BAE-EADS merger talks collapse

October 10, 2012

The proposed merger of Europe’s biggest defense and aerospace contractors collapsed Wednesday after European political leaders failed to agree on terms.

The combination of London-based BAE Systems and Paris-based European Aeronautic Defence and Space would have created a colossus to rival U.S. giants Lockheed Martin and Boeing, as well as concerns at the Pentagon about such a huge foreign-owned contractor.

Experts said the failure of the deal could leave the U.S. arm of BAE Systems — which is based in Rosslyn and employs 6,000 in the Washington area — better positioned to participate in a wave of smaller consolidations sweeping the defense industry, as companies jockey for position in a time of budget cuts and shifting Pentagon priorities.

“For the big U.S. defense contractors looking at where growth will come from during the next couple decades, BAE’s U.S. operations would seem to be in a sweet spot,” said August Cole, an adjunct fellow at the American Security Project. He speculated that BAE could be an attractive takeover target, but the company dismissed that notion.

“We are not seeking any activity in that regard. . . . I can assure you I don’t view it that way,” Linda Hudson, president and chief executive of BAE’s U.S. unit, said in an interview. Hudson added that the end of the merger discussions will not have an impact on the company’s operations.

The deal would have created a defense and aerospace giant with more than $90 billion in revenue and operations throughout the United States, Europe and even Saudi Arabia. EADS, the parent company of the Airbus commercial jetliner, and BAE work on some of the world’s most popular weapons, including the MRAP armored vehicle, the Eurofighter jet and parts for the F-35 fighter plane.

Announced last month, the merger was always expected to face an uphill battle as it came under regulatory scrutiny from multiple governments. France, for example, owns nearly 15 percent of EADS, while Germany’s government has influence through the 14.9 percent that Daimler owns.

“The companies had agreed on how they would be managed, what their strategy would be . . .and even what their dividend levels would be,” said Loren Thompson, a defense industry consultant who advises BAE on multiple issues, including this transaction. “They just couldn’t get buy-in from the French and German governments.”

On Wednesday, the companies said that it “has become clear that the interests of the parties’ government stakeholders cannot be adequately reconciled with each other or with the objectives that BAE Systems and EADS established for the merger.”

The U.S. arm of the combined company also would have needed approval from the Committee on Foreign Investment in the United States, known as CFIUS, as well as clearance from the Pentagon’s Defense Security Service to do national security work for the government. The separate companies already have such clearance.

A Pentagon spokeswoman declined to comment Wednesday on the collapse of the deal, noting that there was never a formal agreement for U.S. officials to consider.

For U.S. contractors, the deal’s collapse was a relief. As a combined company, BAE and EADS would have put pressure on rivals such as Boeing and Bethesda-based Lockheed Martin to get even bigger to stay competitive, Thompson said.

The U.S. operations of EADS, which are based in Herndon, are relatively small, with about 3,000 employees. But BAE Systems’ U.S. unit is one of the Pentagon’s largest suppliers. The subsidiary had $14.4 billion in sales last year and more than 41,000 employees overall.

BAE has aggressively expanded its business with the Pentagon in the past decade. Lately, it has increased its focus on services, moving away from its traditional status as a military equipment powerhouse. In 2009, 78 percent of sales were tied to products, leaving 22 percent for services; by 2011, products had declined to 68 percent of the company’s business. BAE has particularly focused on highly technical and classified services, such as analyzing intelligence data and managing cybersecurity.

Hudson is looking to grow the company in new areas, particularly commercial aviation; for instance, BAE is selling engine controllers to GE and providing avionics to Boeing.

The merger could have helped BAE expand some of those lines of business, Hudson said. “One of the benefits for us was access to capital because of the strong balance sheet that EADS would bring to the party,” she said.

But, she added, there was a downside: “It would’ve tied us up for months going through the regulatory process and precluded our strategic movements . . . while we were going through that.”

BAE’s U.S. unit has been attempting to adapt to declines in defense spending. It consolidated its human resources and back-
office financial functions into a single office and has been competing increasingly for commercial aviation work.

Other defense contractors have also been adapting by shedding or adding business units that help them respond to changing priorities at the Pentagon. Some, such as General Dynamics, have focused on making acquisitions in areas such as cybersecurity, while others have been divesting less profitable busi­nesses or even splitting up their companies, as in the case of Science Applications International Corp.

Consolidation of the defense industry is likely to continue through 2014, said Byron Callan, a director at the District-based research firm Capital Alpha Partners.

“Had BAE Systems [and] EADS gone ahead, you could argue it might have been an accelerant,” Callan said. “But I think regardless there was going to be another round of consolidation.”

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