The big surprise of 2005 was the merger of France's Snecma and Sagem. There was nothing to match that in terms of shock value and scale in 2006. But what do the next 12 months hold? Could it be the year that the much-talked-about consolidation of the European defence industry giants gets into gear? Unlikely, say analysts. Even as the latest high-profile marriage founders, with management turmoil and profits warnings at Safran, political considerations are likely to hamper any deals beyond the asset swaps in the space and security sector between Thales and Alcatel in the short term.
European defence consolidation has long been considered overdue. "But defence consolidation at prime contractor level is still governed by politics, whether within a nation or between nations," says Michael Richter, co-president and head of the aerospace and defence investment banking group at Jefferies Quarterdeck.
Look at EADS for proof that national pride and protectiveness towards indigenous industry play a large part - particularly in France. News that Russian state-owned bank Vneshtorgbank had bought a 5% stake in EADS in August was greeted with horror. EADS may be keen to get a slice of the action in the potentially lucrative Russian market, but it is anxious not to cede too much control in doing so. "EADS's management has amply proven that it is smart enough not to let the Russians get a strong position in the company," says Richard Aboulafia, vice-president, analysis of Teal Group. "EADS's quest for investors may be urgent, but it isn't foolish and desperate."
In fact, despite its attractions, Russia may turn out to be a troublesome market. "Six months ago, many European companies were considering expanding their direct investment in Russia to capitalise on skilled, low-cost labour, coupled with a resurgent indigenous demand for aircraft," says Richter. "However, recent Russian government activity in the oil and gas sector and, more recently, gold, where the government has been applying pressure on foreign companies to scale back their investment and renegotiate contracts, means companies are reappraising their strategies for Russia."
Back in Europe, talk of Thales and EADS teaming up - a hot topic this time last year - has gone quiet, as EADS focuses its energy on dragging itself out of the quagmire of A380 delays and management infighting. The long-running saga of what will happen to the 7.5% stake in EADS that DaimlerChrysler is expected to sell is likely to be resolved early in the new year, with the German government keen to make sure it retains German influence.
"However, there could - or should - be further consolidation among the engine manufacturers," says Richter. "But national politics is a partial barrier, as are existing cross-shareholdings and joint ventures."
BAE Systems got caught up in its own storm of national sensitivity when it chose to withdraw from its 20% shareholding in Airbus, with UK industry fearing this would jeopardise suppliers' work on future programmes. But BAE has long made it clear it is more interested in the lure of the west than Europe's declining defence arena. The company is likely to bolster its already strong US position and may already have targets in its sights. "Whether BAE pursues a large transaction like L-3 or DRS Technologies will very much depend on whether companies like that become 'available', with underperforming shares, for example," says Richter.
Setting a precedent
As for aerostructures, George Burton, director of Consultancy Counterpoint Market Intelligence, believes the Spirit Aerosystems takeover by Canadian investor Onex, also the new owner of Raytheon Aircraft (RAC), sets a precedent for the sector, which is embarking on its consolidation phase.
More transatlantic aerostructures deals are likely in 2007, with European players seeking to increase their market access and dollar cost bases as the threat of currency exposure shows no sign of abating. As the trend towards transatlantic mergers grows, companies will be able to take advantage of economies of scale in production and gain valuable access to important programmes. "They will benefit from a broader and better business base," says Burton.
For Europe the weak dollar is likely to be this year's big hurdle. But, says Richter: "Dollar weakness provides further momentum to the well-established trend of European companies buying in the US."
The industry has seen its share of management changes in 2006, with Louis Gallois becoming Airbus's third chief executive and EADS's second French co-chief executive during the year. Safran got rid of long-serving Jean-Paul Béchat as the long-running scuffle between former Sagem and former Snecma employees came to a head.
More poignantly, L-3 Communications emerged intact from a flurry of takeover talk after the unexpected death of its chief executive and co-founder Frank Lanza in June. Stallard agrees it is now "highly unlikely" L-3 will be taken over by anyone.
But if 2006 at times seemed dominated by personalities, 2007 may see more corporate activity. And Finmeccanica could emerge as the star of the show - this may be the year it gets full control of ATR. "Finmeccanica has made significant strides in recent years to gain fuller control of its operations," says Richter. "A resurgent ATR is its next priority. It is also actively seeking US and European acquisitions."
Aboulafia says: "Finmeccanica is in the best financial position on the continent. This has freed them up to do a curious mix of smart and less-than-inspired things."
The company's inroads into the US market and, in particular, the JSF programme are good moves, he adds, although "their Russian initiatives look less well thought-out, but if they can adopt their own version of the Superjet, and buy up ATR, they could create a regional transport entity that eclipses Bombardier". But Aboulafia warns: "Investing in Russian programmes is an exceptionally risky move."
Closer ties between Alcatel and Thales could pave the way for increased co-operation between Finmeccanica and Thales.
Further down the supply chain, Tier 2 and 3 players may be more active this year. "Many aerospace companies are becoming cash-rich, so they will be under pressure to reinvest their earnings, return it to shareholders or restructure their debt load," says Jason Steen, partner at mergers and acquisitions advisory firm Steen Associates.
Stallard adds that US defence players at this level of the supply chain are especially likely to see more mergers and acquisitions activity in 2007.
Source: Flight International
