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Austerity, Merger Efforts Drive European Planning

Aug. 3, 2014 - 03:45AM   |  
By PIERRE TRAN   |   Comments
New Land Arms Group? As Nexter and Krauss-Maffei Wegmann discuss a possible merger, Nexter's véhicule blindé combat d'infanterie is seen as vulnerable and in need of export customers.
New Land Arms Group? As Nexter and Krauss-Maffei Wegmann discuss a possible merger, Nexter's véhicule blindé combat d'infanterie is seen as vulnerable and in need of export customers. (Nexter)
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PARIS — In Europe, it is a tale of two cities as Paris waits to see the outcome of talks between Nexter and Krauss-Maffei Wegmann (KMW) to create a French-German land arms group, while London hunkers down ahead of a general election next year and a fresh defense and strategy review.

There may be reported pockets of domestic concern in France and Germany over the plan by Nexter and KMW to create a joint holding company, but there is also confidence in Paris the deal will go ahead.

“The negotiations are going forward,” a Nexter spokeswoman said. “All is well.”

The French and German companies have said the nine months of exclusive talks are aimed at the “future unification of the two companies.”

Some of the anxiety in France stems from labor unions’ concerned over possible job losses, while there is worry in Germany the deal could make it easier to sell arms to controversial countries, such as Saudi Arabia.

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Nexter and KMW are in exclusive talks to create a joint venture controlling €2 billion (US $2.7 billion) of annual arms sales, but there are reports Rheinmetall also has expressed interest in a merger with KMW, which raises uncertainty.

“What’s the German government going to do?” said Christina Balis, head of European operations at consulting firm Avascent.

Rheinmetall Defense reported a 97 percent slide in 2013 operating profit to €4 million, due mainly to €51 million of restructuring costs tied to its site in Vienna, analyst Patrick van den Ende said in a June research note in Defense & Industries, from think tank Fondation pour la Recherche Stratégique.

Rheinmetall Defense reported a revenue decline in 2013, due mainly to lower sales in combat systems and wheeled vehicles, the note said. Exports accounted for 68 percent of sales, up 1 percent, with the Middle East and Asia seen as key markets.

If the Nexter-KMW deal went ahead, there may be decisions to slim down the product range.

“I would not be surprised if Nexter gets out of certain platforms. The question is what to give up to keep what’s sustainable in the future,” Balis said.

The véhicule blindé combat d’infanterie is seen as vulnerable as Nexter needs to find export customers for the infantry fighting vehicle, as production for the French Army is due to close in 2015.

Ammunition, however, remains a strong business for Nexter, she said.

Labor Cuts Likely

A certain amount of rationalization and adjusting of the industrial footprint is inevitable if the alliance goes ahead. And if the talks fail, there would be job losses, Balis said.

Governments might seek to protect jobs, but as the failed merger talks between Airbus and BAE Systems in 2012 showed, a company will still lay off workers when a deal is not done, to remain competitive.

“Rationalization is inevitable, to ensure long-term growth,”she said.

A deal between Nexter and KMW is considered likely.

“I give this 60:40, both sides need this,” she said.

In London, cuts in military spending in the UK and the US, where most of Britain’s major defense companies have substantial interests, have made for a tough year.

“Industry has had a difficult 12 months and one that has required industry players to look deep inside their organization to ensure that they still have sufficient relevance,” said Howard Wheeldon of Wheeldon Strategic Advisory.

If the past 12 months have been tough, the next 12 to 18 months pose further challenges, over which industry has little control.

First up is a Scottish independence vote in September, followed next May by a British general election and a government strategic defense and security review (SDSR).

Budget austerity continues and further spending cuts are possible after the election.

“The next 12 months may be tougher than the last but I do think that the period ahead will mark a bottom in the fortunes of UK defense,” Wheeldon said.

“Notwithstanding fear of what might emerge in SDSR ’15, industry is fit for purpose and still well placed in terms of export potential.”

Wheeldon reckons the prospects for further merger and acquisition (M&A) activity are limited, at least in Europe.

“Most of those engaged realize the inevitability of a further consolidation requirement for European defense. I doubt that, apart from isolated smaller events, we will witness progress along these lines.

“If anything, the deteriorating politics of Europe has made the process of consolidation and M&A activity in defense that much more difficult to achieve. I would not, however, rule out an increased level of participation by US defense companies on the UK scene,” he said.

Saab Overhaul

The size and scope of Saab’s defense business model changed markedly in the final quarter of 2013 when the Swedish government voiced concerns over the future direction of the Navy’s A26 next generation submarine program run by ThyssenKrupp Marine Systems (TKMS, formerly Kockums), the Sweden-based shipyard subsidiary of German parent ThyssenKrupp.

The spring decision by the Ministry of Defense to cancel its A26-based cooperation with TKMS resulted in an invite to Saab to determine whether it had the capacity and technical capability to take over the A26 project and carry out a midlife update on two Gotland-class submarines. This dramatic twist in the tale of the A26 project offered Saab the handsome opportunity to significantly expand its underwater offerings.

The A26 and Gotland-class submarine contracts have a combined value of US $3 billion to $3.5 billion. With the delivery and completion dates for both projects set to run to 2024, the economic impact for Saab promises to add $300 million to $350 million to Saab’s revenue base annually over the next 10 years.

The $37 million paid by Saab to acquire TKMS and its shipyard facilities in Sweden represents an initial investment by both the state and the defense group to rebuild the country’s naval submarine and surface vessel industry, and capacity. The acquisition will add $245 million to Saab’s turnover in 2014, lifting its revenue base to nearly $4 billion.

Fundamentally, the acquisition of TKMS by Saab realizes an important strategic goal by the group to not only strengthen its global position in naval markets, but reinforce its export potential to become a complete supplier of naval military systems while raising its ability to deliver high-end air and land systems.

This strategic direction will enable Saab to operate as one of the few small nation-state headquartered corporations capable of producing advanced combat aircraft, transport and surveillance planes, submarines, long-range weapons, ground-based air-defense and precision engagement systems.

Finmeccanica's Future

After years of expansion into the UK and US, followed by a rationalization program, swelling debt, a series of scandals and four CEOs in as many years, Italy’s Finmeccanica is now set for a tough diet under its latest boss, Mauro Moretti.

After taking the reins in April following a successful stint at Italy’s state rail network, the no-nonsense manager has set out to study Italy’s state-controlled defense group from top to bottom with a view to rooting out duplication, selling off non-core businesses and slimming down the product line to high tech, high profit kit.

Ending overlaps could save 20 percent of group costs, he has promised, while hinting that non-core activities heading for sale could include US unit DRS.

Finmeccanica will need to improve its margins as Italian defense spending takes further hits from a government desperate to balance books and dig Italy out of near recession.

This year, Italy has sliced €153 million from joint strike fighter spending, part of an overall €400 million cut to the Defense Ministry budget.

Next year also looks tight. In a three-year plan published last year, overall Defense Ministry spending for 2015 was forecast at €14.5 billion. In an updated plan published this year, the figure for 2015 was down to €13.91 billion, almost €600 million less.

Potential good news came in July with suggestions from US Air Force Lt. Gen. Christopher Bogdan, head of the F-35 Joint Program Office, that he might help steer JSF customers toward Cameri in northern Italy where Italy has built a JSF assembly and maintenance hub, and will need overseas customers to make it pay off.

Bogdan’s comments were followed by a visit, after the Farnborough International Airshow, to Cameri by Frank Kendall, US undersecretary of defense for acquisition, technology and logistics. ■

Andrew Chuter in London, Gerard O’Dwyer in Helsinki and Tom Kington in Rome contributed to this report.

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