President outlined some tax reform ideas in his January 24 State of the Union Speech. There would be some form of “basic minimum tax” for multinational corporations, tax penalties for moving jobs overseas, and an array of incentives for corporate good behavior that would seem to go against the momentum for tax simplification on the Hill. Yet it remains to be seen how much in the President’s proposal is really new:  he has proposed changes to deferral and other international tax breaks in all three of his previous budgets, just as he has called for higher taxes on oil companies and clean energy tax breaks. The level of detail provided may be less than a formal legislative proposal.

Telecom – Robert Kaminski

Verizon-SpectrumCo/Cox: Congressional Hearings Soon, Importance Overstated
Verizon’s cable company spectrum purchases and joint marketing agreements will be getting at least a Senate hearing soon, as announced last week by Antitrust Subcommittee Chair Herb Kohl (D-WI). Congress has no formal oversight role in the regulatory review process, so we think last week’s characterization by the WSJ, that “political headwinds are building” against the deal, may be off the mark. We believe any hearings will ultimately be benign for Verizon. They provide sound bite opportunities for critics, but we do not think they will materially impact the process at the FCC and DOJ.

Election 2012 – Charles Gabriel

Romney Train Heads to AZ and MN
We think our “red stock thesis” should remain viable to investors (for now), after back-to-back Romney victories. Doubts are nevertheless becoming more pronounced amid the improving economy, Mitt’s gaffes, and the GOP candidates’ food fight.

Having sustained momentum with a win in Saturday’s Nevada GOP caucuses, Mitt Romney is now expected to play similarly strong hands in Minnesota, Colorado and a nonbinding “beauty contest” in Missouri on Tuesday, February 7, ahead of the Arizona and Michigan primaries on February 28 and Super Tuesday contests (in 10 states) on March 6. Nevertheless, low turnout in the early events  has raised concerns about GOP voters’ enthusiasm, while doubts on Romney’s electability have risen amid Newt Gingrich’s  attacks on his conservatism and with each new self-inflicted (“I don’t care about the poor. . .”) wound. Meanwhile, the spread out primary calendar and proportional allocation of delegates (rather than winner take all)  in many states suggest that the nominating phase could go on for months – or at least through April 2, when Gingrich has based his unlikely strategy on winning the Texas primary. Separately, though Obama’s reelect prospects have seemed to improve with the firmer January employment report, other indicators, like consumer sentiment, betray continued vulnerability.

No Quick Deal on Removing Near-Term Sequester Risk

On Feb 2, several Republican Senators (Jon Kyl (R-AZ), John McCain (R-AZ), Lindsey Graham (R-SC), John Cornyn (R-TX), Kelly Ayotte (R- NH), and Marco Rubio (R-FL.) introduced the “Down Payment to Protect National Security Act of 2012.” The Senate bill proposes budget savings of $110 billion by extending a federal pay freeze to June 2014 and restricting federal hiring to two persons for every three that leaves until the total size of the federal workforce is reduced by 5%.   The bill is similar in spirit to H.R. 3662, which was introduced last December.  The House bill called for hiring one person for every three that leaves employment and there are differences in how both bills treaty the spending caps in discretionary accounts.

Defense stock prices didn’t appear to react to the Senate move last week, which we believe is appropriate.  We continue to expect that the time is not ripe for deal enabling approval of either House or Senate version of offsetting cuts that would remove sequestration’s risk for 2013.  Democrats are going to hold out for higher taxes, instead of cuts to the federal workforce.

Observations:

• The roll out of the FY13 DoD budget and plan has been quite different prior budget releases.  DoD leadership spent hours with Congress last week on the plans.  There have been two press briefings by the Air Force and one by the Army.  We think the aim here is to get Congress to understand the impact of the first tranche of cuts under the Budget Control Act with the unstated implication of how difficult another $250 billion for FY13-17 would be under sequestration.   The BRAC proposals in particularly, as well as loss of Air Force squadrons that affect bases in a number of states are painful at state and local level.
• Rand released a report entitled “Unmanned Aircraft Systems for Logistics Applications.”  AVAV’s Raven and Puma are mentioned (page 39) as well as “Gorgon Stare” on which XLS participates.  The NOC BACN and LEMV programs are mentioned though these may not be material to its earnings.
• We found this paper on whether Australia should continue building its own warships interesting because it’s a debate that plays out in many countries and the debate might have some relevance to BA/ LN, HO FP and RTN.

CBO Picked a Good Week to Drop In

New Highway Trust Fund (HTF) revenue and spending projections are here. For comparison, the previous update (dated August 30) is here. We had previously speculated that the shortfall for Fiscal Year 2013 could be shrinking to manageable proportions – thus postponing the day of reckoning at least a few months. And indeed, whereas CBO in August had the FY13 shortfall at $8.4 billion, they now show the shortfall shrinking to $3.2 billion – a much more manageable sum. Reductions in outlays for FY12 and FY13 are correct. Slight increases in revenue also helped, although CBO is projecting slightly less revenue for FY14-16 before reversing and posting an incremental $0.5 billion by the end of the decade.

Postponing the day of reckoning for the HTF by even six months could be crucial, as a newly-elected Congress might find it difficult to focus on the Highway Bill immediately. They will potentially be preoccupied with 1) yet another debt ceiling crisis, 2) tax legislation, and 3) the major early-term presidential priorities either of a reelected Barack Obama or his Republican replacement (most likely Mitt Romney). 1 and 2 could be dealt with in this year’s November-December “lame duck” session, but early 2013 will still be a very busy time for members of Congress.

Coming Soon: Big Transit Fight

The Senate Banking Committee marked up their portion of the Highway Bill yesterday, largely to the satisfaction of transit advocates. That is, they appear to have largely preserved current law. The House Ways and Means Committee is marking up the financing portion of the House bill today, including a proposal to replace the funding mechanism for transit. Instead of gas tax money, transit would get general revenue under the plan.

Transit stakeholders, by and large, hate this idea, as it would leave transit far more exposed to spending cuts. We have been forecasting a fight over transit for a year now, since Republicans and Democrats have both ideological and raw political reasons to oppose each other. In the end, we do think transit spending will be cut more than highway spending on a proportional basis, but we do not think the cuts will be devastating.

Positive for Trains on Positive Train Control

It’s been known for months that Mica planned to propose a five-year delay in Positive Train Control implementation, from December 31, 2015 to December 31, 2020. However, he is also proposing that rail carriers be permitted to implement “alternative risk reduction strategies.” His draft bill text (847 pages) is here; with Section 8401 on Positive Train Control appearing on page 771.

Trucks Lose, Rails Win Along with safety advocates, the rail carriers (CSX, UNP, others) were successful in killing proposed language that would have allowed states to clear larger, heavier trucks onto U.S. highways. While a few states already have pilot projects allowing trucks over 80,000 pounds, members opposed cited safety concerns and potential costly bridge improvements in passing an amendment to strip out the proposal. Large trucking concerns (HTLD, WERN, JBHT, KNX, and SWFT) were not able to organize a defense. As the partisan composition of the House of Representatives is not expected to change significantly this November, it would appear unlikely that the language can be put back in next year, although we wouldn’t count it out.

Could Be a Rough Road This Year

Our overall thesis continues to be that Congress is not likely to agree on a full Highway Bill this year. Now we’re starting to think there won’t even be House passage. House Speaker John Boehner (R-OH) very much wants to pass the bill through his chamber to demonstrate a commitment to jobs and infrastructure. However, Democrats, led by Rep. Nancy Pelosi (D-CA), have no interest in helping Boehner, and no level of commitment to highway construction will offset, for 90+% of House Democrats, their objections to proposals to expand domestic oil & gas production. It’s not a surprise that House Democrats are opposed, however, since House Transportation and Infrastructure Chairman John Mica (R-FL) has written his bill largely without Democratic input.

In fact, while the theme of the last week has been Democratic complaints that Mica shut them out of the process, they have had the same complaints for nearly a year. In other words, it’s not news that Boehner may need 218 Republican votes – that is, a majority composed entirely of Republicans. However, we’re starting to see notable resistance among more conservative Republicans, with Rep. Jeb Hensarling (R-TX), a member of leadership, voicing uncertainty about the bill. We still expect Boehner to muscle through this vote, while reassuring his caucus that the Senate will never take it up. However, should conservatives resist, Boehner may find it simply not worth the trouble and the potential threat to his Speakership to ram through yet another bill that disappoints conservatives. At a minimum, Boehner will have to allow open amendments to the bill, creating uncertainty.

Other Resources on the House Bill

Mica’s roundup page of the committee action so far, including amendments and video replays, is here. His press release is here.

Capital Alpha Thesis

Infrastructure spending by the federal government is facing a tough challenge in coming years. By spring of 2013, the Highway Trust Fund could be completely exhausted, forcing Congress to act. The 18.4 cents per gallon federal gas tax does not produce enough revenue to sustain current spending levels. Simply using general revenue to patch the shortfall is probably not a long-term option, and raising the gas tax is a political nonstarter. Creative thinking will be needed, or cuts will continue – the current fiscal year already lops $800 million off contract authority from Fiscal Year 2011.

Congress will likely not be able to pass a full reauthorization of the Highway Bill before at least that crisis point in 2013. Short-term extensions will be the rule until that point, with policy tweaks part of the conversation to find ways to stretch dollars further. Environmental and livability concerns will also be a factor.

Some Relevant Stocks ASTE, VMI, MLM, VMC, GVA, CAT, MTW, DE, SHAW, NUE, URS, AC M, KBR, TPC, TEX, IR, and OSK. Relevant industries: Construction & Engineering, Industrials & Materials, Electrical Equipment, Construction Machinery, Transportation Infrastructure, and Environmental & Diversified Services.

Previous Notes on This Topic

• Highway Bill Could Pass House With Focus on Deregulation – January 31, 2012

• Possible Highway Bill on Display This Friday – January 25, 2011

• Highway Bill: Grim 2012 Outlook – January 10, 2012

• Highway Bill Thoughts; Rear Visibility Reg for Autos; Hours of Service Reg for Trucking – December 22, 2011

Secretary of the Air Force Michael Donley spoke at an Air Force Association event this morning in Virginia.  For investors and analysts, there were a few incremental take-aways:

• Air Force plans to rely more on multi-role aircraft, coupled with delays in the F-35A Joint Strike Fighter program, will entail upgrades to approximately 350 F-16s.  These upgrades are to center on airframe life extension and should include new avionics.  This is a potential opportunity for COL (avionics) and potentially other firms, though clearly incremental sales from this program in 2014-2017 would have to be weighed against other budget changes.
• Senior DoD leadership briefed the Senate yesterday on the FY13-17 plan and House members will be briefed today.  There are more detailed briefings for professional House and Senate staff on Friday.
• The Air Force released this “white paper” summarizing the changes in FY13-17 and a more detailed review of force structure changes will be released on Friday.
• Sec. Donley noted that in the FY13-17 plan the Air Force “protected the size of the bomber force” and “largely protected” space.
• The cuts to mobility aircraft are mainly as a result of plans for smaller ground forces
• “Readiness” was protected, as Donley noted that future contingencies don’t allow long planning periods.  He mentioned that for Libyan air operations last year, the “potential arose in weeks” and the “execute order was done in days.”  This should be reflected in stable funding for spares and maintenance, in our view, and this is a watch item for us in the budget release.
• The Air Force has no plans to change its total buy of F-35As but that decision would not have to be made for another decade (we expect it will be cut, but concur this is beyond investors’ horizons).  Sec. Donley did not have a firm view on pricing for F-35As on lower FY13-17 buys; however, international demand could fill in some of the slots vacated by the U.S.
• The A-10 aircraft cut of 102 aircraft will still leave the Air Force with 246 in its inventory.  We don’t know how this impacts a re-wing program that BA is prime on and KAMN is a subcontractor, but will try to run this down.
• The Air Force share of the $60 billion in new “efficiencies” identified for FY13-17 is $3.4-$3.5 billion.  IT was mentioned as one area of additional savings, as was energy.
• Sec. Donley stated that “we have excess infrastructure” and noted that in the 2005 BRAC, the Air Force did a lot of realignment but did not close many facilities.  Since then it has retired 250 aircraft and another 286 will come out in FY13-17.

We have some other quick thoughts from news in the past 24 hours:

• Yesterday Bloomberg reported that the V-22 (BA, TXT) program would be cut by 24 aircraft over FY13-17 in the next multiyear.  This was not included in the Jan. 26 DoD briefing and we expect there will be more of this salami slicing evident when the FY13 budget details are revealed.
• Front page news this morning that SecDef Panetta will aim to accelerate a drawdown in the U.S. combat role in Afghanistan may start to weigh on stocks with exposure to combat unit needs in Afghanistan.  However, we would expect the U.S. will still aim to retain a logistics/support/intelligence/SOF footprint to keep the Taliban at bay and ensure that new safe havens don’t emerge for al Qaeda
• The Army awarded development contracts to BA/ LN and NOC for the CIRCM program.  XLS had also been pursuing this program.

• Senate Antitrust Subcommittee Chairman Herb Kohl (D-Wisc.) announced yesterday that he will hold a hearing on Verizon’s pending cable company spectrum purchases and joint marketing agreements.
• We think the WSJ overstated the significance when it cited the announcement as why “political headwinds are building” against the deal.  Congress has no formal oversight role in the regulatory review process.
• We expect that the deal will attract some scrutiny, but we maintain that Verizon benefits from the simplicity of the transactions relative to AT&T/T-Mobile. It is seeking to deploy unoccupied, fallow spectrum and is not eliminating a retail competitor

Discussion

Senate Antitrust Subcommittee Chairman Herb Kohl (D-Wisc.) announced yesterday that he plans to hold a hearing on Verizon’s pending cable company spectrum purchases and joint marketing agreements.

We think the WSJ this morning overstated the significance of the announcement when it published

that “political headwinds are building” against the deal, citing critical statements made by Kohl and fellow antitrust hawk Sen. Al Franken (D-Minn.).

We note that Congress has no formal oversight role in the regulatory review process for transactions such as these. The spectrum license transfers are being reviewed directly by the FCC. The Justice Department is reviewing the joint marketing agreement.

Members of Congress generally exercise broad discretion in holding hearings across a wide range of topics, but have limited authority to interfere in the regulatory review of private transactions. Many hearings serve educational purposes for members.

We would be surprised to see an ordinary spectrum purchase receive such attention.  But the scale of Verizon’s proposed transactions and the existence of joint marketing agreements that could be perceived as collusive may be “too soon” for industry agitators after the AT&T/T-Mobile collapse.

We ultimately believe that this and any future Congressional hearing will be benign for Verizon as its cable company transactions move through the regulatory process. Though hearings provide sound bite opportunities for critics, we do not think they will tip the scale at the FCC and DOJ.

Investment Thesis

We maintain that Verizon benefits from the simplicity of its cable company transactions relative to AT&T/T-Mobile. It is seeking to deploy unoccupied, fallow spectrum and is not eliminating a retail competitor.

After the T-Mobile collapse, we see the Verizon spectrum purchases as proof that the “Big Four” carriers will continue to expand, but in creative ways that avoid the antitrust questions of a traditional horizontal merger.

As the top wireless carrier by subscribers, we expect the FCC’s central focus in the regulatory review will be whether Verizon will have “too much” spectrum, and, if so, potential remedies.  The mechanics of the joint marketing agreement will be reviewed at the DOJ but matter less at the FCC.

For more on Verizon-SpectrumCo/Cox, see our January 30 memo, Capital Alpha Investor’s Guide to the Verizon – Cable Company Spectrum Purchases.

DISCUSSION

Arguably benefiting from White House positioning for the election have been for-profit colleges, who have watched as the President, last week, proposed to make some $10 billion in campus-based aid contingent on all schools’ ability to curb tuition inflation while effecting “quality” education outcomes. [See Obama's "Blueprint for Keeping College Affordable and Within Reach of All Americans" here.] This has been read as spreading the Education Department’s unwanted Gainful Employment (GE) focus to not-for-profits, arguably to appeal to the middle class and insulate the President from criticism that he has surgically attacked only a small cross-section of the college universe (for-profits representing 10 percent of enrollments) while Washington has nevertheless continued to inflate an education bubble.

Meanwhile, apparently responding to an opening from House Veterans Affairs Committee Chairman Jeff Miller (R-FL), the Association of Public Sector Colleges and Universities (APSCU) yesterday (Jan 31) joined a broad cross section of education groups to write Miller and the Committee’s ranking member, Rep. Bob Filner (D-CA), suggesting that the VA take measures to:

1)  ensure that up-front counseling is provided to student-veterans who use any chapter of the now-more robust G.I. Bill (with its Post-9/11benefit); and

2)  establish a better system to process and track student complaints.

[See a copy of the letter here]

While it might seem like an additional slap at the for-profits the move instead may be designed to help address concerns about schools’ aggressive marketing to soldiers, veterans and their families without resorting to more emergency measures.  Per a source, this may reflect VFW/VSO belief that 90/10 reform is not a viable solution politically or policy wise, so they are looking for other practical alternatives.

Meanwhile, a top VA source is said to have expressed strong doubts that the Administration will address 90-10 via regulation, apparently noting that last week’s rumors of such a “nuclear option” were “completely blown out of proportion.”

Separately, former Massachusetts Governor Mitt Romney’s decisive victory in the Florida primary can also be viewed as a positive for the for-profits, as Romney, perhaps more than any of the other candidates, has repeatedly held up private career colleges as exemplary in their flexible approaches to meeting students’ needs.  While this has attracted mixed reaction from sources in the media, it serves as a welcome counter-point to Obama, who has freed his Education Department to seemingly villainize for-profits while missing no opportunity to promote competing community colleges.

Finally, as the New America Foundation’s Jason Delisle noted in a Higher Ed Watch blog yesterday, the student loan interest-rate component of the President’s “Blueprint” would cost some $4.3 billion annually to offset — which, as we noted on January 25, “might inevitably create a search for revenue offsets.”   This could create “at least some chance that lawmakers might look to Sen. Sherrod Brown’s (D-OH) ‘Debt Swap’ bill that would assume up to $9 billion in savings by letting student borrowers consolidate private, non-federal loans into Federal Direct loans.” We also noted: “We strongly doubt such legislation would gain traction, but believe it could add to headline risk already in store as a result of an expected ED/CFPB study on private loans due this summer.”

Discussion
The new mortgage refi proposal would allow “responsible”-but-otherwise-ineligible borrowers with non-GSE and even low-LTV loans to refinance non-jumbo/single-family mortgages through the Federal Housing Administration (FHA). Borrowers with GSE-held loans would also benefit, largely from lawmakers’ approving “streamlining” changes that the “Plan” memo states “we believe. . . are within the existing authority of the FHFA. . . however, to date the GSEs have not acted.” One read of the proposed result is that while 3.5 million homeowners with non-GSE loans might benefit, a large number of another 11 million with Fannie-Freddie mortgages might be newly empowered to do so as well.

Not surprisingly, though, the proposal has been declared DOA by Hill Republicans, in part because of resistance to a notional large-bank tax to be used as a funding source but also based on opposition to setting FHA toward an even more expansionist course while it remains under-reserved. In any event, the need to pass legislation to effect this part of the “Plan” should allow Obama to claim he tried all avenues but was hampered by GOP obstructionism.

Meanwhile, increasing perceptions of the White House’s incentive to throw election-year proposals in the air – regardless of where they land – has some observers speculating that a Friday deadline for state AG and lender buy-in to an emerging mortgage servicing legal settlement might also be designed to force many banks to resist and, in doing so, become even bigger whipping boys for Obama on the campaign trail. We question such a thesis, and believe the administration has been mostly focused on effecting maximum and optimally-pre-election homeowner relief via a settlement in order to augment modest results from the HAMP and HARP programs. Thus, we think it had sought, at least until last month, to steer towards as broad a deal as possible. Nevertheless, after failure to effect an agreement before the State of the Union, we think it began to resort to more coercive tactics (e.g., creation of the new mortgage-related crime task force headed by New York AG Eric Schneiderman) – throwing a bone to increasingly wary liberals (who have feared an “overly-generous”deal for the banks) in the process. As a result, the degree of lender legal protection the agreement might afford is more than ever in doubt.

Finally, a piece of mixed-to-positive news comes in the form of afternoon reports that the FHFA has decided to shelve a servicing-fee reform proposal that would have abandoned minimum service fees in favor of a fee-for-service or hybrid structure. While some firms who service more troubled loans may have been better off under the proposal, others would have suffered. Meanwhile, as one source noted for a reason why FHFA has for now demurred: “Why make such draconian changes for an issue that had nothing to do with mortgage crisis?”