IN FOCUS: Finmeccanica revitalisation drive built around aerospace, helicopters, defence electronics and security

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At Foggia, on Italy's Adriatic coast, Finmeccanica's Alenia Aeronautica makes the horizontal stabiliser for Boeing's carbonfibre 787. At a massive, purpose-built factory at Grottaglie, further south in the heel of the Italian boot, it makes fuselage barrels.

Both projects are massive undertakings, pushing the limits of carbonfibre manufacturing capabilities and, like the entire 787 project, they have both been beset by difficulties.

In 2009, with the 787 two years into a series of setbacks, Boeing discovered wrinkles in the skins of some barrels, above door frames, and issued a stop-work order to Grottaglie to resolve the problem.

 

 ©Alenia Aeronautica

Finmeccanica's Alenia Aeronautica plant in Foggia, Italy where the horizontal stabilisers are made for Boeing's 787

More trouble came a year later, when Boeing found structural gaps in Alenia-supplied stabilisers and slapped temporary operating limits on the five test aircraft it had flying at that time, citing improperly installed shims and mis-torqued fasteners. For Alenia, that turned out to be an expensive mistake, adding insult to what has turned out to be a financially injurious programme.

Finmeccanica took a €753 million ($998 million) charge against the 787 in its third-quarter 2011 results, including €161 million in anticipation of penalties likely to be paid to Boeing for "non-compliance" of stabilisers.

Chief executive Giuseppe Orsi, in a briefing for London securities analysts, said the other €592 million reflect the "substantial" additional costs associated with the 787 programme's "major technological, process and structural challenges".

The €592 million figure was based on a huge increase in Finmeccanica's assessment of the contract cost. Up until the end of the first half, Orsi explains, Finmeccanica valued the programme at only 300 shipsets, as there had been a "tangible risk" that a permanent increase in development and industrialisation costs would lead Boeing to cancel the 787 programme. In the event of cancellation, Finmeccanica would have kept a Boeing cash advance, but with certification and first delivery finally achieved, cancellation is "quite unlikely" and that, says Orsi, changes the calculations dramatically, as the contract is now valued at 1,022 shipsets.

Orsi believes the 787 will, now, prove profitable over the 1,022 aircraft plan, and should provide "low single-digit" profitability during the early programme period.

In the meantime, aeronautics - including the Alenia Aeronautica and the Alenia Aermacchi units - has a lot of catching up to do. For the nine months to end-September, sector revenue was flat at €1.87 billion as falling 787 and Eurofighter revenue (Finmeccanica's Selex Galileo unit supplies the radar) wiped out gains in the M-346 jet trainer and ATR programmes.

On the profit side, rising costs and the third-quarter 787 charge turned a meagre €71 million operating profit in the period last year to a whacking loss of €768 million. The fourth quarter will include a €200 million hit against pending redundancies as a major restructure of the aeronautics sector gets under way.

That aeronautics restructuring - which will see all businesses brought together in a single unit, job cuts, possible factory closures in Italy, supply-chain streamlining and the end of some programmes - highlights the fact that Finmeccanica's struggle in aeronautics goes far beyond 787 travails.

Indeed, the group's difficulties go far beyond aeronautics and Orsi - who headed up Finmeccanica's AgustaWestland helicopters division before taking over the group role earlier this year from Pier Francesco Guarguaglini, who is now chairman - does not pretend the company faces anything short of an immense challenge.

In 2010, Finmeccanica made a net profit of only €557 million on sales of €18.7 billion, and halfway through 2011 reported a six-month profit of €456 million, which looks impressive except for the fact it included a €443 million gain from the partial sale of the troubled Ansaldo Energia power generation division.

Those first-half numbers left no room to hide from severe structural and market problems. As the group's report notes, there are "many sources" for a deterioration in profitability, including Western government financial pressure to cut infrastructure and defence spending. Shorter-term troubles stemmed from the Japanese earthquake and conflict in Libya, which impeded some ongoing energy projects.

However, now Orsi has warned that 2011 results would be "worse" than management expected back in July, and he is making no financial forecasts for 2012. In the meantime, Orsi says, he will deal in "facts rather than hopes" and will limit his remarks to "achievements rather than promises", while striving to restore the finances of a group in desperate need of major structural reform.

Indeed, Orsi more than hints at the root cause of Finmeccanica's troubles, which a plan to focus on aerospace, defence electronics and security by at least partly selling off the energy and rail and bus transport businesses will not address. In addition to cutting €140 million out of general and administrative costs through 2013, and judiciously selling off assets to cut debt from €4.7 billion today to €2.5 billion by the end of 2012 in a determined bid to retain Finmeccanica's investment-grade credit rating, Orsi wants to drive a profound shift in Finmeccanica's management culture.

Chief executives of operating companies, says Orsi, are already being told to take greater responsibility for the financial performance of their operations. In his London analysts briefing in November, Orsi made several references to the urgency of driving accountability down the management chain. Henceforth, business unit bosses at Finmeccanica are expected to be profit driven.

NEW FINMECCANICA

The plan for a new Finmeccanica calls for emphasis on four strategic sectors - aeronautics, helicopters, defence electronics and security. Finmeccanica will aim its solo efforts at products or sectors where it can be a world leader and focus on cutting-edge technology programmes.

Elsewhere, it will either "leverage" its capabilities - that is, put more effort into finding solid partners - or get out. That means the energy and transport businesses will be largely divested, and question marks remain over activities such as space services.

In aeronautics, a "3R" plan - restructure, reorganise, relaunch - is under way. Alenia Aeronautica and Alenia Aermacchi will be brought together as a single company. Details have yet to be hammered out, but a group-wide recognition that the business and product portfolio is too diversified will lead to some programmes being axed and others pushed into partnerships.

On the civil side, high-technology programmes such as the Boeing 787, 777 and 737 Max will be prioritised. Exposure to unprofitable programmes will be reduced - Dassault Falcon, Boeing MD-11, Airbus A300 and A340. Finmeccanica will phase itself out of the anti-submarine warfare variants of ATR turboprops, made in partnership with EADS.

As for ATR and the Finmeccanica's part in the Sukhoi Superjet 100 regional jet programme, Orsi points to more "leverage", and promised to have a "redefined" strategy by the end of 2012. One option being discussed with Finmeccanica's Russian partners is the possible development of a larger version of the regional jet, in the 120-seat range.

On the military side, the focus will be on proprietary products such as C-27J transports and M-346 jet trainers. More leverage is in the plan for collaborations - Eurofighter, Lockheed Martin F-35 - and Finmeccanica will pursue a role in new initiatives such as the prospective European medium-altitude long-endurance unmanned system.

Three production sites are to close, at Venice, Rome and Casoria. There will be management integration of capabilities into several clusters - Cameri and Turin (to form an integrated defence aircraft centre), Capodichino (military transports), Pomigliano (civil aircraft), Nola (metallic structures) and Foggia and Grottaglie (composite manufacturing).

About 750 aeronautics staff will lose their jobs, some activities will be outsourced, and there will be a redefinition of "make or buy". Suppliers had better watch out for an "optimisation of the purchasing process and renegotiation of supply contracts".

A "single-entity approach" will see the Selex businesses - Elsag, Galileo and Integrated Systems - and DRS, the US electronics business bought in 2008 for $5.8 billion, reorganised as Selex in Europe and DRS in the USA. The purpose will be to "streamline" from several under-performing companies into a tighter group focused on defence electronics and security.

However attractive the plan is, Orsi is in no doubt that what counts is execution, and he is confident "the new Finmeccanica has huge potential" to be "materially more profitable". In the meantime, there are many details to be worked out, such as deciding which businesses to sell and which to keep, and how many jobs to cut.

These are all decisions which will no doubt keep Orsi and his executive-suite colleagues in regular dialogue with Rome, where a new government that owns a short third of Finmeccanica faces its own deficit-cutting and growth-promoting restructuring challenge. Italy right now certainly needs a big, national champion such as Finmeccanica to be financially sound, profitable and growing.

So there is some irony in another aspect of the plan for Finmeccanica, which Orsi describes as the intensification of "our drive for greater internationalisation of the group". Underscoring this message was the fact that Orsi outlined Finmeccanica's revitalisation plans in the company's London headquarters - which he called its "British home" - in English.