European aerospace: Not in formation

A flurry of deals, but Europe is gridlocked

THE recent consolidation in Europe's aerospace industry has come after years of speculation about which combinations will emerge. But any hopes of stronger transnational groups look destined to be disappointed. Instead, the deals are likely to freeze the industry in its present fragmented state, with cross-border links restricted to joint ventures.

Last week DaimlerChrysler and France's Lagardere simultaneously raised euro2 billion ($2.4 billion) each from the long-expected reduction of their stakes in EADS, a Franco-German aerospace-defence group that owns 80% of Airbus. Soon after, Britain's BAE Systems said it was in early talks to sell its 20% share in Airbus to EADS, worth some pounds 3 billion-4 billion ($5.2 billion-7.0 billion). This sale is a long-overdue consequence of the transformation of Airbus from a consortium to a stand-alone company. Since 2001, when BAE's wing-making factories joined the new Airbus business, BAE has been a sleeping partner.

Also last week, the French Thales defence group bought the satellite interests of Alcatel as the telecom-equipment maker tidied itself up to take over America's Lucent. The deal increased Alcatel's stake in Thales to 21.6%, enough to block any move by EADS to buy it--something that has been openly talked about on and off for more than a year.

Within a few days the French government announced that a state bank (the Caisse des Depots et Consignations) will take almost a third of the 7.5% tranche of EADS shares being sold by Lagardere. This upsets the delicate Franco-German balance, with the French government and Lagardere holding nearly 25% of EADS, compared with the 22.5% now to be held by Germany's DaimlerChrysler. It sets the scene for yet more bickering.

EADS is dominated by the largely French civil-aircraft business of Airbus, which accounts for most of its sales and profits. The remaining defence business is largely German, although there is a missiles joint venture with BAE and Italy's Finmeccanica. The best hope for further consolidation might be for the British to sell their share of this to EADS and the Italians, if the British government consents.

It could happen. BAE is getting out of military metal-bashing and also out of Britain. From the moment it jilted Germany's DASA at the altar in 1999 in favour of a takeover of another British company, GEC-Marconi, it became clear that BAE saw its destiny across the Atlantic rather than in Europe. GEC-Marconi already had American defence businesses, which now account for at least a third of BAE's sales. There have been moments when the US department of defence has been a bigger customer for the company than Britain's own ministry of defence.

So the sale of the Airbus stake, to be followed perhaps by an exit from the missiles joint venture, could constitute a clearing of the European decks in preparation for a big push by BAE in to America. Since it acquired United Defense Industries, maker of the Bradley armoured vehicle, for $4.2 billion in 2005, BAE has become a key contractor to the Pentagon. Given that America accounts for about half of the open defence-equipment market, this westward migration makes sense.

Yet there are difficulties. BAE is a partner in the huge American joint strike-fighter programme (JSF), to which the British government has contributed some $2 billion in development costs. Congress, however, is still blocking Britain's access to software codes which could threaten to curtail severely British industrial participation in what will be the world's biggest defence-procurement project.

The trouble is that some of the American defence companies that have caught BAE's eye have proved too expensive. Four years ago it wanted Rockwell Collins, but could not afford it; the next temptation was L-3 Communications, a black-box maker spun out of Loral's merger with Lockheed, but talks went nowhere: now, at $10 billion, that is also too expensive. So BAE seems set on a path of small purchases in America, plus perhaps the return of some cash from the Airbus sale to its shareholders. That is a strategy which the markets appreciate.

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