Failure on take off

The announcement that British defence giant BAE Systems was in talks with European Aeronautic Defense and Space Company (EADS) about a possible merger came as a shock to all associated parties. Both companies had a unique and vast reach, as well as their own reasons to benefit from the arrangement. But it was not meant to be; competing interests and political deadlock meant EADS and BAE could not join forces.

There were any number of reasons the deal fell apart. There were critics at every level, including shareholders, government officials and industry analysts who had reservations about the prospects and power of the larger corporation, and feared for their investments in a changing industry.

Analysts have been left wondering what each side could have offered, what would have happened to competitors and could it really have, as chiefs of both companies announced in a joint statement, “produced a combined business that would have been a technology leader and a greater force for competition and growth across both the commercial aerospace and defence sectors”?

Merger talks within these industries are not uncommon and this is not the first time BAE has been through negotiations to protect its future. It has reportedly had discussions with EADS’s biggest competitors in the past, including Boeing, Lockheed Martin and Northrop Grumman. The current bid for collaboration started in early September. Terms of the deal gave shareholders in BAE and EADS 40 percent and 60 percent of the combined company respectively. There was an immediate call to renegotiate terms from investors on both sides, including BAE’s majority shareholder Invesco Perpetual. It had “significant reservations” and said it did not understand the “strategic logic” behind the deal.

Further obstacles emerged as the British, French and German governments began dialogue. The British requirement for a capped nine percent for each foreign government investor was heavily contested as both European partners demanded bigger shares in the new business. German Chancellor Angela Merkel also announced fundamental objections to the creation of the largest integrated defence and aviation company, giving little hope for completion. Unable to agree any workable solution, the deal collapsed.

For each side, the prospect of collaboration was filled with opportunity. For BAE it was a route back to the thriving civil aviation sector it had left years before, access to a wider audience across the Asia Pacific and the stronger balance sheet it needed to ride out the severe cuts in defence spending that were looming from its prominent American customer base.

EADS, home to successful plane maker Airbus, did not have the fears for the future that BAE had as its commercial market was continuing to grow. It did, however, see hope for expansion through the deal, exploiting the joint client collection and benefiting from expansion into a US market which it had yet to conquer.

EADS was also partial to the deal’s terms, which would have seen a distinct reduction in the influence the French and German governments had in its operation; the US’ terms for agreement meant there was a cap on foreign investment to limit involvement in closely guarded American security files. As it turned out, though, this particular contract condition would be one of the deal breakers.

In a changing economic climate, both companies saw an opportunity in collaboration to maintain their impact and grow in new regions and reach new markets. Both BAE and EADS have proven themselves successful for many years, have expanded progressively to build up their respective reputations and fortunes, and have sought to capitalise through synergy. EADS is a European corporation that unites the capabilities of four unique manufacturers, including: Astrium, Europe’s leading space programme; Cassidian, the defence and security arm; and Eurocopter, the world’s largest helicopter supplier. But by far the biggest earner for EADS is Airbus, a leading aircraft manufacturer that accounts for around two-thirds of the corporation’s revenues. Airbus and its US adversary Boeing have taken over the aerospace market, leaving little room for competitors, and have been in a constant war to rule the skies for decades.

The merger would have given Airbus a new sword edge with which to fight this close battle; for years the US market was out-of-bounds and strictly Boeing territory. Prospective partner BAE is Europe’s biggest security contractor for air, land and naval defence forces worldwide: its biggest market being the US military. It is also heavily involved in contracting the Pentagon and other intelligence services with the systems needed to maintain national security. These include advanced electronics, information technology and support services for computers, as well as armour for defence vehicles and aircraft. BAE and EADS have collaborated in the past and the security multinational produces a significant number of the systems on board Airbus aircraft. Current projects include the world leader in missile technology development, MBDA, and the Eurofighter Typhoon, which, despite controversy over its costs, is currently being used by numerous air forces including the RAF and Royal Saudi Air Force.

What wasn’t
The multi-billion-euro merger could have been immense despite its rejection by the majority of shareholders. A corporation that size would have had a significant impact on the industrial landscape. Both EADS and BAE have offerings that could have made the alliance a formidable player: one that accomplished Airbus’s original mission statement to “strengthen European cooperation in the field of aviation technology”. It would have presented a substantial rival to Boeing: which, despite being most famous for its leading aircraft manufacturing, gets around 30 percent of its proceeds from defence operations.

Pooled revenue figures reveal the size the merged company could have been initially, and presents a case for significant growth potential that could have overtaken rivals across both security and aerospace industries: on turnover at least. Figures from 2011 show EADS had takings of £39bn and BAE of over £19.1bn. This would have meant that the merged corporation had combined returns exceeding £58bn. Boeing’s £42.7bn in 2011 sales, combined with its 1997 merger with McDonnell Douglas Corporation, make it the largest aerospace company. Airbus’s latest report also presents more growth potential, particularly if research and development funding resources are pooled. The European airspace manufacturer is expecting its commercial market to escalate, predicting that, over the next 20 years, it will deliver around 27,900 new aircraft across its designs and mount » a market value of almost £2.2trn: bear in mind these figures do not include growth into competitive US territory as a result of a merger with BAE. This figure, combined with the prospective extension into new commercial and security aircraft markets, would have meant the merged corporation exceeded even Boeing’s expected demand by 2031 (it recently announced a predicted market value of £2.8trn).

The merged company could also have become an influential defence contractor to the US Army. Merging resources and client lists would have widened growth prospects as BAE and EADS also combined manufacturing. BAE Systems has a huge American client base and is the ninth-largest supplier to the US defence sector, making £4.5bn from its Paladin howitzer, various combat vehicles and naval gun sales. Market leaders Lockheed Martin and Boeing make triple that figure. EADS is yet to make its mark on the US defence market. Although it is a frontrunner in the commercial aircraft field, it remains a fledgling competitor in security, offering just UK-72 Lakota light utility helicopters to the American army. Merging EADS’s aeroplane capabilities with BAE’s massive US presence would have made a stronger force, more capable of competing effectively with rivals for US defence contracts.

The collaboration would have created a 220,000-strong workforce across the world and new markets to tap into as geographical scope widened and market leverage strengthened. In comparison, Boeing employs just over 170,000 people across its divisions in 70 countries. EADS currently boasts growing key markets across Brazil, Russia, China, India, Australia and the Middle East. BAE’s biggest markets are based in the US and UK, with unique access to national security documents. Although these are set to decline as military forces retreat from Afghanistan, there is an emerging interest from a new Saudi Arabian market. Together, the partnership would have taken over a huge part of both sectors, building upon respective reputations in their selective markets as a more powerful alliance.

Broken ties
As well as having the scope to take over a huge geographical base, an impending collaboration would have placed a further, more personal burden on Boeing, as BAE is one of its suppliers. In fact, BAE’s efforts in providing Boeing with military and commercial aircraft apparatus were commended in a recent awards ceremony, further signifying just how deep the disruptions could have been for the wider industries as a result of the deal. President and CEO of Boeing Defence, Space and Security Dennis Muilenburg said: “There are national security questions, industrial questions, and those will have to be dealt with… [This is] a serious matter that needs to be scrutinised.”

Among other things, BAE currently supplies the American corporation with automatic flight control systems for its V-22 Osprey tilt-rotor, a touch-screen attendant control panel on the 737 single-aisle airliner, and engine-control systems on the 767 and 787 Dreamliner jets. As it shared its research and development resources with Boeing’s rival, and helped boost its own credentials rather than reduce them, the merged company would have had an advantage in the market. EADS and BAE’s relationship would also have compromised competition confidentiality, as Boeing’s interests were no longer valued. BAE would most likely have shifted any shared plans for development to Airbus, helping develop and strengthen the competition. Boeing would have to have found an equally advanced, alternative contractor to replace electronics that are currently installed in more than 6,000 Boeing planes across 181 airlines.

Despite the prospects of the larger company, negotiations were terminated, leaving BAE and EADS’s futures uncertain. Some analysts have suggested there is a chance the two companies will try to restore their pact at some point in the future. BAE chief Ian King has reportedly said he “still believes in a full merger with continental aerospace group EADS” and would consider organising further discussions if “politicians, particularly those in Germany, could be convinced to change their views”.

In light of huge cuts in defence spending by US clientele (which account for around 40 percent of the company’s revenue), much of the discussion centres on BAE. Some analysts predict BAE will attempt to merge with another firm in the near future or consider other drastic options as it continues to struggle to maintain its business model.

Financial services provider Morgan Stanley said: “While BAE’s lack of near-term growth is well known, the proposed merger could be seen as an indication that the outlook for defence is more difficult than is currently expected. We therefore believe investors will now turn their focus to BAE’s next possible strategic move (e.g. a merger with a different party or [the] break-up of BAE).” tne