GE's tier one rivals must respond to the Honeywell takeover
Chris Jasper/BUSINESS EDITOR
Just when it seemed that merger activity in the aerospace manufacturing industry had peaked, along came the world's biggest company and put an industrial-sized spanner in the works of the other tier ones. General Electric's take-over of Honeywell will create a giant among aerospace suppliers - smaller than the primes, but considerably bigger than its direct rivals, which now face a major headache.
With Northrop Grumman closing 2000 by purchasing Litton, aerospace analyst Neil Hampson of Roland Berger calculates that in terms of transaction value, 2000 was the busiest year ever for deals completed. "If we stack up GE-Honeywell and the rest, this is the biggest year for aerospace merger and acquisition activity," he says. "It has got bigger every year, but in pure value terms this will probably be the biggest for many years to come."
Hampson says GE's swoop will lead to "a redefinition of the tier ones", and is "so compelling" that in 2001, companies such as Rolls-Royce, UTC, Thales, BFGoodrich and Rockwell International will want to counter it. Vertical mergers - building size, rather than specialty - would be one response.
At the level of the primes, the Northrop-Litton deal may be the last big merger of its type, with future moves likely to be transatlantic. The merger, which should secure Northrop's future as a major defence systems player, means that the two primes on either side of the Atlantic which had seemed most in danger of being left behind by the consolidation process have now acted to keep pace with the opposition: the other straggler, Thomson-CSF (now Thales), pulled off a major coup by purchasing Racal Electronics.
Elsewhere among the primes, merger activity has centred on niche buys aimed at adding new competencies, such as Boeing's purchase of Hughes Satellite Systems, which catapulted Boeing into number one position in the space launcher market, significantly changing the weighting and - ultimately - the direction of the world's biggest aerospace manufacturer.
While the logic of aerospace consolidation now points to transatlantic moves, these must await an easing-up of ownership restrictions, which may or may not come with the new US presidency. Transatlantic ventures established this year - between Northrop Grumman and EADS and most recently between Raytheon and Thales on ground-based air defence - fall far short of the deep alliances or mergers that would most benefit companies.
Consolidation at tier one level continues - Smiths Industries buying TI Group, for example - and Hampson predicts that "the disappearance of tiers two and three will continue for the next 10 years".
The year 2001 will be big for EADS, which has shrugged off general disinterest in its flotation but remains more exposed to the vagaries of the market than most, given its reliance on Airbus and civil manufacture. The move to the Airbus Integrated Company and the A380's launch are as important to EADS as to Airbus, but the A380 is capital intensive and EADS is footing most of the bill. Investors will therefore regard it warily. Also, the integration of its constituent companies, spanning three nations, remains a huge challenge as it seeks to extract synergies while combining different business cultures. It has at least made a start by revamping its Defence and Civil Systems unit.
EADS will be keen to build its defence portfolio, but ties to the USA and its massive defence market remain relatively weak. BAE, by contrast, now has a major presence in the USA, aided by big deals in 2000, and is now a defence systems integrator with rump civil activity.
US industry has worked hard to overcome the difficulties of a few years ago, with a series of sectoral disposals in 2000 aimed at improving focus. Lockheed Martin, for example, sold its control systems and electronic warfare businesses to BAE, and Northrop Grumman sold its aerostructures unit before the Litton buy.
Looming over the industry in 2001 will be the prospect of a US economic slump. Though the defence market remains flat, the soft landing apparently in store for the civil sector means confidence remains high after a year in which the sector generally performed above expectations.
"From what we have seen, it has not been as bad this year as everyone predicted," says Hampson. "It was not that drastic. People have generally done well, and we think 2001 will be even better." One factor that should lesson the sector's exposure in choppy waters is the relatively modest ratio of ordered aircraft to aircraft in service, which should help airlines and manufacturers manage a slowdown. Analyst Chris Tarry of Commerzbank says the airline industry's orderbook is in far better shape than it was before previous industry shocks. "Part of the problem in the Gulf War was massive over-ordering in 1986-90."
Boeing chief Phil Condit sees no reason for pessimism. "We're not seeing any effect on airline demand," he says. "We see 4-5% growth and 3% aircraft replacement, which equals 7-8% of fleet that needs to be ordered every year. And we have not gotten into a situation where airlines order higher than demand and hope to get market share from someone else, which leads to higher capacity. Load factors are as high in the USA as ever, and we have great confidence in the US economy."
Any downturn the industry does endure will give a further nudge in the direction of new types of business activity, including space and communications, information technology, finance and service provision in general. The primary manufacturers all now acknowledge the importance of services, with 2001 set for a major expansion in that direction.
"Services are the big thing," says Hampson. "The sector offers growth of 6% a year against 3-4% for manufacturing. And services is a fragmented market not well served by primes, so it's ripe for someone to come in."
Ironically, while GE has seized the initiative at a strategic level with its Honeywell move, it is also ahead of the rest as a services provider, with all-conquering GE Capital. Yet it may not be unassailable. "At least airframers have a better idea of cost," says Hampson.
Source: Flight International
