When there are few places to look for stable, long-term growth, be assured the wheels of war will continue to pound the sand.

— Gregg Early, executive editor of Personal Finance

Last week, I wrote an article on Afghanistan discussing the bleak prospects for U.S. involvement there. The revelation over the weekend that the Pakistani Inter-Services Intelligence (ISI) agency is sabotaging U.S. efforts by secretly cooperating with the Afghan Taliban — recently releasing two insurgents wanted by the U.S. — only confirms my concerns.

The Afghanistan Troop Surge Means Profits!

But the likelihood that the U.S. will end up the loser in Afghanistan is a long-term worry. In the short-term, military contractors doing business in Afghanistan will make a boatload of money as the U.S. is committed to a “surge” that will accelerate military spending. President Obama has decided to (partially) follow General McChrystal’s advice and send 30,000 additional troops to Afghanistan by May of this year in a last-gasp effort to reverse the tide of the war.

Big Dollars Being Spent

Let’s look at the numbers according to the Congressional Research Service: through September 2009, the U.S. military has spent a total of $227 billion in Afghanistan since the war began, which averages out to a little less than $30 billion per year. Adding an additional 30,000 troops to Afghanistan may require the Pentagon to spend an additional $15-$20 billion per year there, according to some estimates.

Granted, President Obama has set an arbitrary July 2011 deadline for beginning to withdraw combat troops from Afghanistan. So this extra spending is only guaranteed for the next 16 months. One analyst has characterized this time period prior to the deadline as a “military frenzy.”

Don’t Be Spooked By Obama’s Withdrawal Deadlines

This deadline date, however, is only the start of a long, drawn-out withdrawal process — nobody believes that all combat troops in Afghanistan will leave in July 2011. And even when most are gone, a U.S. presence will remain in the form of military advisors and contractors helping the Afghanistan government defend itself. The same holds true for Iraq, where the deadline for complete withdrawal of combat troops is August 2010 and December 2011 for all other U.S. troops.

But even these deadlines are in doubt. For example, there is speculation that “combat” troops will be reclassified as “advisory” troops in order to stay after August and negotiations with the Iraqi government will result in an extension or redefinition of the “all out” December 2011 deadline.

Military Contractors are Multiplying

In fact, troop drawdowns in Iraq and Afghanistan could actually increase the use of military contractors needed to fill the void left by the withdrawing troops. In testimony before Congress last November, Rear Admiral Tom Traaen stated: “The ratio of contractors to military has been 1:1 for the past several years, but it is predicted this will increase to 1.5:1 by next August.” Similarly, the Wall Street Journal reported last December that the U.S. is hiring military contractors at a “fast pace:”

Contractors already outnumber U.S. forces in Afghanistan and their numbers have been rising all year. The Defense Department’s latest census shows that the number of contractors increased about 40% between the end of June and the end of September. Officials want U.S. troops focused on combating insurgents, not on the nuts and bolts of sustaining what will be the largest fighting force the Pentagon has sent to the nation.

A Defense Department official said contractors in Afghanistan and Iraq “will continue to provide a wide range of tasks essential for operations including maintenance, construction, transportation, security and base support.” The Obama administration has made moves to reduce the use of government contractors at the Pentagon itself. On the battlefield, however, their use is rising in what has become a permanent shift in how the U.S. military operates overseas.

In fact, according to University of Maryland public policy professor Jacques Gansler, approximately 70% of the U.S. force structure in Iraq and Afghanistan are private contractors!

What Type of Military Contractors are the Winners in Afghanistan?

The question remains which military contractors are most likely to benefit from the troop surge and aftermath in Afghanistan.

For help on this question, I turned to KCI’s own Gregg Early, executive editor of the Personal Finance investment service and an expert on the defense industry. Nobody – and I mean nobody — knows more about the defense industry generally, or the subspecialties of cyber-security and electronic warfare, than Gregg. Fortunately, my office is right down the hall from Gregg, so I was able to spend some quality time with him. The following bullet points summarize what I learned from Mr. Early:

• When the country isn’t engaged in live wars of significance, the government looks to modernize weapons systems – new planes, ships, tanks, and telecommunications. At the current time, this scenario DOES NOT APPLY.

• When the country is fighting, the monies are diverted to the boots on the ground and the logistics services needed to support them. Logistics include transportation, maintenance, construction of buildings, and services needed to support the troops on the ground. BINGO. Focus on military contractors that provide logistics, not weapons!

• President Obama has ordered an end to most of the paramilitary and interrogation contracts that caused international scandals in the past. The dominance of contractors like Blackwater (now called Xe) is OVER.

• In addition to logistics, the hot areas are: (1) troop and police training of Afghans; and (2) command, control, communications, computing, intelligence, surveillance and reconnaissance (C4ISR) services.

Some Favorite Military Contractors

As far as specific companies that fit these themes, Gregg was gracious to give me four names. His favorite overall is an electronic intelligence and cyber-security firm called ManTech International (NasdaqGS: MANT). In a recent article for Personal Finance, Gregg wrote:

Mantech (NasdaqGS: MANT) operates almost entirely within the intelligence community. And when you have two hot wars, a global terrorism network or two, and increasing corporate and governmental espionage from new and old rivals, you’re in a growth business. Even in this economy, Mantech is in growth mode, thanks to its work with the military, intelligence and intelligence contractors in Afghanistan. The company is obviously held in high esteem across U.S. security operations.

In military logistics, he mentioned Oshkosh Corporation (NYSE: OSK), which provides platforms and armor to the Joint Light Tactical Vehicle (JLTV), a beefed-up armor-plated successor to the vulnerable Humvee. According to Gregg, Oshkosh is “seeing a huge influx in business” for “theater-ready logistical vehicles such as tractor trailers and supply trucks.” Gregg originally recommended this stock in October 2008 when it was trading for less than $10. At today’s $40 per share price tag, Oshkosh has been a four-bagger and obviously is not as much of a screaming buy as it was back then, but he still likes it.

Lastly, he mentioned DynCorp International (NYSE: DCP) and Fluor Corp. (NYSE: FLR) because they hold between them the largest Defense Department contract for supporting troops in Afghanistan – the Logistics Civilian Augmentation Program (LOGCAP). DynCorp is responsible for the operation and maintenance of U.S. military bases in the southern half of Afghanistan, as well as training Afghan police. Fluor is responsible for similar military base services in the northern half of Afghanistan.

Author’s note: A few hours after this article was published, private investment firm Cerberus Capital Management announced it was acquiring DynCorp International for $17.55 per share in cash, a 49% premium over DynCorp’s closing price on Friday. You can read more about the takeover here.

Cautionary Note

There are House and Senate Bills in Congress right now that would phase out the use of private military contractors. If they were to pass and become law, they would seriously undermine the investment case for military contractors. I’m not too concerned, however, because the sponsors of these bills, Democrat Jan Schakowsky of Illinois in the House and Socialist Bernie Sanders of Vermont in the Senate, are two of the most left-wing members in the entire Congress and have very little mainstream support. Bottom line: these lunatic bills will never pass.

Afghanistan Trivia

According to the U.S. Department of Commerce, there are at least two things you should never do in Afghanistan if you want to be a successful businessman: (1) eat with your left hand; and (2) call an Afghan an Afghani.