Europe's defence industry

Six years after the last wave of consolidation, Europe's defence companies are looking at merger targets again

Back in the early 1990s, when America cut defence spending at the end of the cold war, rationalisation of its defence industry proved relatively easy. The Pentagon gathered industry chiefs for a "last supper", as it was later called, and within a few years 15 defence contractors had shrunk through mergers to five. Europe found such a big consolidation tougher, because politics got in the way. But a few stealthy mergers went ahead, and now another effort could be getting underway.
The last time around Europe was left with minnows compared with America's defence giants. Europe's leading defence aerospace company, EADS, has only attained the size of Lockheed Martin and Boeing by virtue of the runaway success of its civilian Airbus passenger jets. Even a gigantic £13 billion ($25 billion) in-flight refuelling contract for Britain's RAF, won this week by EADS (plus firms such as Cobham and Rolls-Royce in a consortium), is using converted Airbus A330 widebody jets. They will be fitted with nozzles to become petrol stations in the sky, when needed, and at other times they will be leased as civilian passenger jets (the petrol tanks are in the huge wings).
An Anglo-German marriage of British Aerospace (now BAE Systems) and Daimler-Benz's DASA collapsed acrimoniously when the British jilted DASA at the altar and ran off in a tie-up with GEC-Marconi, in a thoroughly British deal. Furious, the Germans quickly found consolation in the arms of Aerospatiale Matra, a partly privatised French group. Thus was born EADS, which is owned 30% by the French (half shares each to the government and the Lagardθre conglomerate), 30% by DaimlerChrysler and 6% by SEPI, the Spanish government's industrial holding company. The remaining 34% is publicly traded.
EADS already represents quite a consolidation for Europe in that it is now a tri-national company. Other mergers include Thales, a French defence-electronics company that became Franco-British after buying Racal. It now has 11,000 employees in Britain and wins local contracts. Britain's Ministry of Defence has fostered Thales to provide competition to BAE Systems, with which it has rowed for years about cost over-runs and contract delays. Thales already makes 10% of its sales in Britain and that could grow. It will design new aircraft carriers for both France and Britain, and the company is a member of the group that won this week's RAF deal.
Another quiet move towards consolidation is represented by Italy's Finmeccanica, which in five years has gone from being a state-owned financial-holding company to a mostly-privatised industrial group concentrating on aerospace and defence. Since it bought Westland helicopters from Britain's GKN late last year, Finmeccanica has become an Italo-British group, with some 10,000 employees in Britain. In January it bought part of BAE Systems's defence communications and avionics businesses. Then there is the €4.9 billion ($6.4 billion) merger of two French defence aerospace companies, SNECMA (which makes jet engines) and SAGEM, an electronics group, though this is a combination pushed by the government as part of its privatisation programme and makes little industrial sense.
Europe's defence companies need to get bigger. The five leaders still fight over military budgets that add up to less than half the $150 billion or so that America spends on new equipment (mostly in defence aerospace) each year.
To get more scale and satisfy jealous national governments, who want defence spending to create jobs at home, Europe has turned to joint ventures, such as the consortium that makes the Typhoon, which started life as the Eurofighter plane. This brings together BAE Systems, EADS and Finmeccanica, but excludes the French who insist on plugging on with their own Mirage and Rafale fighters. The other notable tri-national joint-venture is the MBDA missiles company, which brings together BAE Systems, EADS and Finmeccanica.
Now there is a flurry of interest in further mergers. Impatient at its slow progress in defence, EADS bosses (encouraged by the French government) wanted late last year to buy Thales, a quoted company which is owned 31% by the French government and 9% by Alcatel, a struggling French telecoms-equipment firm in need of money. For the government, this would have had the distinct advantage of turning EADS into a more French company than the Franco-German partnership it has been since its creation. But Thales's boss, Denis Ranque, was less than keen. And DaimlerChrysler, as an EADS shareholder, was opposed to buying a French company. EADS plus Thales would have been bigger than Boeing.
The latest buzz is that Thales and Finmeccanica might merge to become the biggest defence-electronics combine in Europe, and a big force overseas. But because the French and Italian governments still own around 30% of each firm, their approval would be necessary. Given the Paris preference for a grand Frenchification of EADS through a takeover of Thales, its permission seems unlikely—even if the Italians warm to a deal.
Meanwhile, EADS could become more French in another way. Noλl Forgeard, boss of Airbus, which provides the bulk of EADS's sales and virtually all of its profit, is to become co-chief executive of EADS alongside a German, Tom Enders. But Mr Forgeard, who wanted to become sole CEO, is manoeuvring to keep oversight of Airbus, thus making him a much more powerful figure than Mr Enders, and cementing French influence in the company.
DaimlerChrysler could insist on the French government selling its EADS shareholding to counter French influence. Indeed, the whole shareholding structure of EADS looks unstable. The Lagardθre group is due to sell its holding within a few years to concentrate on media. DaimlerChrysler is likely to sell its 30% stake sooner or later to concentrate on its car businesses. Tellingly, Arnaud Lagardθre, boss of the eponymous group, has joined the board of DaimlerChrysler, adding fuel to rumours of a co-ordinated sell-off by EADS's big shareholders.
Adding to the prospect of wholesale change is the probability that BAE Systems will sell its one-fifth stake in Airbus (EADS owns the other 80%) in order to finance a big acquisition in America. BAE Systems is growing fast on the other side of the Atlantic; it has sales of $5.6 billion and 25,000 employees there. Last year it bought another five small American companies, even as it sells European assets, such as its half stake in Saab Aircraft and a joint-venture with Finmeccanica. It is also a big partner of Lockheed Martin in the F-35, a joint strike fighter and the world's biggest military project with potential sales of $200 billion. Having turned its back on a big European merger last time, BAE Systems seems determined to sit out the continental skirmish once again.