“We doubt that doubling up on defense makes sense to shareholders,” RBC Capital Markets wrote in an investor note. “Equally for BAE, being acquired by a European company could limit its ability to work for the U.S. government in sensitive areas.” On the other hand, BAE has been struggling already because of its full dependence on largely declining defense markets, and the integration into a broader structure looks like it could give BAE more stability and better prospects.
Some in the financial community assert that operating margins for companies conducting business in the U.S. are peaking, indicating that the merger would take place at the financial apogee for BAE's U.S. activities. This is prompting questions about why EADS is pursuing the deal now. By next year, the U.S. Congress will have to address the question of sequestration—significant automatic cuts to defense that will be implemented unless lawmakers strike a compromise to handle the national debt. Additionally, the Pentagon will be forced to operate at 2012 funding levels even when fiscal 2013 starts in October because the legislature has failed once again to pass a budget on time.
“You could be looking at the most significant European consolidation that has yet been and probably [ever] will be,” says Douglas Barrie, a senior fellow for military aerospace at the International Institute for Strategic Studies. “This could create a genuine European powerhouse on the defense side.”
Barrie suggests that consolidation is inevitable in Europe, given the shrinking budgets around the continent. And it could prompt a reconciliation of some competing product lines into single, and potentially more globally competitive, designs. The area of UAVs, for example, has far more concepts in development than either appetite or budget from would-be customers. Such a merger could force the large aerospace companies in Europe to select specific designs not only aimed at European customers, but that will also have a better chance of competing with U.S., Israeli, Chinese and Russian options.
“If you look at the European market and what budgets can support, it is kind of inevitable,” says Barrie. “The debate becomes how many defense aerospace manufacturers can we credibly afford to support.”
For example, the deal would likely put an end to competing UAV projects in Europe, where BAE has been developing drone technology with French aerospace giant Dassault Aviation against rival efforts underway at EADS.
Earlier this year, U.K. Prime Minister David Cameron and then-French President Nicolas Sarkozy agreed to forge ahead with joint development of a medium-altitude, long-endurance (MALE) drone, part of a broader defense agreement that aims to boost the A&D sectors of both countries (see page 31). Since then, the new government of French President Francois Hollande has taken a fresh approach to the country's MALE strategy. In September, France's defense ministry unveiled plans to bring Germany into the mix.
In a joint declaration signed Sept. 12, the two countries agreed to strengthen cooperation in various sectors of armaments, including MALE platforms. In a communique issued by the French ministry late Sept. 12, both sides appeared to have devised a common set of operational requirements for a possible European MALE venture.
One CEO of a major European aerospace supplier says the proposed deal will definitely trigger another wave of consolidation. Even now, the pressure to expand and move into a position to be able to self-fund more development programs has grown to an extent that many second- and third-tier suppliers are thinking about exiting the market, he points out. However, melding the biggest European aerospace and defense (A&D) companies into one entity would give it considerably more market power—particularly on the defense side—when it comes to negotiating with their suppliers.
The executive highlights, however, that the number of original equipment manufacturers (OEMs) is actually rising in spite of the proposed deal. The growing clout of aerospace industries elsewhere—in China, Russia, Brazil, India and South Korea—is giving suppliers new business opportunities beyond EADS and BAE. Margins are almost definitely going to be higher there, but so will the risk, he concedes.