Counter Terrorism Strategy

EADS & BAE merger: A defence marriage made in heaven?

It would create the largest aerospace and defence company in the world by revenues, with 223,000 staff spread across more than 50 countries.

On September 12, EADS and BAE Systems announced that they are exploring the creation of an aerospace and defense combination which would be the largest in the world. October 10 sees the deadline by which the two organisations must submit a formal merger proposal or seek an extension. Afterwards, many political and financial hurdles will still remain due to the complex makeup of the ownership of both companies.

BAE is the only foreign owned company to be one of the big six suppliers to the US Department of Defense. It has been able to expand its US subsidiary (BAE Systems Inc) into a $14bn-a-year business employing 40,000 people, by building up a trusted relationship with US politicians. It has received work on very sensitive projects including the $1.5 trillion F-35 joint strike fighter programme, which plan to build a jet capable of avoiding surface-to-air missiles. Some 45 per cent of its income came from America last year.

BAE Systems is the UK’s largest manufacturing employer and the UK’s biggest employer of professional engineers, with 18,000 engineers from its 38,000 UK employees. The company is responsible for 80 per cent of all manufacturing related jobs in Barrow-in Furness, 40 per cent in Portsmouth and 70 per cent in the Ribble Valley. Each employee contributes over £78,000 to the UK economy based on productivity levels, compared to a national average of £42,200. BAE Systems’ share price suffered heavily during the 2008 financial crisis, and has remained largely flat over the past few years.

EADS shows steady growth
The European Aeronautic Defence and Space Company (EADS) was created in 2000 when DaimlerChrysler Aerospace in Germany merged with Aérospatiale Matra in France and CASA in Spain.The company currently employs 133,000 staff around the world, including a 15,000-strong UK workforce. Board members include Jean-Claude Trichet, the former head of the European Central Bank, and Lakshmi Mittal, the Indian steel magnate.

EADS’ share price has grown steadily over the past five years. The group includes Airbus as the leading manufacturer of commercial aircraft, with Airbus Military covering tanker, transport and mission aircraft; Eurocopter as the world’s largest helicopter supplier; Astrium, the European leader in space programmes from Ariane to Galileo; and Cassidian as a provider of comprehensive and integral systems solutions for aerial, land, naval and civilian security applications. Through Cassidian, EADS is a major partner in the Eurofighter consortium as well as a key stakeholder in the missile systems provider MBDA.

Greater Consolidation
Nick Clegg, the deputy prime minister, has come out publicly in support of the deal stating: “I personally have always been in favour, over time, of greater consolidation in the European defence industry.”

Business secretary Vince Cable, who was savagely critical of BAE over bribery allegations whilst in opposition in 2010, said: “It is a very, very important decision and has major implications for the country, both in terms of employment and national security. We will have to look at the costs and benefits very, very carefully.”

Keith Hayward, head of research at the Royal Aeronautical Society said of the proposed merger: “It would create the largest defence-aerospace group in the world, link all of the Typhoon partners, provide BAES with a civil interest just as defence spending world-wide and especially in Europe and the US flattens or even declines, and afford EADS a better and more positive profile in the US. Strategically it would be a marriage made in heaven.” 

Joint Statement
On September 30, the chief executives of both organisations (Ian King, BAE Systems and Tom Enders, EADS) issued a joint statement to UK newspapers, which read: “Since news emerged that BAE Systems and EADS are considering a combination which would create a world class defence, aerospace and security group, much has been said on the subject. It has been analysed and interrogated from every conceivable angle by politicians, pundits and competitors alike.

“Inevitably, as our discussions with several governments continue, we are not yet in a position to tell the full story and explain the significant benefits of the combination to our shareholders, employees, and other stakeholders who rightfully have an interest in the outcome of our discussions. But it is important to correct some myths and misconceptions.

“The first thing to say is that this is a combination borne out of opportunity, not necessity. BAE Systems and EADS are both strong businesses with clearly defined strategies that have enabled them to make progress in the last five years, and which would take them forward as independent companies.

“But there comes a time when it is right to seize the moment and to create something that is even stronger and better. We believe that time is now. With the necessary political will and support, management determination, and proper governance, BAE Systems and EADS can produce a whole that is greater than the sum of its parts.

“Together, we would become a business with a global footprint, and a wider customer base. We would be able better to ride the cycles of civil aviation demand and defence spending. And we would be a business with the scale and stability to invest more in R&D, and a force for greater competition and growth. All of this would deliver tangible benefits to our customers in each of the defence, aerospace and security worlds.

Complimentary Markets
“The rationale that drives this transaction is growth, not contraction. BAE Systems and EADS operate in complementary markets. Clearly, there will be scope for efficiency savings when two companies of our size come together, but great benefit will derive from our ability to exploit new business opportunities. That has to be good for jobs and economic prosperity in the long term. It would also mean that we can ensure our key markets stay at the cutting edge of technological development.

“We are working hard with our respective governments on this combination. As we said in our initial announcement, we are very focused on agreeing arrangements which protect the strategic and national security interests of the governments with which we work, particularly in France, Germany, the United Kingdom and the United States, given the importance of those markets to the combined group. We propose to replace the shareholder arrangements which currently give Daimler, Lagardère and the French state joint control over EADS. That would mean creating a business with governance structures which would enable it to operate in a normal commercial manner and which confers the same rights on all shareholders, large and small.

“We believe that a combination on these terms would provide the best strategic opportunity for our organisations, with world class management, technology, investment capability and customer access, to the benefit of all our stakeholders.”

Political Interference
The merger is currently the subject of a Defence Select Committee Enquiry, which will examine the likely impact on UK defence including the protection of sovereign capabilities and the nature of the defence industrial base.

BAE Systems and EADS operate highly capable and sensitive defence businesses in many countries including the UK, the USA, France, Germany, Spain, Sweden, South Africa, India, Saudi Arabia and Australia. The merger of two such large defence contractors would have a significant and strategic impact on their relationships with UK, US and European Governments. It could also radically alter the defence industrial base in these countries.

Earlier in the month, former defence secretary Liam Fox has highlighted ‘undue political interference’ as the greatest risk to any merger between BAE Systems and EADS. Fox warned that intervention from governments in France and Germany was likely to be the biggest factor in scuppering the deal. Support for it would be required from three separate European governments and the US Department of Defence, which presents a number of significant hurdles. France directly owns 15 percent of EADS, the maker of Airbus jets, and wants to retain its right to influence group strategy, currently conducted through a complex pact with 7.5 per cent shareholder Lagardere. Germany is not a direct shareholder but sees the transaction as a chance to tighten its grip on a stake currently held by Daimler AG and a group of banks.

Dr Fox insisted there was no need for interference from foreign governments. “Without clear mechanisms to preclude foreign interference, the British Government should not support the proposals,” he said. Fox went on to state his ‘instinctive preference’ for any such partner for BAE to originate from the US, building on BAE’s decision to ringfence its US defence arm to maintain secrecy regarding defence contracts. No French or German executives will serve on the US board, with just one British director being elected to that position in BAE chief executive Ian King.

France and Germany have agreed a common strategy for the planned merger, a German magazine Der Spiegel reported, citing high level civil servants. The plan foresees France and Germany each holding a nine percent stake in the merged entity.

A bold move
Dr Robin Niblett, director of international affairs thinktank Chatham House, called it “The biggest redrawing of global defences since the cold war.”

Dr Niblett wrote: “The idea to create one of the world’s largest defence and aerospace companies is indeed a bold move. It would offer its participating countries the opportunity to repeat the success of Airbus in other sectors, such as air defence missiles and unmanned aerial vehicles, while reducing their exposure to the ups and downs of the defence and civilian aerospace markets. But if the UK wants to be a core partner in this initiative, then it may find it needs to commit to a more continental European approach to its success and buy itself a stake in the new company.”

Further information
Defence Committee - www.parliament.uk/defcom
Chatham House - www.chathamhouse.org
EADS - www.eads.com
BAE Systems - www.baesystems.com



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