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Top 100 Europe: Mergers Find Little Traction

Jul. 21, 2013 - 04:16PM   |  
By ANDREW CHUTER   |   Comments
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Missed Opportunity: EADS CEO Tom Enders said he doesn't see the possibility of restarting merger talks with BAE Systems 'for years to come.' (Agence France-Presse)
  • Filed Under

CompanyRankCountryDefense revenue
BAE3UK$26.81 billion
EADS7Netherlands$14.91 billion
Finmeccanica8Italy$12.53 billion
Thales11France$9.21 billion
Almaz-Antey14Russia$5.75 billion
Rolls-Royce16UK$5.10 billion
DCNS22France$3.77 billion
Russian Helicopters24Russia$3.49 billion
Safran25France$3.48 billion
Babcock International27UK$3.11 billion

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LONDON — It could have looked so different at the top of the Defense News’ listing of the world’s largest defense companies if only Angela Merkel hadn’t thrown a spanner into the works of a proposed merger between EADS and BAE Systems, aimed at creating an industry giant to rival Lockheed Martin.

Others might have been watching and waiting to derail the scheme if the German chancellor hadn’t blocked the merger, but had it survived, the combined company would have put a non-US defense contractor within reach of the No. 1 spot for the first time.

Instead, the collapse of the merger has left Europe pretty much back at square one when it comes to significant cross-border consolidation efforts.

And who knows whether the deal has gone away forever.

EADS CEO Tom Enders says there was a window of opportunity last year, based largely on relative values of the two businesses, but that window has now closed.

“I don’t see a link-up for years to come,” he told This Week in Defense News TV program at last month’s Paris Air Show.

Others are not so sure.

The proposed deal was a one-off, as far as its size was concerned, but serves as a “reminder to large and medium-sized players in European defense that they will not find it easy to make acquisitions involving Germany or France,” said Howard Wheeldon of Wheeldon Strategic Advisory in London.

BAE and EADS are putting sizable amounts of cash into share buyback programs rather than spending it in a merger-and-acquisition (M&A) market clouded by sequestration in the US and falling budgets in Europe.

When the BAE-EADS merger looked likely, Finmeccanica managers scrambled to decide where it would leave them and whether they should seek partners, but have been quiet on merger activity since the deal fell through. The Italian firm is trying to rein in its debt by offloading energy and transport activities it does not consider central to its focus on defense, aerospace and security work, although local unions, politicians and even churchmen have been vocal in resisting the sell-off of units overseas for fear of losing jobs.

For the time being, the focus here remains on tier two and tier three acquisitions with bigger companies spinning off businesses that have marginal value and bolting on niche firms that impart technical or market advantage.

“While small acquisition and consolidation efforts will continue, I suspect the main activity in European companies will be subsidiary consolidation as opposed to group takeover,” Wheeldon said.

British company Cobham proved the point, announcing July 15 it was paying £74 million (US $111.7 million) for the 50 percent of defense helicopter training company FB Heliservices that it doesn’t already hold.

Wheeldon said that while he does not expect to see any significant activity over the next two to three years, the breakup of a major contractor can never be ruled out.

The drive for a breakup would be led by shareholders rather than reasons of defense consolidation, he said.

And it’s not just companies here that are looking to acquire European niche businesses. US contractors have their own shopping lists.

Raytheon Missile Systems President Taylor Lawrence said during a Paris Air Show interview that Europe was a possible target for small-scale acquisitions.

“We would look at bringing in capability, especially from Europe. If it brings a technology to the company, if it opens up a market to us, particularly in Europe, we are certainly interested. More in the second or third tiers, but we are always looking for technologies to add to our portfolio,” Lawrence said.

One side effect of the merger collapse is a possible shake-out of noncore business at Cassidian, the defense arm of EADS.

Enders told Defense News TV that once an ongoing company review is complete, they will have a clearer picture of what the company should and shouldn’t do on the M&A front.

“In general terms, though, our activity is focused on our key identity core business of aeronautics,” Enders said.

Heinz Schulte, a German defense industry analyst, said the expectation is that a refocused Cassidian could provide pickings for regional tier one players.

“There is an expectation in Berlin that the Cassidian review might lead to companies like Thales acquiring parts of the business,” he said.

One Italy-based analyst warned that if the merger failed one year ago, it would be even less likely to succeed today.

“The political climate that halted the deal has worsened since and the economic crisis has negatively impacted the defense sector, with new programs being delayed,” said Michele Nones, head of the security and defense department at the Istituto Affari Internazionali, a Rome think tank.

Rather than boosting the argument for mergers, the crisis weakened it, he said.

“Everyone is seeking to defend their own market and fighting for what export markets there are,” he said.

Nones said one catalyst to industrial integration could be the European Council meeting in December, which will focus on defense.

“The council would need to relaunch integration with concrete measures, such as instituting the regular meeting of European defense ministers, and work on integration of sectors like training and the common certification on military products,” he said.

All of this is not to say attempts aren’t being made to better organize Europe’s industrial effort at a time when austerity is making it increasingly tough to justify resources being wasted on a fragmented industrial effort.

Two months ago, French officials let it be known that Paris was looking at whether a merger between state-owned land systems producer Nexter with Germany’s Krauss-Maffei Wegmann (KMW) was feasible. Aside from the possible moves on Nexter, the French official said consideration was also being given to a possible purchase of shipbuilder DCNS by minority shareholder Thales.

French defense industry consultant Bruno L.G. Carré said the restructuring will be driven by the “solution which brings most money into the government’s pocket to ease the pressure on the French defense budget and does not translate into a single redundancy.

“Nexter’s takeover by the Germans is a 20-year-old dream of the French authorities. The question is, what’s in it for KMW? Very little, in my opinion,” he said.

Takeover of DCNS will greatly depend on Thales shareholder Dassault, and Carré said he’s not sure that the aircraft maker’s boss, Eric Trappier, is enthusiastic about it.

Carré said government ministers could have a big say in the outcome of any takeover.

“Generally, though, I wouldn’t discard Safran as a possible major actor in French restructuring,” the consultant said.

Schulte said it is too early to speculate how such a venture with Nexter could affect the consolidation of the German land systems industry through Rheinmetall or KMW.

“It appears that Rheinmetall is increasingly looking outside Germany with a special emphasis on its South African business. There has also been speculation that either of the two German land systems companies might be interest­ed in acquiring the Italian Oto Melara gun capability,” he said.

Rheinmetall could also play a part in any German maritime restructuring triggered by Thyssen-Krupp’s financial problems, Schulte said.

“Since the overall financial situation of ThyssenKrupp is dire, due mainly to a commitment in Brazil to a steel works, there has been speculation that it might seek to sell its TKMS naval activities,” he said.

TKMS primarily involves submarine builder HDW, the Blohm + Voss naval surface warship operation and a 51 percent share in Atlas Electronic; the remainder is held by Cassidian.

“There has been repeated interest by the French DCNS group in the German conventional submarine business. So far, the German government has steadfastly refused to put the local underwater capability into French hands,” Schulte said. “It has been speculated that Rheinmetall might seek to become a national champion, in which case the underwater capability cluster comprising submarines, mines, torpedoes, sonar and underwater robotics might well go its way.”

With the exception of merger successes like missile maker MBDA, cross-border consolidation remains something of a rarity.

It’s easy to say and difficult to do, as Sofradir President and CEO Philippe Bensussan testifies.

Paris-based Sofradir is Europe’s leading infrared detection system company, a position boosted in late 2012 with the merging of Thales and Sagem product lines into Sofradir to consolidate French capabilities.

Bensussan said he has been trying for years to engineer a European consolidation with AIM of Germany and Selex’s activities in the UK, but has been rebuffed.

“The French Ministry of Defense has been interested. They understood that with consolidation they would pay less but get more,” he said. “Take AIM — a portion of their German MoD funding is used to reproduce what we already have, so on a European scale this money is not used efficiently.”

The Sofradir boss admits there are challenges with issues such as sovereignty, but said it would be possible to avoid unacceptable closures and rationalization and to eventually pool engineers and funds with each country specializing in certain aspects of infrared (IR) detection.

Bensussan said that with the consolidation in France, Sofradir is on its way to becoming an IR systems world leader, but European industry could be in that position today if players in the sector had acted together.

The approach in Scandinavia has been similar to many other parts of Europe, where growing operations has taken a backseat to groupwide cost reduction and extracting maximum value from organic growth by bolstering strategic partnerships.

That said, Nordic defense groups in the 18 months to June 30 totaled 14 acquisitions, most of them minor, with Saab and Norwegian-based ammunition maker Nammo accounting for the lion’s share of completed transactions.

In the meantime, companies such as Patria, Systematic and Terma raised the bar and intensified efforts to generate greater sales and order momentum by using strategic domestic and international partnerships.

Saab has been by far the most acquisitive of the leading Nordic companies. In March, it bought the rights to the protection technology Soft Armour, and associated assets from Swedish industrial firm Protaurius. The acquisition marks Saab’s biggest step into the field of “self-healing” ballistic protection technology.

The Swedish company’s acquisition of defense-based technical documentation company TIKAB underlined the buyer’s intent to shore up capability in niche product areas. The same strategic reasons were behind Saab’s takeover of local firm Täby Displayteknik from ISD Technologies and German signal processing and recognition firm Medav in 2012.

Tom Kington in Rome, Albrecht Müller in Bonn and Gerard O’Dwyer in Helsinki contributed to this report.

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