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Our View: First of a New Wave

Sep. 17, 2012 - 02:49PM   |  
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BAE Systems and EADS have yet to formally announce their merger plans, but the mere confirmation that talks are underway will fundamentally reshape the global defense and aerospace industrial base.

If approved by regulators in Britain, France, Germany, Spain, the U.S. and the EU, the new company would have combined sales of $96 billion, leaving Boeing, the current No. 1 in aerospace and defense, in distant second place with $68 billion.

The sheer size, breadth and political heft of the new company already has governments and competitors assessing the deal and its implications to determine whether, first, to oppose the transaction, and later how best to respond.

U.S. and European companies perched atop mountains of cash have been assessing possible mergers and acquisitions, waiting for the right moment to start what many expect will be a cascade of transactions. Activity in America was expected to start after the presidential election and after the budget situation becomes more clear.

The deal, spurred by EADS’ CEO Tom Enders, who took office in June, is a masterstroke that addresses shortcomings facing the European giant.

It would change EADS’ product mix from 70 percent commercial and 30 percent defense, to a more healthy 50-50 balance while expanding its global marketing reach, with BAE’s North American unit key to growth in the U.S. defense market, which despite budget cuts remains the world’s largest.

EADS’ U.S. defense sales are about $300 million a year, largely for light helicopters and satellite imagery, while BAE generates $15 billion from armored vehicles, ship repairs, munitions, and advanced electronics, including electronic warfare, communications and cyber gear, as well as security systems, services and a highly classified intelligence business with 6,000 employees with clearances above top secret.

Plus, the deal would reform EADS’ governance structure, which now allows the French, German and Spanish governments to exert influence on the company, and allow it to move toward becoming a wholly commercial firm for the first time since its birth in 2000. And British executives would reset the Franco-German dynamic in the company, which hasn’t always been healthy.

But challenges remain. BAE and EADS have said the deal won’t work if France, Germany and Spain maintain their current approach of occasionally trying to influence company operations, a critical step that’s not assured. But the new ownership structure being considered may hamstring the operational flexibility of the company and burden its management team.

Meanwhile, regulators in Europe and America will be hearing from governments the companies serve, as well as their competitors, who will freely express views that will help determine approval.

While experts say antitrust overlaps between the two companies are minimal, European Commission regulators have rejected mergers they say constrain competition or are simply too big. GE’s proposed acquisition of Honeywell was opposed on scale grounds, and BAE and EADS are each bigger than competitors Thales, Finmeccanica and others combined.

In America, security questions will be paramount. BAE was allowed to buy sensitive U.S. businesses by falling under the special relationship between Washington and London, but it was required to run its North American unit independently of London. To allay possible DoD concerns, BAE and EADS stress that BAE North America would remain independent.

What’s clear is that BAE-EADS is the starting gun of a race that will reshape the defense and aerospace landscape, first in Europe, then in the United States, as profoundly as the consolidation wave following the end of the Cold War.

U.S. and European officials have spent years thinking through what they want their supplier bases to look like. DoD leaders have made it clear there’s room for consolidation, but not at industry’s upper tiers.

The collective challenge now is to ensure the industry that emerges after this consolidation phase preserves enough competition, drives industrial efficiency and cuts costs and preserves key domestic capabilities while benefiting from global innovation and markets.

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