For years BAE Systems' identity was British, but with its investment in foreign markets increasing, change is just around the corner
This year could determine whether the B in BAE Systems continues to connote British, or whether, like another national icon now playing on a global stage, the B comes to mean something beyond nationality.
Perhaps it is apt that Dick Olver, former deputy chairman of BP, takes over as BAE chairman this month. BP shed its identity as British Petroleum, favouring an image that goes "beyond petroleum", and BAE may have to accelerate its move "beyond Britain" if it is to survive and prosper.
In 1999, as British Aerospace, BAE turned down a merger with Germany's DaimlerChrysler Aerospace (DASA) to nail down the domestic takeover of GEC's Marconi Electronic Systems. BAE saw more value in consolidating its hold on the UK defence market, and establishing a foothold in the USA.
The strategy made sense at the time, but it was to have massive repercussions. Jilted by BAE, DASA turned to France's Aerospatiale Matra and Spain's Casa to push through the mega-merger that created European Aeronautic Defence and Space (EADS) in 2000. Thwarted in its efforts to woo GEC, France's Thomson-CSF (now Thales) established a UK presence that same year taking over Racal Defence Electronics.
Open competition
BAE is operating in the only truly open defence market of any size and, far from having locked up the role of preferred supplier to the UK Ministry of Defence, now faces competition for prime contractorship from EADS and Thales, and from the US primes Boeing, Lockheed Martin, Northrop Grumman and Raytheon.
For the British, much reading of the tea leaves follows any action by BAE - and with good reason, as the strategy behind some of the company's recent moves is far from obvious. There were two interpretations of the April news that the company was reviewing the future of its shipbuilding business, the straightforward one being that BAE wanted to return to being an aerospace-only company, perhaps to make itself an attractive merger partner for a US company. The more twisted theory held that the company wanted to hit back at the MoD for its plan to take the role of prime contractor on the UK's CVF future aircraft carriers away from BAE and Thales and take it in-house.
There have been two interpretations of BAE's bid to take over UK tank maker Alvis, the straightforward one being that the company wants to strengthen its RO Defence business and secure the role of prime contractor on the MoD's Future Rapid Effect System family of armoured fighting vehicles. The more convoluted one is that BAE was pressured by the UK government into outbidding General Dynamics to prevent Alvis falling into US hands in the wake of GKN's decision to sell UK helicopter manufacturer Westland to Italy's Finmeccanica.
Whatever its reasons for the Alvis move, as a consequence of the deal, BAE is expected to halt its shipyards sale. This should help relations with the MoD, but is likely to set back plans for finding a US merger partner. Boeing publicly scotched any hopes of a merger earlier this year, after three years of on-again/off-again talks, saying it was not interested in a business as vertically integrated as BAE. Merger interest from GD, which does have shipbuilding and tank-making businesses, also waned last year.
Staying in these businesses, and remaining a broad-based UK defence company, only makes long-term sense if BAE can persuade the MoD to adopt a policy to protect the country's defence industrial base. To BAE that means being treated as the national champion, a move to cost-plus contracting and resolute negotiation of US technology transfer as an "absolute condition" of a UK purchase of the Joint Strike Fighter.
BAE is unlikely to be guaranteed major MoD programmes as the UK government is committed to competitive procurement, a policy that has cost the company dearly in recent years. Mainland Europe still clings to the concept of national champions, while the USA adheres to competitive procurement, but restricts the contest to US prime contractors, who play on a field that is level for them but adversely sloped for foreign companies. The UK is the only truly open and sizeable market worth fighting over.
Analysts say BAE's recent troubles are down to both poor programme management, and to its major customer for having aspirations beyond its means. Budget-related delays to MoD programmes have made it difficult for BAE to plan, they argue.
BAE has spent the last two years working to restore its financial health. The problem areas were BAE's major MoD programmes, which account for 20% of annual sales and include the delayed Nimrod MRA4 maritime-patrol aircraft and Astute attack submarine development programmes; and its international partnerships, which constitute most of BAE's business in continental Europe and make up about 13% of sales.
After taking a £750 million ($1.36 billion) charge in 2002 - £500 million for Nimrod and £250 million for Astute - and negotiating new contracts with the MoD, BAE has reported progress in removing excessive risk from both programmes. The MoD's July 2003 decision to award BAE an £800 million contract for up to 44 Hawk advanced jet trainers, followed by India's memorandum of understanding (MoU) in March for the $1.5 billion purchase of 66 Hawks, has shored up BAE's programmes business, although the UK contract is not signed.
International progress
Internationally, BAE has made progress in improving its profits, or cutting its losses, from its European ventures. Missile house MDBA, in which BAE has a 37.5% stake, is performing strongly as several programmes transition from development to production, with sales up 34% last year and expected to grow 25% this year. BAE says this underlines the wisdom of placing its once-ailing guided-weapons business into a larger joint venture with EADS and Finmeccanica.
BAE has also taken 100% ownership of Germany's Atlas Elektronik, hoping to improve its control of the venture, and sold its 27.5% stake in loss-making satellite manufacturer Astrium to EADS. The next step is to conclude a complex deal with Finmeccanica to combine their avionics and C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) businesses into a joint venture, EuroSystems, with annual sales of around €3.7 billion ($5 billion).
EuroSystems will comprise a systems integration business 60% owned by BAE and including most of Alenia Marconi Systems (AMS), at present a 50:50 joint venture between the two companies; and an avionics business 60% owned by Finmeccanica. Under the planned deal, a preliminary MoU for which was signed a year ago, the Italian company will take over relevant BAE communications activities in the UK and the air traffic management business of AMS.
While BAE's international business looks stronger, it still faces domestic challenges, not least with the Eurofighter Typhoon, in which the UK firm has a 37% stake. Deliveries of Tranche 1 Typhoons have been stretched out and negotiations on the capability and quantity of Tranche 2 aircraft are dragging on. BAE says it will not record any profit on Typhoon production until the uncertainty over the transition from Tranche 1 to Tranche 2 is resolved.
Reports suggest it is now the MoD that is dragging its heels on signing the Tranche 2 development and production contracts. While praising the performance of the Royal Air Force's initial aircraft, UK defence secretary Geoff Hoon says the government has yet to negotiate the "right price" for the more-capable Tranche 2 fighter. It was Hoon who overruled the UK Treasury to award BAE the vital Hawk deal, so he may yet deliver on Typhoon. Negotiations on the CVF programme are also at a difficult stage, with BAE estimating the cost of the two carriers at £4 billion, well above the MoD's budget of £2.9 billion. Chastened by its Astute and Nimrod experience, BAE says it will not sign a contract until the cost, capability and delivery requirements can be balanced.
Looking stateside
While it works to put its UK and European businesses on a sound footing, BAE is looking to the USA for growth. The company's North American operation accounted for 21% of sales and 30% of profits last year, with another 10% organic growth targeted for this year. In the absence of a transatlantic merger, BAE is likely to pursue more US acquisitions - and not just in defence, as this month's deal to purchase Boeing's commercial electronics business illustrates.
The tea leaves suggest BAE's current strategy is to do what it can to protect its UK business base and repair its relationship with the MoD while looking for profit and growth in markets where there are both programmes and budgets. For the foreseeable future, that looks to be the USA.
GRAHAM WARWICK / WASHINGTON DC
Source: Flight International
