General Dynamics Tank Rival Wins a Big Contract in Poland

Polish Army T-72 main battle tank. Image source: Polish Ministry of National Defence.

With nearly 600 units in service, the Soviet T-72 main battle tank serves as the backbone of the Polish Army today. There's just one problem: These tanks, built by Russia and requiring Russian spare parts to maintain them, are currently pointing their guns at Russia -- which became an increasingly urgent threat after its 2014 invasion of Poland's eastern neighbor, Ukraine.

Now, Poland does have some tanks of its own manufacture -- more than 230 homegrown PT-91 tanks in various derivations. But in an effort to further integrate itself into NATO's self-defense forces, Poland's recently been turning to the West to supply an increasing number of its heavy weapons.

Strange bedfellows In particular, it's turning to Germany. In 2002, Poland bought 128 used Leopard 2A4 main battle tanks from Germany, using them to outfit its own 10th Armoured Cavalry Brigade. Subsequent purchases of 14 more 2A4s and 105 more advanced Leopard 2A5s lifted the number of Leopards in Poland's inventory to 247 units. Today, German-built Leopard tanks outnumber Polish-built PT-91s.

Krauss-Maffei Wegmann's Leopard 2A4 main battle tank. And that gun on front? Rheinmetall makes it. Image source: KMW.

And as we just learned, Poland has embarked upon an ambitious project to overhaul and upgrade perhaps its entire fleet of Leopards to a much more modern configuration, dubbed the "Leopard 2PL."

"Tanks" for (almost) nothingAs reported by Defense-Update.com last week, Poland has contracted with German industrial conglomerate Rheinmetall to begin modernizing its original fleet of 128 Leopard 2A4s with new thermal sights, expanding magazine capacity, and improving turret armor. Modernization work is to begin next year, and conclude in 2020. At that time, Poland may elect to upgrade the 14 additional Leopard 2A4s it bought subsequently. Janes.com thinks that when all's said and done, modernization work on the first batch of tanks could cost Poland $606 million -- about $4.7 million per tank. By extension, that implies the cost of upgrading all of Poland's 2A4s could surpass $672 million.

And even then, Poland may not be done. While Janes says the upgrades will effectively transform Poland's old Leopard 2A4s into more advanced Leopard 2A5 tanks, to truly unify its tank force, the tanks bought as 2A5s will also need to be modified as well. Converting the whole motor pool to the Leopard 2PL configuration is a process that would cost even more millions.

What it means to investorsDefenseIndustryDaily.com notes that globally, Germany's sales of used Leopards are "choking sales of competitive designs," such as the Abrams main battle tank produced by General Dynamics . What's more, Germany is grabbing market share in Eastern Europe in a very clever manner.

Describing the November 2013 deal to sell Poland 14 Leopard 2A4s and 105 2A5s, DID called the sale "incredibly cheap" at a total cost of just $241 million-- about $2 million per tank. Of course, Germany is now turning around and charging more than twice that upfront cost to upgrade the tanks through Rheinmetall. But with so much money sunk into the initial investment already, Poland had no choice but to ante up for the upgrades. New tanks from General Dynamics, after all, would have cost even more.

What does it mean to investors in General Dynamics in particular?Ordinarily, Russia's rise as a renewed threat in Europe should have helped General Dynamics to win sales in Europe. Instead, the company looks to have been outmaneuvered by Rheinmetall. Curiously, Rheinmetall also appears to have beat out defense holding company Giat Industries, which owns the Leopard's maker, Krauss-Maffei Wegmann. This further reinforces my view that Rheinmetall is one very smart operator in the European arms market.

In fact, if we set Rheinmetall side by side with what we know about its competitors at Giat, it now looks like Rheinmetall, not Giat, may be the defense contractor to beat in Europe. While privately held Giat was last clocked at $2.2 billion in annual sales, data from S&P Global Market Intelligence show that the more highly diversified (and publicly traded) Rheinmetall sold $5.6 billion worth of goods and services last year. With only $114 million in profits on those sales, Rheinmetall may be less profitable than Giat -- but if accepting lower profit margins is what it takes to win contracts in Europe, that seems to be OK with Rheinmetall.

This is not good news for General Dynamics, however. With Rheinmetall and Giat fighting among themselves for market share in Eastern Europe, General D's chances of breaking into the market are looking less attractive by the day -- and its chances of earning a profit from such business, even slimmer.

Germany's Krauss-Maffei Wegmann, a subsidiary of defense giant Giat Industries S.A., builds a whole range of products for the modern military -- but it's Rheinmetall that's stealing the business. Image source: KMW.

The article General Dynamics Tank Rival Wins a Big Contract in Poland originally appeared on Fool.com.

Rich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 282 out of more than 75,000 rated members.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.