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After Merger Fails, EADS, BAE Seek New Start

Oct. 14, 2012 - 01:44PM   |  
By PIERRE TRAN and ANDREW CHUTER   |   Comments
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PARIS and LONDON — EADS is taking a long, hard look at its ambitions in the weapons business while BAE’s top executive is brushing off speculation that his company is now in play for a possible takeover or breakup as the dust settles from the collapse of merger talks that would have created the world’s largest aerospace and defense company.

After negotiations to create a 70 billion euro ($91 billion) merger broke down Oct. 10, EADS Chief Executive Tom Enders told his staff that his company’s 2020 strategic plan will need to be

revisited.

“We will need to review our group strategy and defense activities in particular,” Enders wrote in the letter, a copy of which was obtained by Defense News.

“However, one thing is already clear: There will be no turning back to where we started from, and that pertains not only to strategy,” Enders wrote.

The EADS Vision 2020 project aims for an even split between the booming Airbus airliner business, and the defense, security and services sectors. Airbus made up 76 percent of EADS’ 2011 sales of 49 billion euros.

Berlin was widely seen to have blocked the merger, for reasons including electoral anxiety, pacifist sentiment and protection of national industrial interest, specifically with the EADS Cassidian defense and security unit.

Chancellor Angela Merkel faces a general election in the autumn of 2013, and a regional election in Bavaria, where Cassidian has headquarters in Munich.

For BAE, the merger talks were widely seen as putting up a “for sale” sign that will be hard to take down, analysts said.

The British company faces declining military spending in its core U.K. and U.S. markets, and a marriage to EADS would have renewed ties with a thriving commercial aircraft side. BAE abandoned that business in 2006 when it sold a 20 percent Airbus stake for 1.87 billion pounds ($3 billion).

BAE Chief Executive Ian King told Defense News that a takeover or break-up isn’t in the cards.

“Personally, I do not believe the floodgates are going to open with people coming in with offers for this company. Think of the price they would have to pay,” he said.

BAE is operating in a world where defense budgets are being cut, U.K. Defence Minister Philip Hammond said.

“It’s going to have to evolve its business model to be effective in a different business climate. That’s going to be a challenge for the business team,” Hammond said in a video on the Guardian website.

After ‘BEADS’

The merger approach marked a turning point for EADS, an analyst said.

“There will be an ‘after EADS-BAE,’ “ said Loic Tribot La Spiere, deputy director of think tank Centre d’Etude et de Prospective Stratégique. EADS may have offered Berlin guarantees about jobs and keeping sites open, but they were for four years, La Spiere said.

German officials were concerned the new company would move the defense business to London, handing the military side to Britain, while commercial aircraft would go to France and Germany would be sidelined.

“Things won’t be the same,” La Spiere said. “All the effort and energy deployed will go into increasing [EADS’] size and to make defense bigger.”

EADS needs to look for “complementary” acquisitions that do not upset the Franco-German relationship, and respect the national interest of the two countries, La Spiere said.

One defense sector EADS is likely to look to for acquisitions is services and support.

The company purchased Canada’s service company Vector Aerospace last year and similar deals are expected to be targeted in the coming months and years.

Chief strategy and marketing officer Marwan Lahoud will have tough questions to answer. Does EADS want to rebalance to a 50/50 split between Airbus and non-Airbus business models? Is defense indispensable?

EADS could get out of defense, but that “would not be very wise,” said François Lureau of consultancy EuroFLconsult. “There needs to be a defense base in Europe.”

Defense is a special area, and security of supply is a major issue, he said.

“Governments need to know they have permanent access to military technology,” Lureau said.

With political and legal agreement, a government can be assured it will have guaranteed access even if a product is built abroad, he said.

Any merger-and-acquisition defense deal needs to take into account security of supply, Lureau said.

The restructuring of the Anglo-French missile industry under the One MBDA program can be seen as a model, he said.

Consider Cassidian

EADS’ defense and security interests are vested in Cassidian, which had 2011 sales of 5.8 billion euros or 12 percent of group sales. The unit holds a 37.5 percent stake in the MBDA missile company and the German share in the Eurofighter consortium.

Cassidian is too small and weak in military technology, said François Chopard of consultancy Impulse Partners. The business is essentially subsidized by the German government, which wants to retain a minimum competence in defense equipment, he said.

EADS could sell Cassidian, to perhaps another German company such as Diehl, but that is unlikely, Chopard said.

“This division has never really managed to find its cruising speed,” Hélène Masson, senior research fellow with think tank Fondation pour la Récherche Stratégique, wrote in research report published just two days before the merger plan was declared dead. “The number of internal reorganizations since 2003 illustrates this difficulty.”

The Cassidian business is mainly based in Germany, with some 11,000 staff, compared with 2,000 in France.

Buying assets could help grow the defense side. EADS could try to buy U.S. companies. “Not easy,” Lureau said.

Washington sources said both BAE and EADS have proven themselves as trustworthy Pentagon suppliers, key requisites to further growth in the U.S. market. Both have grown through major mergers and acquisitions. Despite government ownership, EADS bought Vizada and Geoeye and supplies helicopters to the Army, radars for both littoral combat ships and sensitive systems for intelligence agencies. Finmeccanica, which is partly owned by the Italian government, was cleared to buy DRS Technologies in 2008. These sources added EADS would be judged on its merits should it move to buy another U.S. firm.

EADS could look for European acquisitions but the pool of companies is small, Lureau said.

In addition, EADS has to revisit an alliance with Thales, Maulny said.

The European company previously made overtures to Thales, but these led to nothing. In part, Berlin disliked the idea because a deal with Thales would have boosted the French side, and outweighed German business.

Another option might be to bid for the Selex defense unit of Finmeccanica, rather than a full merger with the Italian group, Maulny said.

In Germany, however, the view is that EADS needs to look outside Europe.

“EADS has to look around for other partners now, but those probably won’t be in Europe,” said Christian Mölling, of the German Institute for International and Security Affairs in Berlin.

It is highly unlikely EADS will seek a merger with European companies such as Thales or Finmeccanica as these are partly state-owned, Mölling said.

“Thomas Enders will have to coordinate better with German politicians in the future,” Mölling added.

Enders in his staff letter pointed to defense cooperation with BAE. The two groups are partners in the Eurofighter program and in MBDA, Masson said.

After the failure to strike a deal with India to sell the Eurofighter Typhoon, the two companies would do well to put into a common pot their industrial activities in Eurofighter, or at least create a joint British and German sales team, Masson said.

BAE and EADS have invested heavily, including their own funds, in UAV programs. They could cooperate in technology on autonomous systems, particularly in tactical and medium-altitude, long-endurance UAVs, Masson said.

BAE’s Fate

Since the deal collapsed, King has been pushing back the notion that BAE is facing sale or break-up.

Another senior BAE executive pointed out that potential suitors haven’t been kicking down the door of the company’s headquarters, even when the share price was languishing around the 2.50-pound mark compared with the 3.27 pounds the shares were trading for at lunchtime on Oct. 12.

Rob Stallard, an analyst at RBC Capital Markets in London, supported King’s view.

In a client note last week, Stallard said RBC maintains its view that “U.S. defense primes are not interested” in buying BAE subsequent to the merger talks collapsing.

The note cited concerns about being able to complete the deal in the U.S. and the possible reluctance of the Saudi Arabians to seeing BAE swallowed by a rival because it might want to keep separate arrangements with its prime British and U.S. suppliers.

The Saudis are one of BAE’s biggest customers, buying Typhoon fighters and Hawk trainer jets and other equipment. Last week in an interim management statement, the company said it had 7 billion pounds in contracts under negotiation with the Saudis.

Despite the clamor to review future growth plans, King said the company’s core strategy of developing its international business, maximizing benefits from platforms and services, and growing electronics and cyber businesses still stands.

“Plan A is very robust. The business is very robust,” King said.

Nevertheless, the theory goes that once a company is in play, it opens itself to potential takeover or break-up activity.

King said that at no time has BAE hung up a “for sale” sign.

“If we had been selling this company we wouldn’t have been selling for the value [we agreed with EADS]. We would have been selling it for 14 percent more than that,” he said.

King said with the EADS merger dead, he wouldn’t be returning to the European market anytime soon for merger or takeover targets, although they will continue to drive forward European initiatives such as Eurofighter and missile maker MBDA.

“You can’t buy anything in Europe on the defense front without getting hamstrung by government restrictions. We had our fingers burnt a long time ago with [European] governments.

“We were trying to set up a structure with the EADS merger which reduced the influence of governments and they clearly came back and said that’s not the position they want to be in,” he said. King removed the British government from that criticism, saying BAE’s relationship with the Conservative-led coalition administration had been “very progressive and forward leaning. They went above and beyond and did everything we asked of them.”

The end of the merger talks almost takes BAE and EADS back to the point where the idea of a possible tie-up was spawned. They had been holding discussions, also involving the third shareholder, Finmeccanica, about how to revive the fortunes of the Eurofighter Typhoon project in the wake of the loss of the Indian jet contract.

“This started when Tom Enders and I started discussing what we had to do to the Eurofighter arrangement to make it fit for purpose. Those discussions continue and have been reinforced, not reduced, by our experience with EADS.

Don’t expect any big acquisitions from BAE, though. The company has been pursuing a policy of acquiring small to medium assets recently, and King indicated that more of the same was in the offing.

“Bolt-on acquisitions are fundamentally part of the strategy. That will include expanding in the civil aerospace sector where we see expansion organically and through acquisition,” he said.

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Tom Kington in Rome and Albrecht Müller in Bonn contributed to this report.

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