Talk of a BAE and Thales merger may force long-needed changes to allow cross-border consolidation to create truly worldwide companies

Last week's spat between BAE Systems and Thales over what was or was not offered in the way of a merger around a breakfast table in a London hotel has once again highlighted consolidation as an issue at the heart of the aerospace and defence industry.

With the aerospace world gathered in Paris there are plenty of reminders of the upheavals that the industry has gone through in the past 10 years. Lockheed Martinis a combination of Lockheed, Loral and Martin Marietta, BAE and Thales are similarly born out of consolidation.

But in recent years the merger rate among the largest players has slowed to a trickle, not because industry is losing its appetite, but because national governments are putting barriers in place, or at least raising objections. Why? Because governments wish to ensure competition when they make high-profile, expensive procurements while cross-border consolidation raises the thorny issues of national ambition and prestige.

There is of course an imbalance between the prime contractor, tier 1 players, and those lower in the supply chain. Mergers and acquisitions are still frequent between tier 2 companies and below. Tiers 2and 3 stir up less emotion than prime contractors so they have been able to acquire and merge, and national borders have been less of an issue, perhaps because there is more competition and almost certainly because the politicians are less worried about where the avionics or fuselage components are built.

Rumours of BAE joining with one of the US giants - most usually Boeing, but occasionally Lockheed Martin or Northrop Grumman - occur more frequently than the Paris air show, probably every two months rather than every two years. UK-headquartered BAE is seen as a natural fit with a US-based rival. BAE already has significant US holdings, non-UK nationals already own more than 50% of the company's shares and many of its programmes are joint operations with its US rivals. But BAE also has a European dimension: it owns one-fifth of Airbus, it is a partner in several defence joint ventures such as Eurofighter and part-owns MBDA and other pan-European companies.

Whatever really went on around that breakfast table, it is difficult to see the sense behind a marriage of BAE and Thales. They, after all, have significant avionics overlap, which would almost certainly require rationalisation. But the reality is, if the two chief executives had agreed on such a move, the French and/or UK governments would probably have blocked a deal.

In the UK, BAE and Thales are the two biggest prime contractors, with the majority of UK competitions seeing the pair entering separate bids. The UK government carefully ensured it had competing "national primes". It was happy to see Thomson-CSF acquire Racal and become Thales and is hardly now likely to be enthralled by the prospect of its two national primes becoming one.

The French government is equally likely to be less than happy about the prospect of Thales being swallowed up by its larger rival, particularly one in "perfidious Albion".

The likelihood is that there was no serious proposal, if there was one at all. The furore may have been an attempt to make national governments face realities to which they have so far turned a blind eye.

A merger between BAE and Boeing or any other US major requires a sea-change in government policy towards transatlantic tie-ups. And with Italy's Finmeccanica and BAE looking increasingly close, a revision of European integration policy may also be required. At present it is as if there is a series of glass cages placed around the industry, unseen but preventing the various players getting any closer.

The aerospace and defence industries have continually changed since the 1950s as equipment became more expensive and new programmes became fewer, and companies began to merge with their home competitors, eventually creating national champions. The continual reduction in new programmes and their increasing cost led these national champions to form joint ventures. But apart from EADS - which combined France, Germany and Spain's biggest players - there has been no merger of national champions. EADS went ahead because of political desire and aspirations - mainly related to the European Union - of the three governments.

Now other governments must begin to build a framework to allow the final stage of consolidation. Programmes are already global, and it is about time that industry was able to consolidate into a truly global business.

Source: Flight International