Sales are up, profits are improving – after the low point that was 2003, the global defence and commercial aerospace industry is back on a growth path
It’s official: the aerospace downturn is over. All the figures are in and Flight International’s annual Aerospace Top 100 survey – compiled in association with PricewaterhouseCoopers – shows that the industry has recovered significantly from the trough of 2003.
Publicly available data including published company reports for 2004 shows that revenues increased by about 13% and profits by around 22% for the Top 100 aerospace companies, confirming that 2003 was the bottom of the latest downturn in this cyclical industry. With defence sales remaining strong, it is the recovery in commercial aviation that is driving the improvement.
While there was no significant increase in commercial aircraft deliveries in 2004, orders returned, and strong growth is expected for 2005 and beyond as production ramps up, says Neil Hampson, a partner in the Valuation and Strategy group of PricewaterhouseCoopers. With the half-year results now in, the growth trend is clear.
Profitability is returning as revenues recover. From a low point of 6.9% in 2003, the average operating margin of the Top 100 aerospace companies improved to 7.2% last year. “This is nowhere near the levels of the late 1990s and early 2000s, but it is building back up,” says Hampson. “If you look at the quarter by quarter reports, there are big jumps in profitability. I expect a one percentage point increase in industry profitability in 2005.”
While overall Top 100 profitability is heading back towards its recent high of 9.7% in 2000, the average returns at Tier 1, 2 and 3 suppliers remain higher than those of the primes – although highly variable among Tier 2s and 3s. “A lot of technical content has been devolved by the primes to their Tier 1 and 2 suppliers, which maintain tight control over important technologies,” Hampson says. “The aftermarket revenue stream is the main reason why Tier 1s and 2s have better financial performance than the primes.”
The effects of increased US defence spending showed through in the 2004 results of those companies able to access the market. While the Pentagon’s development and procurement budgets appear to have reached a plateau, and are coming under increasing pressure, continued high spending on Iraq operations and homeland security is feeding through into corporate revenues and could help insulate the industry.
Top 10 status quo
As if illustrating the broad base of the recovery, the Aerospace Top 10 remains unchanged from last year. Rankings are based on revenues in US dollars, calculated using an average 2004 exchange rate for non-US companies (see explanatory notes P36), but even factoring out the distorting effect of the weak dollar, all but one of the companies reported increases in 2004 aerospace and defence revenues.
Boeing held on to its pole position, an 11% increase in defence revenues offsetting a 6% drop in commercial aircraft sales and providing further vindication of the US company’s decision to diversify. Based on 2005 half-year results, 2004 was clearly the low point for Boeing’s commercial sales, and the company has raised its revenue forecast to $58 billion for 2005 and $62 billion for 2006, with Commercial Airplanes expected to grow at twice the rate of Integrated Defense Systems – a performance that will keep Boeing well ahead of its closest rival.
Having weathered far less of a dip in commercial aircraft sales than Boeing, second-ranked EADS resumed its growth path in 2004, with revenues increasing 5%. Sales were up 6% at Airbus, which accounted for just over 60% of the European company’s 2004 revenues, but also increased across EADS’s defence and space businesses. Based on its half-year results, EADS is on track to meet its 2005 target of a 10% increase in defence revenues, to €8.5 billion ($10.3 billion), but this is likely to be eclipsed by growth in commercial aircraft. In the first six months, sales at Airbus were up 12%, accounting for 70% of EADS’s revenue.
Lockheed Martin cemented its position as the number three aerospace company – and number one defence contractor – with a 12% increase in revenues in 2004. In a clear sign of the changes under way in the defence arena, growth began to shift last year from the US company’s military-aircraft manufacturing business to its system integration and information technology sectors. This trend has continued into the first half of 2005, with an 11% increase in sales at the Systems & IT group offsetting a 6% decline at Aeronautics .
Riding the same wave of US defence spending, fourth-ranked Northrop Grumman saw its 2004 revenues increase 13%. After being edged out of the number four position in last year’s Aerospace Top 100, the UK’s BAE Systems kept its fifth-place ranking with a 7% increase in 2004 revenues and held off Raytheon, which saw its sales rise 12%. Hard on Raytheon’s heels, meanwhile, is seventh-ranked General Dynamics (GD), which increased its 2004 sales by 17%.
With defence spending levelling off, the US primes are forecasting more modest revenue increases for this year: 3-7% at Lockheed, to $36.5-38 billion; 5% at Northrop, to $32 billion; and 7-9% at Raytheon, to $21.6-22.1 billion. BAE, meanwhile, has moved to increase its share of the US defence market through the acquisition of United Defense.
Benefiting from both the strong defence and recovering commercial markets, and with increases in both original-equipment and aftermarket sales, United Technologies (UTC) and General Electric put in good performances in 2004, holding on to their respective eight and ninth rankings. UTC reported revenue increases ranging from 9% at equipment supplier Hamilton Sundstrand to 15% at helicopter manufacturer Sikorsky.
Sales at UTC’s Pratt & Whitney engine business rose almost 11%, but were outstripped by the 13% increase in revenues at rival GE Aircraft Engines. Both are turnarounds from the declining sales of the previous two years.
European recovery
Rounding out the Top 10 for a second year in a row, France’s Thales saw its aerospace and defence sales slip 3% in euro terms. The sharpest drop was in the Air Systems missiles business, where sales fell 8% on the completion of several major programmes. While overall sales reversed their decline in the first quarter of 2005, at the aerospace division an increase in Airbus avionics sales was offset by a decrease in military export sales – highlighting the vulnerability of European companies to the vagaries of the non-US defence market.
Contrasting with the stability in the upper ranks of the aerospace industry ranks, there have been a number of changes below the Top 10, with more to come. One of the most dramatic is Bombardier’s continued slide down the table, from number 10 in the 2002 survey to 15th place in this year’s rankings. The reason is the dramatic drop in deliveries of 50-seat regional jets at the Canadian manufacturer, coupled with revenue increases at France’s Snecma, Italy’s Finmeccanica and the UK’s Rolls-Royce that lifted these companies higher in the table.
Bombardier’s slide is likely to be arrested by the strong recovery in the business jet market, but other factors may prevent the company regaining its place in the Top 10. One is the merger earlier this year of Snecma (ranked 12th) with Sagem (41) to form Safran, a combination that would rank 11th in the aerospace league table if their 2004 revenues were combined. Ranked 13th, meanwhile, Finmeccanica is projecting year-on-year revenue growth of 20% for 2005, and another 10% in 2006, based on the consolidation of helicopter manufacturer AgustaWestland, defence electronics businesses acquired from BAE and space activities forming part of a new joint venture with Alcatel. Another factor is L-3 Communications’ just-completed takeover of US government-services specialist Titan, which will restart the 16th-ranked company’s rapid rise up the Top 100. With revenues expected to reach $11.5 billion by 2006, L-3 will also be knocking on the door of the Top 10.
Acquiring success
Acquisitive L-3 is one of the big winners in this year’s survey, its revenues increased 36% in 2004 with a similar jump forecast for 2005 . Other fast-risers include Embraer, a 61% increase in sales from regional jet deliveries lifting the Brazilian manufacturer from 27 to 22 on the Aerospace Top 100. DRS Technologies, a US defence firm in the L-3 mould, climbed from 48 to 42 on a 33% boost in sales; while similarly acquisitive Curtiss-Wright rose from 77 to 68 on a 28% increase in revenues .
The August 2004 acquisition of Dunlop Standard Aerospace by a partnership of US private-equity firm The Carlyle Group and Meggitt of the UK boosted the year-end revenues of two Top 100 companies: Carlyle-owned Standard Aero (51) saw a 46% increase in sales on higher US military and regional airline engine overhaul business while integration of Dunlop’s manufacturing business contributed to a 23% increase in 2004 aerospace revenues at Meggitt (52).
There were also some impressive results nearer the bottom of the Top 100, with French aerostructures and wiring systems specialist Latécoère climbing from 94 to 88 on a 33% rise in 2004 sales, the result of increased work on the Airbus A380, Boeing 787 and Dassault Falcon 7X. Belgian aerostructures company Sonaca, meanwhile, climbed from 97 to 89 on a 36% increase in 2004 revenues from work for Airbus, Boeing, Embraer and Dassault.
There are two new entrants in this year’s Aerospace Top 100: US cabin-products and interior-refurbishment specialist DeCrane Aircraft at 97; and US engineered-components manufacturer Ladish at 100 .
Nadir passed
In an industry renowned for its ups and downs, 2003 can now be confirmed as the bottom of the latest in many boom-to-bust cycles, and 2004 as the year in which the recovery began. Airbus delivered 320 aircraft in 2004, up from 305 a year earlier, while Boeing edged ahead of its 2003 low total to deliver 285 aircraft. More importantly, the customers returned, Airbus ending 2004 with 370 net orders against Boeing’s 272. That balance has reversed as the order flow has continued into 2005, Boeing booking 417 orders in the first six months against 268 for Airbus. The bulk of orders have been for narrowbodies, but Boeing’s backlog includes 143 new 787 widebodies.
Although the market recovery began in 2004, the production ramp-up is only really getting under way this year. Airbus expects to deliver more than 360 aircraft in 2005, and Boeing 320. Each company is forecasting deliveries around the 400 mark for 2006 – closing the production gap that opened in 2003 when the European manufacturer overtook its US rival for the first time. Boeing is confident it will retake the lead when 787 deliveries begin in 2008 (Flight International, 2-8 August).
While Airbus took the lead in deliveries back in 2003, 2004 was the first year in which it won pole position in commercial aircraft revenues, its sales increasing to almost $25.2 billion as Boeing’s declined to just over $21 billion (see table P36). Bombardier held on to third place despite lower regional jet deliveries, while Embraer climbed to fourth place on higher regional jet deliveries. Business jet manufacturers Gulfstream, Dassault, Cessna and Raytheon took the next four places, all with improved results. Regional turboprop manufacturer ATR, jointly owned by EADS and Finmeccanica, held on to 10th place thanks to higher revenues.
Barring unforeseen events, the civil-aircraft sector is expected to keep improving. Demand for air transport is forecast to grow 7.2% annually over the next five years, says Hampson. This is expected to drive airline capacity growth of 6.5% a year, benefiting the original equipment manufacturers (OEM), and to push spares and aftermarket demand up by 8-9% a year. OEM growth areas include longer-range commercial aircraft and larger regional jets, while continued outsourcing of maintenance by airlines is expected to drive solid long-term aftermarket growth.
Emerging trends
Overall, civil aircraft production is expected to increase by more than 40% from 2004 to 2009, Hampson says, with different dynamics driving each segment of the industry. In the large commercial aircraft market, new programmes like the 787 and Airbus’s A350 are expected to produce strong growth. In the regional aircraft sector, the entry into service of larger 90- to 110-seat regional jets is expected to be the driver, although there will be continued demand to replace turboprops with jets, Hampson believes. For the business aircraft industry, growth is expected to be greatest at opposite ends of the market: large intercontinental business jets and very light jets.
These trends began to emerge in 2004, and have accelerated over the first six months of 2005. Both Bombardier and Embraer have been hit by the dramatic downturn in orders for 50-seat regional jets. The Canadian manufacturer offset the drop with higher deliveries of larger CRJ700/900 regional jets, and a 44% increase in business jet shipments, but its aerospace revenues still fell almost 4%. Deliveries are expected to be at a similar level this year, but with more business jets and regional turboprops in the mix.
Bombardier’s Brazilian rival, meanwhile, began its transition to the larger E-170/190 regional jet family in 2004, and while Embraer expects deliveries to remain essentially flat for 2005 and 2006, the proportion of these higher-value aircraft in the mix will increase to 50% this year and 73% next year, boosting revenues. With production of the smaller ERJ family slowing down and development of the E-Series almost complete, the company is moving aggressively into the business-aircraft market, launching development of a very-light jet and light jet that will enter production in 2008 and 2009, respectively.
Established business aircraft manufacturers had a good year in 2004, the market rebounding as corporate profits took off and tax incentives stimulated demand. Deliveries of jets increased by 14% and turboprops by 18% and the momentum has continued into 2005, with year-on-year increases of almost 37% and more than 28%, respectively, in first-half shipments. Manufacturers are increasing delivery forecasts for this year and next, although they are struggling with raw-material shortages and supply-chain issues as they try to ramp up production to work off backlogs that are beginning to push aircraft availability beyond the buying horizons of many customers.
Defence aerospace
The picture of the defence industry revealed by this year’s survey is essentially unchanged from last year’s: those companies with access to the US market are doing well while those reliant on European and export markets face a more challenging environment. The picture for 2005 is likely to be similar but there are already signs that more difficult times lie ahead for US defence contractors. Major programmes are under review, and could be cut, as the Pentagon tries to cope with a $50 billion shortfall in funding over the next six years.
For 2004, however, the picture looked rosy. Lockheed was again the largest contractor, with defence aerospace sales of $31.7 billion, up almost 11% from 2003 (see table P36). Boeing, Northrop Grumman, BAE Systems and Raytheon were next in line, with revenue increases of similar order. Largely unable to tap into the US market, EADS’s defence aerospace revenues increased by just under 7% in 2004, keeping the European company in sixth place. Facing similar constraints, Thales saw its defence aerospace sales slip almost 4% but the French-headquartered company held on to its 7th place. Ranked 8th, Italy’s Finmeccanica reported an increase in defence aerospace revenues of almost 12% in 2004, with the full consolidation of helicopter manufacturer AgustaWestland by year-end.
Rounding out the Top 10, the defence aerospace businesses of General Dynamics and L-3 Communications both achieved some of the highest growth rates in the sector, with the trend continuing into the first half of 2005. Overall, however, US defence contractors are forecasting more modest, single-digit revenue increases for this year. The need to fund operations in Iraq is putting pressure on the Department of Defence’s development and procurement budgets and, while industry is benefiting from the supplemental spending, much of it is going towards protecting troops and overhauling equipment.
Potential pitfalls
Rumours are already circulating that this year’s Quadrennial Defense Review (QDR) will call for big cuts to some major programmes, possibly including the F-35 Joint Strike Fighter (JSF) – a key source of future revenues for Lockheed, Northrop and BAE, as well as engine manufacturers P&W, GE and R-R and a long list of US and international suppliers.
The Pentagon leadership moved earlier this year to cut several programmes, only to run into Congressional opposition. An attempt to terminate Lockheed’s C-130J Hercules airlifter programme has been overturned, but a plan to end procurement of the Lockheed/Boeing F/A-22 Raptor stealth fighter early, in 2008, remains on the table. The future of the F/A-22, as well as that of the F-35, is expected to be decided by the QDR.
Future US defence budgets, whatever shape they take, are almost certain to remain higher than in Europe, where there is expected to be a long-term decline in defence spending, says Hampson. The only way to make up for the decline, he says, is for European defence procurement to become efficient, so that more of the money can be spent on equipment. “The figures show that procurement efficiency is still a major issue in Europe,” Hampson says. “Military doctrine development, procurement processes and subsequent system design remain uncoordinated.”
The divergence in defence spending is raising concerns over whether Europe can sustain the next level of technology investment and is “driving renewed analysis into what technologies Europe should be world-class in”, says Hampson. Exports remain vital to European manufacturers, meanwhile, but US opposition to the European Union lifting its arms embargo on China is putting more at risk than just the industry’s ability to tap a potentially huge aerospace market.
The USA is threatening to bar any company that sells sensitive technology to China from doing business with the DoD. This is a serious issue for companies like BAE Systems, EADS and Finmeccanica. With European defence spending flat or declining, the UK’s BAE has turned its focus towards gaining a greater share of the DoD market, where its North American arm is able to compete on equal footing with the US defence primes. BAE North America generated almost 25% of the company’s 2004 revenues, and this will increase with the acquisition of United Defense. Other US acquisitions are expected.
Anticipating a long-term shift in procurement from platform- to network-centric systems, as well as eyeing the near-term homeland security market, US defence contractors have been moving into the government IT business. For companies that already winning homeland security contracts, most of the work is on the government IT side. It remains to be seen whether growth in homeland security spending in the USA and elsewhere will compensate for any cuts in defence programmes.
Other sectors
A look at other industry sectors within the Aerospace Top 100 shows similar pictures of improvement. The engine manufacturers , able to participate in both the civil and military markets and with strong original-equipment and aftermarket positions, staged strong recoveries in 2004, led by first-place GE Aircraft Engines with a 13% increase in revenues to $12.1 billion. Pratt & Whitney followed with an almost 11% increase in sales to $8.3 billion. Revenues at third-place Rolls-Royce increased almost 8% in sterling terms, while Snecma managed an increase of almost 9% in euro terms to edge into fourth place ahead of Honeywell.
Long a source of disappointing results, the space sector also began to turn around in 2004, largely a result of rationalisation reducing overcapacity. Leading the sector by a wide margin, Lockheed saw its space revenues increase by more than 5.5% to $6.36 billion. EADS reported a 7% increase in space sales which, when converted to dollars, just edged the European company into second place ahead of Northrop – despite the US firm recording a rise in space revenues of almost 16%. Boeing’s space revenues declined slightly, and will again in 2005 before stabilising in 2006, but the division’s operating performance turned around in 2004. France’s Alcatel and Italy’s Finmeccanica, which have since combined their space activities in a pair of joint ventures, came in fifth and sixth respectively.
Finalised in July, the tie-up between Alcatel and Finmeccanica combines Alcatel Space and Alenia Spazio to create space systems manufacturer Alenia Alcatel Space, owned 67% by the French and 33% by the Italians. The consolidation creates a satellite and space systems manufacturer with estimated 2004 sales of €1.8 billion. Also created as part of the tie-up is satellite operator and service provider Telespazio, which is owned 67% by Finmeccanica and 33% by Alcatel, with 2004 revenues of €350 million.
Another major change in the space sector is the pending creation of a joint venture combining the launch vehicle development and production and US government launch operations of Boeing and Lockheed Martin. A 50:50 joint venture between the two companies, United Launch Alliance, will build and launch Atlas and Delta boosters for the US government. It will also sell vehicles to their commercial launch operators. Boeing, meanwhile, has completed the sale of its Rocketdyne propulsion business to UTC’s Pratt & Whitney
Cyclical trends
Publicly available data does not allow complete league tables to be compiled for other sectors of the aerospace industry, such as helicopters, missiles and equipment. But the picture that emerges from this year’s survey is again one of general improvement. The commercial helicopter market rebounded in 2004 and EADS company Eurocopter ended the year with revenues up 7% to €2.79 billion ($3.47 billion in 2004 exchange rates). Newly merged Finmeccanica subsidiary AgustaWestland took second place, with sales up 2% to €2.54 billion ($3.16 billion). More significantly, year-end backlog at both European manufacturers was up substantially on higher civil and military orders: by 26% at Eurocopter and 16% at AgustaWestland.
Benefiting from both the commercial market recovery and an accelerating modernisation of the US military rotorcraft inventory, UTC company Sikorsky saw its 2004 sales increase 15% to $2.51 billion. Sikorsky acquired light helicopter manufacturer Schweizer in late 2004, and both deliveries and revenues continued their upward trend into the first half of 2005. Boeing does not separate revenues from its military helicopter business but industry estimates put the company’s sales on a par with those of Sikorsky. Textron’s Bell segment had 2004 sales of $2.25 billion but this includes arms manufacturer Textron Systems. Bell Helicopter generated $1.6 billion in 2004 revenues, spilt roughly equally between commercial and military.
Aerospace equipment suppliers also benefited from participating in both the commercial and defence markets. Honeywell’s 2004 aerospace revenues, excluding its engines business, are estimated at $5.36 billion, an increase of almost 11% over 2003. Goodrich saw an almost 7% increase in sales to $4.73 billion, while UTC company Hamilton Sundstrand managed almost 9%, its revenues reaching $3.93 billion. Sales at Snecma’s equipment business grew just over 4%, to €2.63 billion ($3.27 billion at 2004 exchange rates). Eaton’s fluid power business increased sales by 11% to $3.1 billion, while US commercial avionics and defence electronics supplier Rockwell Collins boosted revenues by 15% to $2.93 billion. Aerospace unit sales edged up at Thales to €2.19 billion ($2.72 billion), and at the UK’s Smiths Group to just over £1 billion ($1.84 billion).
Overall, the Aerospace Top 100 did well in 2004, and is doing better in 2005. “Hardly anybody has dropped out of the table,” says Hampson. Revenues are increasing across the board and average margin is heading back towards 9%. In the commercial market, product development is picking up pace and the industry is again attracting investment. There are challenges ahead in the defence market on both sides of the Atlantic, but for now the picture remains positive.
With the top 20 companies again accounting for around 80% of the profits generated by the Aerospace Top 100, and with no change in the relative positions of the top 10 players, it would seem to be business as usual. But important changes have been taking place, says Hampson, and more will be needed in 2005 as manufacturers and suppliers prepare for the projected ramp-up in aircraft production fuelled by the civil recovery. Although the outlook is positive, preparing for the expected busier times ahead is a challenge for the industry. What are the big players doing to make sure they are ready?
Since the consolidation of the US and European prime contractors in the late 1990s and early 2000s, the rankings of the top 10 aerospace companies have remained essentially stable. Where there have been changes is among the next 10, where consolidation and restructuring continues to bring changes in ranking. Textron at 18 and Goodrich at 19 have both restructured over the past few years to focus on their core aerospace businesses while Snecma at 12, Finmeccanica at 13 and Alcatel at 17 have participated in another wave of European consolidation.
Hampson identifies restructuring as one of the key trends of the last 12 months. “Companies have been adjusting their portfolios, grouping like areas of their business together, making sense of divisions, selling off activities that don’t fit – restructuring to make their businesses address the market better,” he says, adding: “People have undertaken the restructuring necessary in order to make themselves ready for the upturn.”
Streamlining
Big US-based players including fourth-ranked Northrop Grumman and 11th-placed Honeywell have streamlined their businesses, realigning operations to mirror their markets more closely. For companies like these, the products of repeated mergers and acquisitions over the years, reorganisation into “customer-facing” businesses was probably overdue. Unlike the major rationalisations of a few years back, however, the latest restructurings have not resulted in substantial job cuts, with the emphasis on growing more efficiently rather than cutting back.
Although Hampson sees “signs of an industry becoming much more healthy”, he points out that, as commercial-aircraft production rates have not yet ramped up fully, there will be bigger changes to come in the year ahead.
Boeing is driving some of those changes by devolving major roles on its 787 to the Japanese aerospace industry as well as Vought Aircraft Industries and Alenia Aeronautica, who have formed US-based joint venture Global Aeronautica to supply major sections of the new airliner. Boeing has also created some new players in the industry, selling its Wichita/Tulsa division to Canadian investment firm Onex for $900 million as it executes a strategy to exit the commercial-aircraft fabrication business and focus on final assembly.
Restructure pressure
The pressure to restructure is greatest in Europe where there is no defence bounty underwriting the commercial rebound. Already Finmeccanica and fifth-ranked BAE Systems have joined forces to reposition their European defence electronics businesses. Industry number two EADS has agreed the long-awaited deal for missile manufacturer MBDA, which it owns with BAE and Finmeccanica, to take over its German LFK unit. EADS appointed a new management team earlier this year and moved to dissolve its aeronautics business and group some Airbus-related activities, previously under the aeronautics banner, under the leadership of new Airbus chief executive Gustav Humbert.
The commercial aviation recovery is expected to drive further strategic repositioning in the sector, merger and acquisition (M&A) activity – much of which has been defence-driven – is likely to continue at a significant level as companies prepare for the production challenges ahead.
The civil aerospace sector has already seen an increase in interest in M&A activity, Hampson says. Although in some cases firm deals have not yet materialised, “there’s been a lot more discussion in the last three years”, he adds. In contrast to the defence-dominated M&A activity of previous years, Hampson now sees the commercial sector becoming more of a driving force. “Investors see a sector that is large and growing,” he says.
In addition to the strategic acquisitions of smaller businesses or niche activities by the primes and other major players, Hampson expects interest from the private equity sector to increase over the coming months. “They see long-term growth to the end of the decade and they want to invest now, ahead of the curve,” he says. But that interest will not limited to the civil sector – with private equity interest in the defence sector also likely to continue, he believes. There are also expected to be some sell-offs.
The Carlyle Group, which has several investments in the aerospace sector, is widely expected to sell on at least part of its 31% stake in UK defence and security firm Qinetiq. Carlyle also owns a 70% stake in Italian engine maker Avio, which could be another candidate for sale. Avio recently boosted its growth through the purchase of an 80% stake in Netherlands-based Philips Aerospace. Several other companies in the Aerospace Top 100 could change hands before long. The first six months of 2005 have already seen initial public offerings from MTU Aero Engines and global satellite operator Inmarsat. Meanwhile, regional aircraft manufacturer AvCraft Aerospace is still on the look out for a buyer, having filed for insolvency earlier in the year.
European targets
The USA has been notable as an acquisition target for European players during the past 12 months, as declining European military funding pushes companies to increase their footprint in a market where, even if defence spending is unlikely to increase, it is also unlikely to decrease in the near term. The widely held view that European defence spending is in long-term decline adds a further reason for branching out into the USA.
BAE Systems struck the highest profile transatlantic deal yet – and its largest ever acquisition – in March when it agreed to purchase United Defence Industries (UDI) – maker of Bradley armoured vehicles – for $4.1 billion. The deal boosted BAE to the US DoD’s sixth-largest contractor and increased its presence in the land systems sector – a burgeoning market thanks to ongoing operations in Iraq. The move is unlikely to affect BAE’s Top 100 ranking as it is a non-aerospace acquisition. The company has also bought Boeing’s Irving commercial electronics unit and information-processing specialist Alphatech and says it has further US targets in mind.
Other European players are keen to jump on the US acquisition bandwagon. Finmeccanica has said it is on the lookout for acquisition targets in Europe and the USA, in particular for small and medium-sized companies in the high-technology aerospace and defence sectors.
This approach fits in with the general attitude towards purchases: the acquisitions seen in the last 12 months have been predominantly smaller, and have involved either high-technology businesses outside the Aerospace Top 100, or businesses sold off by aerospace and defence primes as they rationalise their portfolios.
L-3 Communications, for example, has balanced its acquisition of US government-services specialist Titan with a number of smaller-scale purchases of product-based businesses such as CAE’s marine controls unit, Boeing’s Electronic Dynamic Devices unit and Northrop Grumman’s Canadian navigation and space sensor business.
UK-based Ultra Electronics, which has moved up five places in the Aerospace Top 100, to 66th place, has made significant inroads into the USA with this year’s acquisition of Audiopack technologies , and is expected to increase US revenues on the back of this.
Niche markets
Ultra is typical of smaller companies making acquisitions for a variety of reasons. Some are buying niche companies to take advantage of the US spending and expand their product ranges. UK-based Cobham’s buying spree has included Remec Defence & Space – doubling its US microwave revenue – as well as parts of Microwave Development and US life-support company Koch - while France’s Zodiac has recently picked up niche businesses Scott Aviation and C&D Aerospace in the USA . Smiths – which has a strong base on both sides of the Atlantic - has bought US equipment supplier Integrated Aerospace.
Protection against currency fluctuations between the dollar and the euro or the dollar and the pound add to the attractiveness of US acquisitions for some companies. Many companies’ currency hedging arrangements are beginning to come to an end, leaving them exposed to further fluctuations in the exchange rate as they carry out transatlantic business. The potential for further changes in ownership of the smaller players remains – as does the possibility of more niche acquisitions from the bigger players.
Paradoxically, the recovery in commercial aerospace reined in the profit margins of the top 100 companies in 2004. As manufacturers and suppliers took steps to prepare for the projected increase in aircraft deliveries and ramp up facilities that have been cut back in leaner years, 2004 results felt the effects of the necessary increased spending. “The cyclical upturn has exposed weaknesses in the supply chain,” says Hampson .
Suppliers are now having to address the issues of improving quality, lead times, risk management and technical content to meet the rising demand for aircraft production. UK-based Doncasters, ranked 94 in this year’s survey, is keen to increase its manufacturing capacity in low-cost economies in order to increase supply chain efficiency . This trend is likely to be repeated at other companies, says Hampson, whether they locate facilities in markets with a pre-established aerospace industry, such as the Czech Republic or in the less well-charted territory of China and India, both of which are expected to want significant chunks of production as their demand for aircraft increases.
The preparation for a healthier year ahead can be seen in the industry’s 2004 profits, with margins improved but not yet close to the levels seen in the late 1990s. Hampson predicts bigger profits this year, saying: “The costs have been borne in ramping up for production in 2005.” Many suppliers have had to invest in improving production having cut back during the downturn. The Netherlands’ Stork, ranked 64th this year, says the ability of the supply chain to ramp up is the key issue for the months ahead.
Supply stream
There is good news for suppliers. This year’s survey shows that the average returns for Tier 1, 2 and 3 players remain higher than for the primes as technology content is pushed down the supply chain with the increase in risk- and revenue-sharing partnerships. Suppliers with a tight grip on proprietary technologies can win key positions on new programmes while continuing to cash in on the aftermarket revenue stream from legacy aircraft.
Hampson predicts that risk- and revenue-sharing arrangements between primes and Tier 1/2 suppliers will continue to increase and will be pushed further down the chain to Tier 2/3 suppliers. Globalisation of the supply base will become more marked, he says, with suppliers positioning themselves in emerging markets.
In addition to these internal changes, talk of further, bigger-scale consolidation in Europe has not diminished, with speculation over possible tie-ups between all of the major players during the last year. The industry was rife with rumours of an impending takeover of Thales by EADS at the end of 2004 but both companies denied a deal was imminent. Later, Finmeccanica was suggested as a possible candidate for a tie-up with Thales, but again details failed to materialise.
Most recently, the possibility of a deal between French naval shipyard DCN and Thales has been touted. Hampson agrees the major restructuring of the European aerospace industry that took place five years ago makes the next move in consolidating the sector hard to predict. “There’s no obvious answer any more,” he says. But as the French government-inspired merger earlier this year between communications specialist Sagem and engine manufacturer Snecma shows, the aerospace industry can still spring surprises.
HELEN MASSY-BERESFORD/LONDON & GRAHAM WARWICK/WASHINGTON DC
Source: Flight International
