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Long-Awaited Consolidation Rolls Forward With Nexter-KMW Deal

Jul. 4, 2014 - 03:45AM   |  
By PIERRE TRAN   |   Comments
Strategic Alliance: Germany's Krauss-Maffei Wegmann and France's Nexter will fall under a new holding company. (CHRISTOF STACHE/ / AFP/Getty Images)
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PARIS — A plan to set up a 50-50 holding company that oversees France’s Nexter and Germany’s Krauss-Maffei Wegmann (KMW) opens the door to a long awaited French-German consolidation in the troubled land weapons industry, analysts and industry sources said.

France had been seeking to strike a deal for Nexter with the KMW owner, the Bode family, to help raise the exceptional receipts seen as needed to fund the annual €31.4 billion (US $43 billion) defense budget.

However, a bid to boost the business outlook for Nexter is driving the planned alliance with the German partner, not a financial gain for the coffers, a French official said.

The land systems sector has long talked of European industrial cooperation as armies receive relatively little funding compared to the navies and air forces, piling pressure on the specialist arms producers.

But the years have rolled by, and apart from a couple of relatively limited partnership and acquisition deals, there has been little to show by way of large company agreements.

That was until the owners of Nexter and KMW met in Paris on July 1 and signed heads of agreement for creating a joint holding company that would control a Franco-German group with annual sales of almost €2 billion, an order book worth €6.5 billion and employ more than 6,000.

There was an intent to “share their future roads ahead,” the companies said in a joint statement. “For the intended unification of the two companies, the current sole owners intend to contribute their shares into a newly incorporated joint holding company.”

Nexter is state-owned, while KMW is controlled by the Bode family through the Wegmann firm.

“Based on the joint statement, the agreement marks a plan for a ‘strategic alliance’ rather than a merger,” said Hélène Masson, senior research fellow at think tank Fondation de Récherche Stratégique.

A deal could bring KMW into the French Army Scorpion modernization program in future years, invite Italian arms maker Oto Melara into the partnership, and encourage a convergence of French and German equipment, said project manager Bertrand Slaski at consultan­cy Compagnie Européenne d’Intel­ligence Stratégique.

Christian Mons, chairman of a trade body Groupement des Industries Françaises de Défense Terrestre et Aéroterrestre, welcomed the announcement.

“This is a significant step toward consolidation of the European defense industry,” he said. “Europe needs to consolidate.”

“We’re going to build a land weapons [version of] Airbus,” French Defense Minister Jean-Yves Le Drian said in a July 2 interview with financial daily Les Echos.

The Airbus airliner is seen in Europe as a business success story with the cooperation of the core partner countries France, Germany and Spain. Britain builds the wings but bailed out of the shared ownership.

“We are engaged and looking for a wedding next April,” Le Drian said of the timetable to formally set up the Franco-German defense technology group.

For Nexter, the plan could be seen as bringing a partner when the French budget is under severe pressure and an expected launch of the €5 billion Scorpion program puts the company in a healthy position to negotiate the details, analysts said.

KMW, meanwhile, carries little debt. Between 2007 to 2010, the company limited borrowing to an average 25 percent of shareholders funds, and had average cash flow of €109 million, FRS analyst Patrick van den Ende said. That low level of debt reflects the Bode family’s determination to control the company, an entrepreneurial style that may explain the reluctance to strike a deal with Germany’s Rheinmetall, a public com­pany, he said.

“An essential issue is that a Bavarian family company works with a French state-owned company,” said Christian Mölling of the Berlin-based German Institute for International and Security Affairs. “That would be a great move in the company’s philosophy.”

KMW has sold the Leopard 2 tank to Saudi Arabia and Qatar, worth a total €5 billion of exports. The company no longer builds new Leopard units but refurbishes and modernizes used stock.

Nexter needs to seal more export deals to keep its production lines open.

“This is not a merger but a ‘strategic alliance’ that allows the partners to pursue common targets while maintaining autonomy and corporate interests,” Masson said. “For example, the companies could coordinate their funds and resources on specific projects.”

Care should be taken in setting up the holding company to avoid the “dysfunctional” governance and industrial organization that came with the creation of EADS and MBDA, she said. KMW focuses on building armored vehicles and has relied on German defense orders, while Rheinmetall is effectively an integrator and electronics specialist, she said.

Nexter has strengthened its munitions business but the company is at the crossroads, just as KMW faces the risk of being sidelined.

“Is this strategic alliance the result of two defensive strategies?” she said.

An industry executive said, “They were driven by necessity.”

Both types of companies — one state-owned and another family-owned — can pursue long-term strategies rather than submit to a short-term profitability “dictatorship,” manage labor and capabilities in a more stable manner, and take a conservative risk management approach, Masson said.

A French executive said KMW and Rheinmetall talked about a merger for years but that failed to work out, reflecting the private versus public ownership debate. When a company is family owned, it is simpler for a corporate decision than a publicly quoted company, the executive said.

The 50-50 ownership of the joint company is probably an interim measure, with perhaps an agreed takeover or a market flotation in a few years, the executive said. An annual sales of nearly €2 billion delivers “critical mass,” the executive said.

There have been exploratory talks for at least 10 years, even decades, between the French and German firms. But now the landscape has changed, Slaski said. German spending is heavily skewed to the Air Force with the Eurofighter Typhoon jet and A400M transport, with relatively little committed to the Army, he said.

There is greater competition in export markets from new players such as Turkey and South Korea, and the US is keen to shed used vehicles from Afghanistan, selling at low cost, he said.

In France, there is a need to find exceptional receipts for the defense budget, and there is also the long-term need for a European consolidation, he said.

“The two companies are in a good state to talk right now, not too strong, not too weak. In fact, they are able to talk as equals. One cannot take advantage over the other,” he said.

The early stage of the alliance will seek cooperation on research and development and agreement on which products to field in export markets, analysts said. Current products such as Nexter’s véhicule blindé de combat d’infanterie infantry fighting vehicle and KMW’s Boxer and Puma remain under national control, while future programs could be jointly managed.

Munitions stay under national control as France will hold a golden share, a veto at the board level.

KMW and Rheinmetall cooperate on the Leopard 2 tank, Puma and Boxer vehicles, and PzH 2000 self-propelled howitzer. A Rheinmetall Defence spokesman said, “currently, we are still assessing the effects on our joint projects.”

On the sensitive export issue, the German policy of tight control would extend to the alliance.

“The strict German system of arms export control is not affected by” an alliance, an Economy Ministry spokesman said. “This means that supplies of arms require approvals under the German foreign trade law.”

That would cover any transfer of German technology to the French side of the planned company, the spokesman said.

Mölling was skeptical about the deal. “The issue is far from being done,” he said.

The alliance plan could have arisen from German Economics Minister Siegmar Gabriel’s intention to implement a more restrictive arms export policy. “It could be intended to increase the pressure on the government in this case,” Mölling said.

Issues to be resolved include: What role the French state will play in the future and how this will go along with the KMW management philosophy, he said.

“It is also important how both countries will support this step with their industrial policy, for example the procurement for their armed forces,” he said.

Mölling points to the issue of product licenses and the fact that many components come from German suppliers.

What is notable was the lack of an announcement of the plan at the Eurosatory trade show for land armaments, a French defense specialist said. The exhibition, a high profile event backed by the French government, ran last month. ■

Albrecht Müller in Bonn contributed to this report.

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