South Korea’s arms procurement agency said Monday, March 25, that it would buy 40 Lockheed F-35 fighter jets in a deal valued at $6.8 billion.  This confirmation from South Korea for Lockheed‘s (NYSE:LMT) F-35 fighter jet program, is in keeping with the increasing interest from international customers in recent months. The deal is expected to close in the third quarter of this year, after detailed negotiations over price and support services. Thereafter, South Korea will join the U.K., Norway, Netherlands, Italy, Israel, Turkey, Australia and Japan in the group of countries, apart from the U.S., that have ordered the F-35.
In our view, this growing international footprint of the F-35 not only helps Lockheed offset the weak defense spending environment at home, but also saves many millions for the U.S. government in its procurement of this jet since a larger international order book lowers the per unit price of the jet.
We currently have a stock price estimate of $155 for Lockheed Martin, marginally below its current market price.
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South Korea Values Stealth Capabilities Over Budget Constraints
In September last year, South Korea surprisingly re-opened its multi-billion fighter jet deal after turning down Boeing’s F-15, which remained the sole bid conforming to its $7.8 billion budget. At the time, the country was looking to buy 60 fighter jets in this budget, but rejected Boeing’s F-15 due to its fewer stealth capabilities. Following this development, we had written that Lockheed’s F-35 is a front runner for the deal, as Korea is now more focused on acquiring jets with advanced radar-evading capabilities.
We figure the country’s focus on acquiring advanced stealth capable jets stems from its regional geopolitical calculations. A stealth capable jet will enable South Korea to hit nuclear installations inside North Korea – a country with which it has technically been at war since 1953. At the same time, Japan’s order of 42 F-35s and China’s development of an indigenous fifth-generation fighter jet featuring stealth capabilities also likely pushed South Korea to acquire an advanced stealth capable jet. Consequently, the country chose F-35 which has advanced stealth features, but in doing so it had to trim its targeted order volume to 40 jets to factor in the F-35’s higher price point. First F-35 deliveries from Lockheed to South Korea are expected to take place in 2018.
F-35’s Growing International Reach Helps Lockheed Reduce Its Dependence On The U.S.
For Lockheed, this growing international client reach of its F-35 program helps offset pressure from lower defense spending in the .US. The Budget Controls Act of 2011 requires the U.S. government to reduce its defense spending by $487 billion over a ten-year period starting from fiscal 2012. 
Lockheed is especially vulnerable to this reduction in US defense spending as it gets over 80% of its sales from the U.S. government contracts.  So, growing international sales will enable the company to reduce its dependence on the government and diversify its risk profile. Lockheed currently targets to generate 20% of its sales from international customers within the next two-three years. In this context, F-35’s growing international footprint will enable the company to achieve its target.
International Orders For The F-35 Reduce Cost Burden On The U.S. Government
For the U.S. government, this order from South Korea is favorable as it will help save many millions for the government, which is in a tough fiscal situation. The F-35 program being a large defense program has put a huge cost burden on the U.S. government. But as international orders for the F-35 grow, the development costs of this plane, which are largely funded by the government, get spread over a larger number of planes. Consequently, the per unit price of the F-35 comes down. In turn, a lower per unit price will save money for the government as it will purchase more than 2,400 of these planes from Lockheed.
Currently, the F-35 costs over $100 million a unit. By the end of the decade, the Pentagon and Lockheed expect its price to fall to around $85 million a unit, driven by gains from higher production volumes and growing international orders. 
Other countries, notably those from the Middle East including Saudi Arabia and the UAE have also shown interest in acquiring the F-35. However, sales of this advanced jet to these countries do not look feasible in the near future due to Israeli concerns. Nonetheless, with each additional international order for the F-35, Lockheed gains as this program will constitute a growing share of its sales in the coming decade. Last year, the F-35 program constituted 16% of Lockheed’s sales, but that percentage will rise significantly in the next few years with the planned ramp up in F-35 production. Notes:
- Lockheed To Get $6.8 Billion Order From South Korea, March 24 2014, online.wsj.com [↩]
- Lockheed’s 2013 10-K, February 14 2014, www.lockheedmartin.com [↩] [↩] [↩]
- South Korean order would drive down F-35 per plane cost lower, November 22 2013, www.reuters.com [↩]