BAE Systems and EADS: A Glimpse into The Future

BAE Systems and EADS: A Glimpse into The Future

BAE Systems is now in merger talks with EADS. While analysts were optimistic about the merger (until the next day when /shares tanked), now many are saying a newly formed BAE/EADS could be a formidable opponent for The Boeing Company (NYSE:BA). Assuming the merger passes regulatory opposition, and does merge, what does it mean for The Boeing Company (NYSE:BA) and the overall defence industry?

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BAE Systems and EADS: A Glimpse into The Future

BAE Systems’s merger discussions with EADS represent a major change in its strategic direction, effectively reversing BAE’s ten year retreat from Europe.  BAE Systems made major moves in the US including spending about £4b in total to purchase United Defense and then Armor Holdings, which until recently comprised the Land & Armaments division with peak revenues in 2009A of £6.7b. At the same time BAE Systems divested ~£2b in European assets including its interests in Eurosystems, Airbus and Saab AB. Working through the government and representing Britain PLC, BAE managed to secure itself a foothold on the F-35 and is now responsible for ~17% of the shipset value including the aft fuselage, vertical and horizontal tails and wing tips, fuel system and crew escape system.

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There is strategic logic to the move, it probably caps or even impairs BAE Systems plc (LON:BA) (PINK:BAESY).’s US ambitions. This puts considerable onus on BAE Systems to complete the EADS NV (EPA:EAD) merger, as investors doubt if the US door will re-open. Strategic rationale – for the 2020s: Combined European defense spending remains small versus the US, and it is shrinking. Yet every generation of defense technology, be it planes, ships or satellites, costs considerably more to develop. Without a change in budget trajectory, which we see as very unlikely, there is no way that European countries can afford to develop and produce sophisticated next generation defense equipment without more co-operation. By joining forces, BAE Systems plc (LON:BA) (PINK:BAESY). and EADS NV (EPA:EAD) should have a better chance of ensuring that the ‘son of Eurofighter’ is developed and made more efficiently. However, the impact of this move is only likely to be seen in the next decade, given the long lead times for defense programs.

Goodbye America

BAE Systems plc (LON:BA) (PINK:BAESY). has been the most successful non-US defense company in the US, but we think this progress is likely to be capped or even curtailed by the merger with EADS. Close US-UK industrial relationships in the intelligence, nuclear and electronics areas could be questioned, especially if the French and German Governments retain shareholdings in the combined group. Investors expect BAE’s US competitors to see this as an opportunity to gain market share, whilst lobbying hard for onerous regulatory controls to be placed on the combined entity. It is doubtful that a US contractor will step in to make a counter bid for BAE Systems plc (LON:BA) (PINK:BAESY)..
A long road from here:

Although there is probably financial and commercial logic for a merger with EADS NV (EPA:EAD), it appears that politics will ultimately dictate if this dealgoes through, and impact many of the terms. Given these multi-national complications, investors think it will take a long time to complete any merger.

Disclosure: No position in any securities mentioned

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