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Business Observer Friday, Jan. 2, 2004 16 years ago

Boeing's Strategy: Use Military Ties to Gain Trust

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Harry C. Stonecipher left retirement in St. Petersburg to help troubled Boeing. Critics say he's too close to the officials who've stepped down to do the job.
by: Janelle Makowski Staff Writer

Boeing's Strategy: Use Military Ties to Gain Trust

Harry C. Stonecipher left retirement in St. Petersburg to help troubled Boeing. Critics say he's too close to the officials who've stepped down to do the job.

SEATTLE, Wash. (Bloomberg) - In a 2001 speech, Boeing Co. Chief Executive Officer Harry C. Stonecipher, then the company's president, touted the "partnership" he helped create with the U.S. Air Force.

He singled out for praise Darleen Druyun, then the Air Force's second-ranking acquisition official, who had described herself as the "godmother" of Boeing's C-17 cargo plane.

"We all campaigned together, the service, the company and our suppliers, for the needed support in Congress," Stonecipher said at a conference in San Antonio.

Now in his first month as CEO, Stonecipher is attempting to recover after Boeing's top two executives left amid allegations the company recruited Druyun for a job as she negotiated a $27.6 billion aerial tanker contract. Stonecipher's paradox: he is trying to restore the military's confidence in Boeing's ethics by using the very Air Force ties he cultivated as the company's second-in-command when misdeeds occurred.

"Someone's got to come in and say, 'This is not going to happen again,' " said Brian James, an analyst with Loomis Sayles & Co. He sold the 484,000 Boeing shares his company held among its $60 billion in assets in the past year.

The Pentagon has put the order for aerial tankers on hold as it investigates Chicago-based Boeing's ties with Druyun. A U.S. Senate panel will hold hearings after Congress resumes Jan. 20. At risk for Boeing is $23 billion more in defense contracts scheduled for awarding next year, including a 13 billion pound ($20 billion) U.K. government tanker order and $3 billion in Air Force rocket launches.

Justice Department Inquiry

Stonecipher has wasted no time renewing old ties in Washington. The CEO said he met with U.S. Deputy Defense Secretary Paul Wolfowitz and Air Force Chief of Staff John Jumper Dec. 10, and visited Washington again Dec. 18 to see Air Force Secretary James Roche.

"I'm going to visit with everyone so they understand we are going to address every problem they have, so I'm busy going around talking to all the people who have a position in this issue of our credibility," he said.

Stonecipher, 67, must also contend with a separate investigation into Boeing's possession of thousands of pages of proprietary Lockheed Martin Corp. documents that may have helped win rocket-launch bidding while he was Boeing president in 1998.

The Air Force stripped the company of $1 billion in business after an inquiry in July, and the military will incur $223 million in extra costs as a result because it shifted launches to Lockheed Martin. The Air Force won't try to recover the money, a spokeswoman said.

'Visit With Everyone'

Boeing should change its oversight of worker behavior, two separate reviews of the company's ethics programs said. Boeing must take steps to avoid conflicts of interest in hiring and contract bids, a Nov. 3 report by the law firm of Paul, Weiss, Rifkind, Wharton & Garrison LLP said. A review dated Oct. 23 by the Ethical Leadership Group recommended an ethics officer report to the chief executive and the board's audit panel.

Another misstep by Boeing, the second-largest U.S. defense contractor, will push more business to rivals Lockheed Martin, Northrop Grumman Corp. and Raytheon Co. Since Stonecipher was named to replace CEO Philip M. Condit Dec. 1, Boeing shares have outperformed the shares of Lockheed, Northrop Grumman and Raytheon this year.

Boeing is counting on Stonecipher, who came out of an 18-month retirement in St. Petersburg, to use experience from running McDonnell Douglas before it was bought by Boeing, and his knowledge from leading defense contractor Sundstrand Corp. A year after he became its president in 1987, the contractor agreed to pay $115 million to settle charges it overbilled the defense department.

'Sleazy Deal'

Opponents of the tanker agreement such as U.S. Sen. John S. McCain, a Republican from Arizona, have called the order a government bailout since it was proposed in 2001. "This sleazy deal would have been a rip-off of our taxpayers," McCain told reporters in Washington on Nov. 24.

Stonecipher's contribution to a "win at all costs" company culture may come under scrutiny, said Keith Ashdown, vice president of Taxpayers for Common Sense, a Washington-based group that tracks government spending.

"He isn't a Boy Scout in this," Ashdown said. "There are ethical issues from his tenure that are still very relevant."

Stonecipher's experience will ultimately make up for the political shortcomings created by his ties with Boeing during ethical lapses, said Rich Turgeon, director of research at KeyCorp's Victory Capital Management.

'Pound of Flesh'

"There's always going to be a bit of grousing, I think that's natural," said Turgeon, whose company held 5.2 million Boeing shares as of Sept. 30. "The best thing for Boeing is that they have a strong leader, somebody that's very capable and knows the ins and outs of Washington and the Pentagon."

James expects Boeing to assuage critics by slicing at least $1 billion off the price of the tankers. "The government is going to extract its pound of flesh," he said.

In the meantime, the political concern creates an opportunity for investors, said Richard Pzena, president of Pzena Investment Management LLC, which added almost 900,000 Boeing shares in the third quarter to take its stake to 4.3 million shares.

"The only time you get to buy is at a time like this," Pzena said. "It's a great franchise at a low price."

The company is relying on defense contracts to make up for a 50% decline in jetliner production since 2001 as terrorist attacks reduced air travel and rival Airbus SAS grabbed market share.

Loss Widens

Boeing recently began offering for sale the 7E7 jetliner, a plane with about 250 seats that's designed to be about 20% more fuel-efficient than the 767s it's replacing. The plane, designed partly to take sales from Airbus, won't start flying until 2008.

As company president, Stonecipher motivated managers by telling them they needed to win $1 billion of business a week to maintain annual sales, which fell 7% to $54 billion last year. Boeing's loss in the first nine months of this year widened to $414 million from the year-earlier $98 million.

The son and grandson of coal miners, Stonecipher got a physics degree from Tennessee Technological University in 1960 and then spent 27 years at General Electric Co., rising to head the company's aircraft-engine business.

He said Dec. 1 that he hadn't negotiated a salary with Boeing and the board would decide his compensation later. Stonecipher has 1.7 million Boeing shares, options and restricted stock valued at about $70 million, according to the most recent proxy statement.

'Respected'

After leaving Sundstrand for McDonnell Douglas in 1994, Stonecipher faced another crisis with the Pentagon. The C-17, one of the company's three largest military-aircraft programs, was on the verge of cancellation because of delays and cost overruns.

Stonecipher insisted on monthly quality, cost and performance goals, then touted the improvements to officials in Washington, said Don Kozlowski, a retired McDonnell Douglas executive. The Air Force has since agreed to buy 140 more for $24 billion.

The turnaround made Stonecipher friends in the military. An Air Force statement after he took over at Boeing called him "an executive with high standards for performance and impeccable integrity."

"He's just very well-known by people in the Pentagon," said Jacques Gansler, the Defense Department's acquisitions chief from 1997 to 2000 and now a professor at the University of Maryland. "He's respected as a good, trustworthy manager."

Tankers Needed

Stonecipher's military ties also present hazards.

He said in his 2001 speech that the company worked with the Air Force to reduce bureaucracy on the C-17. When lower-ranking managers couldn't resolve annual contract disagreements, program managers "would settle the outstanding differences themselves, without the help of their staffs,"' he said.

McCain and other critics say that tight relationship helped the company secure a sweetheart deal.

"They were one team working together rather than at arm's length, the way it should be," said Eric Miller, senior defense investigator at the Project on Government Oversight, a Washington-based group.

Druyun has faced questions about her relationship with contractors in the past. A 1993 report by the Pentagon's inspector general accused her and other Air Force officials of improperly advancing $349 million to McDonnell Douglas for C-17 work. An Air Force review cleared Druyun.

Hullabaloo

U.S. Rep. Norman D. Dicks, a Washington State Democrat who supports the tanker agreement, said Druyun had nothing to do with the agreement reached last month. She left the Air Force in November 2002, a month after Boeing says she discussed a job with former Chief Financial Officer Michael M. Sears. Boeing said Nov. 24 the company fired Sears and Druyun, who worked as an executive in its missile division.

Sears denied in a statement last month that he violated company policy. Druyun declined to comment through her attorney.

"The deal wasn't put together until right at the end," Dicks said. "What's lost in all this hullabaloo is that we need the tankers."

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