The Top 100 aerospace ranking, compiled by Flight International and leading industry experts IPG Consulting, shows an industry in the grip of consolidation. But how long will merger-mania hold sway - and what comes next?
Chris Jasper/LONDON
The aerospace industry, conventional wisdom would have it, is in less than perfect health. With the current civil cycle close to its peak and defence spending worldwide still flat and likely to remain so for the foreseeable future, many have predicted lean times ahead. But while Boeing and Lockheed Martin continue to suffer in the wake of severe production problems, Flight International's Top 100 survey shows that - beyond the big two - aerospace manufacture is in surprisingly good shape.
The Top 100, compiled in association with IPG Consulting, reveals three outstanding truths: that the aerospace industry continues to produce impressive growth figures while operating from roughly the same capital base; that consolidation is happening rapidly on both sides of the Atlantic, with the most frenzied activity occurring in the USA at the level of first and second tier suppliers; and that European industry has become a better investment prospect than the USA, which it equals or outstrips in terms of returns in key areas.
IPG partner Kevin Lynch is impressed by the dynamism exhibited by the industry as a whole, which saw turnover increase by 12% in 1998 compared with the previous year, when it in turn showed a 17% improvement on 1996.
"This is supposed to be a clapped out, metal-bashing industry, but it quite clearly is not," he says. "In compound terms we have seen growth of 32% over the two years, and from a constant level of expenditure."
Against this generally healthy background, the "big story", Lynch says, is consolidation, which has reached supplier level in the USA and which is proceeding among prime manufacturers in Europe. The impact of consolidation is revealed by the marked increase in the size of the top 10 in the survey relative to the other 90.
Big deals along national lines in the UK and France were topped by British Aerospace's acquisition of GEC's Marconi Electronic Systems (MES), which will see BAe regain its position as number three in the world after being overtaken by Raytheon following the incorporation of Hughes Electronics. The Aerospatiale/Matra Hautes Technologies merger is also now a reality, while Germany's DaimlerChrysler Aerospace (Dasa) has reasserted itself through the effective purchase of Spain's CASA. All occured in spite of the shelving of the single European aerospace and defence company (EADC) concept.
Across the Atlantic, the US Department of Defence's blocking of Lockheed's move for Northrop Grumman prevented a further mega-merger in the wake of the Boeing-McDonnell Douglas deal, but consolidation has continued down the hierarchy, with BFGoodrich-Coltec, United Technologies-Sundstrand, TRW-LucasVarity and - most recently - AlliedSignal-Honeywell all joining forces.
"You can say what you want about the failure of the EADC, but consolidation has happened in Europe on a prime basis," says Lynch. "And in the US consolidation has gone beyond primes and is happening at tier one and two level. This is the big trend."
The third significant development revealed by the Top 100 study concerns returns on investment in Europe, which is now, quite literally, giving the USA a run for its money. In terms of operating margins, for example, primes are now looking healthier in both camps, with the US improving to 8.7% (partly because of Boeing's modest recovery) and Europe almost level on 8.0%. At tier one level there is again little difference, while in tier two, Europe is slightly ahead. Figures for returns on capital employed confirm this picture.
"There is a story here in that Europe is catching up, and we have seen that over the last few years," says Lynch. "European aerospace is alive and well and getting better." The trend is explained by Europe's steady progress in an environment lacking the degree of cyclicity suffered in the USA. Among primes, the new Aerospatiale Matra is expected to deliver improvements already secured in the UK and Germany, allowing Europe to further hone its competitive edge.
With the aerospace sector still a heavily populated industry, mergers are meanwhile expected to remain in fashion, with IPG predicting that next year's survey will confirm a continuation of the trend, especially in tiers one and two. Consolidation will continue because underlying causal factors remain unchanged: aerospace remains a capital intensive industry, and the cash needed to meet the high development costs of new programmes at primary level is still best secured through sheer size.
A second force favouring consolidation stems from the complications of gaining access to military markets, with offset deals remaining central to many defence contracts and often extending to 'investment opportunities' as state-owned industries are privatised. Though the sector's globalisation is incomplete, the transformation has begun, and may accelerate, Lynch says, as companies begin to discover the benefits it can deliver not merely in terms of markets, but also on the supply side.
"The aerospace industry tends to concentrate on demand, meaning the market for its products, and ignore the supply element or see it as a pain, forgetting the cost savings to be had in developing countries," he says. Lessons might be learnt from the automotive industry, which has used the globalisation of its supply base to develop strong fundamental capabilities in lower cost environments.
Prospects for further consolidation among primes centre on Lockheed Martin, Raytheon and Northrop Grumman in the USA, and several players in Europe. Boeing and Lockheed are both preoccupied to some degree, with the Seattle giant not completely out of the woods and the Bethesda company concentrating on production matters and its faltering Joint Strike Fighter (JSF) bid. Fire-fighting need not necessarily exclude consolidation, although the Pentagon is unlikely to encourage mergers around a player guilty of continually dropping the ball. Divestment is also an option, and Northrop Grumman, still said to show the 'for sale' sign, could yet stage a retreat to core activities, making disposals along the way.
Raytheon, the USA's number three prime, is actively looking at transatlantic options, and though believed to have an eye on the UK's Racal (desirable because of its strategic positioning rather than its business value), it could seek to land bigger fish.
With US political barriers halting consolidation at three primes (four including Northrop), mergers at this level seem likely to be restricted to intra-European or transatlantic moves. Following French and UK consolidation, a reduction to just two European primes seems most likely, with DaimlerChrysler likely to float Dasa, or spin it off. The German company is clearly a potential partner either for Lockheed, Raytheon or Northrop, while BAe has also hinted at a US move.
The French aerospace sector has successfully played catch-up over the last year, and is now effectively 'in play' as far as potential mergers are concerned. IPG regards Aerospatiale Matra as "a nice looking business", while Dassault Aviation remains a star performer in terms of margins. Thomson-CSF presents more of a conundrum. Lynch describes the systems specialist as "an attractive prospect", but one troubled by "an issue of not just how, but whether, to move", although he judges that "ultimately they will".
Complicating the European question is the future of the Airbus consortium. However, IPG says the picture is becoming clearer, and that Airbus will become a single entity one way or another, with funding for the A3XX super-jumbo likely to force the issue. It will probably remain a multi-national enterprise, retaining links to defence manufacture both for reasons of technology transfer and as a hedge against the cyclicity of the commercial airliner market. Beyond this, anything is possible - new shareholders could be brought in, for example, and not just within Europe but also from North America.
IPG partner Ian Godden expects to see the industry reduced to just five big global primes (defined as having civil capacity but active in defence as integrators), and by extension around 20 companies in the first tier (offering assemblies and systems, including engines) and 100 in the second tier (sub-assemblies, components and sub-systems).
Godden suggests another trend might see the grouping of entities specialising in 'unlike' activities in an effort to reach critical mass, uniting such strange bedfellows as Smiths Industries, Rolls-Royce and Labinal. This type of non-sectoral consolidation has already been furthered by holding companies such as Carlyle, which has proved wise to the returns to be had from investment in what Lynch calls "non-sexy" aerospace firms.
Sitting below this hierarchy are hundreds of smaller suppliers, usually non-aerospace specific, while overlaying it are 'new sector' players active in non-traditional areas including space, services and C4ISR (control, command, communications, computers, intelligence, surveillance and reconnaissance). IPG associate Ashly Brady says it is difficult to quantify the impact of such 'next generation' businesses, but that they seem to be making a bigger contribution.
"The answer is not clear-cut," he says, "because some established companies, such as Lockheed Martin, have seen their hi-tech segments underperform. But there seems to be enough evidence to support the assertion that hi-tech sectors are experiencing rapid growth."
Space/satellite activities have led the charge, with L3 Communications, Orbital Science, Gencorp, Hughes, Honeywell and Loral racking up sales. Top 100 debutantes include new sector players ELOP (thermal imagining, lasers and space systems), Amphenol (comms) and Kellstrom (services and support).
This is not to say that some very traditional sectors have not experienced similar growth, and IPG believes the industry as a whole may be headed for a softer landing than previously imagined. Consolidation is in itself a hedge against a slump, while Godden says that though the civil sector is reaching its peak, it is still likely to produce one more set of "very good" figures and may be followed by a flattening out rather than a fall, with Asia recovering, the US market buoyant and both Airbus and Boeing planning production capacity more carefully. The latter's turnover may fall off, but profits need not.
The military market now seems to have bottomed out after the post-Cold War slump, which saw global military spending drop from 6.7% to 4.2% of GDP between 1985 and 1997. Sales will be boosted by widespread moves to re-equip for the next 50 years or so through projects such as the JSF and Eurofighter, while military outsourcing also promises growth.
Looking a few years into the future, Godden sees not so much an end to consolidation as a change in direction, with some companies diversifying away from the aerospace sector. "I don't think consolidation will stop, but I think we'll see a wave of people trying to diversify out of the industry again in a way we have not seen for 10 years," he says.
Players such as BAe gained focus in the early phase of consolidation by concentrating wholly on core values, with the UK company exiting areas including telecoms (Orange; holding down to 5%), property and cars (Rover, sold in 1994), while picking up businesses such as Marconi along the way. Down the line, however, Godden believes re-evaluation is inevitable.
Factors promoting diversification, he says, include a lessening of the consolidation imperative as critical mass is attained and the absorption of new technology (and managers), leading companies into new business areas - especially through the anticipated rise of the unmanned combat vehicle, with its associated new technologies.
Boeing is already considering major departures into new arenas including space and comms, says chief financial officer Debby Hopkins, and the company of a decade's time may bear little resemblance to the current airframer.
| THE POST-MERGER AEROSPACE RANKING - MID 1999 | ||||
| New Rank | Group | Aerospace Sales ($m) | Current ranking | Relevant acquisition |
| 1 | Boeing | 55,424 | 1 | |
| 2 | Lockheed Martin | 26,011 | 2 | |
| 3 | British Aerospace | 20,500 | 4 | MES |
| 4 | Raytheon | 17,465 | 3 | |
| 5 | Aerospatiale Matra | 13,735 | 8 | Matra |
| 6 | United Technologies | 11,996 | 5 | |
| 7 | DaimlerChrysler Aerospace | 10,960 | 7 | CASA |
| 8 | General Electric | 10,294 | 6 | |
| 9 | AlliedSignal (to be known as Honeywell) | 9,800 | 10 | Honeywell |
| 10 | Northrop Grumman | 9,104 | 9 | |
| 11 | TRW | 5,868 | 11 | |
| 12 | Rolls-Royce | 5,760 | 13 | |
| 13 | Thomson-CSF | 4,900 | 14 | (GEC exits) |
Source: Flight International
