(FORTUNE Magazine) – The opening salvo of Operation Enduring Freedom, a barrage of 50 cruise missiles, was fired from a flotilla of U.S. and British ships somewhere in the Arabian Sea. Three of the ships, the destroyer John Paul Jones, the cruiser Philippine Sea, and the nuclear submarine Providence, were made in two of America's storied shipyards: the Bath Iron Works in Bath, Maine, and Electric Boat in Groton, Conn.--yards that are cornerstones of defense giant General Dynamics.

A conservative Republican in the White House, a nasty war with no end in sight, and a nation gripped by a patriotic fervor unseen in half a century: It's not surprising that shares of defense companies like General Dynamics, Northrop, and Lockheed Martin are up 20% to 40% over the past 12 months, even in this brutal stock market. And it's true the new war will mean more business for defense companies, though insiders caution that no one really knows which companies will benefit or by how much. But here's something you probably didn't know: For General Dynamics, 2001 is shaping up to be just another year at the races. While other defense contractors seem to sputter or surge depending on the Pentagon's whims, GD blasts right along. Its stock has climbed more than 600% over the past decade, far outpacing its competitors and the S&P 500.

How is that? You'd figure that defense contractors would do well during eras like the Reagan military buildup and suffer during times like the Clinton presidency, right? Not General Dynamics. This nearly 50-year-old company had a blowout decade while Bubba was Commander-in-Chief.

No, this stock isn't for everybody. For the most part, General Dynamics is in the war business (70% of sales), and some investors have a problem with that. But generally Wall Street loves GD. Unlike other defense contractors, says Chris Mecray of Deutsche Banc Alex. Brown, "General Dynamics management runs this company for shareholder interest rather than just for national security. The CEO is a careful and deliberate caretaker of shareholder money."

That CEO is 59-year-old Nick Chabraja, who on this late-October morning is looking a little drawn at GD's headquarters in Falls Church, Va. The day before, in an unexpected move, the departments of Defense and Justice--insiders say with some serious prodding from Mississippi Senator Trent Lott--blocked General Dynamics' friendly takeover bid for Newport News Shipbuilding. The Defense Department apparently will allow a rival bid by Northrop, which owns a large shipyard in Pascagoula, Miss., to go forward. For Chabraja (pronounced cha-BRAH-ya), a sharp-witted lawyer, it is a major blow. While admitting that the Defense Department's move surprised him "a little," he says, "This won't stop us. We will move on. There are never any must-buys for us."

Chabraja, a deal dude, has been part of a management team that has bought 19 businesses over the past seven years. That great shopping spree is only the second half of a little known and remarkable story. Before 1990, General Dynamics was the nation's largest defense contractor, manufacturing everything from the vaunted F-16 to Tomahawk missiles to space launchers. It owned coalfields and Cessna Aircraft. The only problem was that by the end of Reagan's second term, most of those businesses weren't worth a damn. In 1990, GD had $10.1 billion in sales (and ranked No. 48 on the Fortune 500) but a market cap of only $1 billion. In walked former astronaut Bill Anders as CEO. He decided that if a business was bad, his company should sell it.

So out went the fighters (to Lockheed), the missiles (to Hughes), and the space launchers (to Martin-Marietta). Revenues dropped, but cash on the balance sheet went up, and lo and behold, the stock went up too. By the time Anders was through, GD had only two businesses left: Electric Boat, which makes nuclear submarines, and Land Systems, which makes the M-1 tank. "We didn't sell them because no one would buy them," says Chabraja with a grin. "Both were considered Cold War relics."

The situation at Electric Boat was dire. The century-old yard--where the world's first nuclear-powered sub, the Nautilus, slid off the ways in 1954--was dead in the water. EB had close to 20,000 employees and almost no business. So, says Chabraja, "we began a program of continuous process improvement. We wanted to aggressively contain costs and improve margins in our backlog." It worked. Electric Boat, which now employs about 9,000, cut a total of some $1.3 billion in costs over the past seven years.

Whereas EB stamped out scores of submarines during World War II and the Cold War, today the men and women in the yard at Groton are working on just two: one of the Seawolf class and one of the new Virginia class. Each costs around $2 billion. "When I first came to work here 22 years ago, you could see submarines in various stages of development. Now you have to watch one get built," says John Casey, vice president of operations, as he steps gingerly through the cramped officers' quarters of the half-built Seawolf, the Jimmy Carter. The ship is to be delivered to the "customer," as the armed forces are known in these parts, outfitted to facilitate the deployment of Navy Seals--potentially a useful feature in this new conflict.

By the mid-1990s, then-CEO Jim Mellor began to focus on more than simply fixing Electric Boat and the tank business. In a sea change, management decided the best use of GD's cash would be to buy other defense companies--this time ones more closely related to its core sub and tank businesses. In 1995, GD bought the Bath Iron Works, which builds Arleigh Burke class destroyers on the banks of the Kennebec River, a shipbuilding site since colonial times. In 1997, the same year Chabraja became CEO, GD bought Lockheed Martin's armament and defense systems and other technology businesses. A year later it bought the Nassco shipyard in San Diego, which makes combat-support and cargo ships. It bought GTE's military-communications-equipment group in 1999. That same year Chabraja made a giant bet, stepping outside the defense sector and plunking down $4.5 billion of GD stock to buy Gulfstream, the maker of luxury jets.

Through this buildup, GD's stock climbed as Wall Street saw these acquisitions pay off. And so General Dynamics had pulled off the rarest of rare business feats. It had dramatically enhanced shareholder value first by radically downsizing and then, in an abrupt turnabout, by rapidly ramping the company back up. The company literally made money coming and going. "The driver of General Dynamics is financial," insists Chabraja. "We focus on return on invested capital." He says he has committed to providing his investors with a 15% annual average total return. Is that too aggressive? "Well, we've done it," he points out.

Here are some key questions Chabraja now faces: (1) Will Gulfstream's business, which was booming, tail off in the weak economy? (2) What happens now that the Newport News deal is kaput? And (3) How much will the war boost GD's business?

"I think many of the reasons we bought Gulfstream two years ago are intact," Chabraja says. "Safety and the hassle factor of flying commercial are even more important today." Chabraja says Gulfstream will cut production by eight aircraft next year to 102, but says this high-margin business should still ring up about $625 million in operating income, the same it's expected to produce this year. And with orders booked solid for the new V-SP jet, Chabraja says 2003 is a lock.

As for Newport News, GD will continue to make subs with that company and its presumed new owner, Northrop. General Dynamics and Newport News are actually splitting construction of each Virginia-class sub, piecing them together from giant, premade modules. Should we expect more acquisitions? "Oh, yes," says Chabraja quickly.

As for how the war will affect GD's business, Chabraja doesn't reveal too much. Clearly some of its businesses will benefit, like munitions and electronics. High-ranking military types have "pulsed" the company to see whether it can step up production in certain areas. "All I can say is watch our backlog," Chabraja says. For the quarter just ended, GD's backlog grew to record levels, up $6 billion, to $30 billion.

Today, just as in 1990, General Dynamics has sales of around $10 billion. Only instead of having a $1 billion market cap as it did a decade ago, the company is worth $17 billion. Whether this latest conflict with terrorism proves to be brief or protracted, it's a good bet that General Dynamics will find a way to improve upon those numbers even more.

REPORTER CREDIT Julia Boorstin

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