A year ago the Farnborough air show was characterised by what bordered on panic about the price of oil - then soaring towards $150 a barrel - and a dollar-euro exchange rate that had European aerospace executives sweating. But if the mood then was one of palpable anxiety, it turned rapidly in the autumn to virtual panic as the global economy went into what looked like a nose-dive.
After a fourth quarter 2008 that rivalled the Great Depression years for the sheer speed of economic decline and a first quarter 2009 characterised by more of the same, there has been much talk of green shoots and recovery. But while it remains to be seen whether those shoots are real or just wishful clutching at any straw - and it must be noted that most green shoots talk is based on the observation that, for many businesses, the rate of decline slowed a bit - there is no doubt that times are going to remain tough for a long time to come.
The situation was well summed up recently by Virgin Blue chief executive Brett Godfrey when he said: "Given the choice we'd rather deal with last year's fuel costs than this year's slump in demand."
Airlines are clearly in a different situation than aerospace manufacturers, especially those that perform any significant portion of their business in the defence sector. But for civil-focused manufacturers there are worrying signs that the oft-cited order backlogs at Airbus and Boeing will not protect them from real pain to come.
According to PricewaterhouseCoopers global aerospace and defence leader Neil Hampson, there are signs of distress in the market. Notably, orders are down for long-lead (nine to 12 months) components, and companies that scaled up their operations to meet the civil demand surge are worried, with some in discussions with their banks.
Most of these firms will ultimately survive, Hampson believes, but this sort of distress is typical of this late stage in an aerospace cycle and some firms will struggle to survive and even fail.
For the industry, the ways out of such a state of difficulty are consolidation and the break-up of struggling firms. Hampson says: "I would expect that to happen in the second half of this year and the first half of next year."
Merger and acquisition activity was down by more than 50% in global aerospace and defence in 2008 compared with 2007, according to PwC figures, and Hampson says all signs are that the mergers and acquisitions market remains "subdued". However, while the current economic climate may slow activity, there is an underlying consolidation trend that will, if anything, be driven forward by a downturn.
Ian Giles, a competition lawyer at London firm Norton Rose, sees evidence that this downward trend is ongoing, with sources inside the European Commission saying that applications for merger or acquisition approval are down 50-60% year-on-year.
Paul Edwards, managing director of Jefferies Quarterdeck's London aerospace and defence group, says there will be a "continuation of previous trends, albeit at a slower pace". In addition to consolidation, says Edwards, the push by European aerospace companies to buy into the US defence market will continue.
He adds that consolidation, so far at least, is not a matter of distress selling in the case of suppliers to Airbus or Boeing, although heavy exposure to the business jet market can mean trouble for small suppliers. Another factor pushing companies to sell would be cases where a parent company is in trouble and looking to raise cash.
A key limiting factor, says Edwards, is finance, given that the private equity companies that have in recent years been so prominent as buyers cannot, today, raise significant funds. Companies costing around $100 million can find buyers even now, says Edwards, but billion-dollar deals are rare to non-existent. He does not rule out a change, as a stocks or bonds rally could change the finance picture and make big deals possible again, perhaps as soon as in nine months.
Ernst & Young aerospace and defence team director Geoff Wood-Hill sees the lack of finance as a barrier to horizontal consolidation of European aerospace, although mergers are possible if they can show shareholder benefits. But, he says, vertical consolidation - tier 1 suppliers buying smaller suppliers - is possible, especially in cases where the motivation is to acquire specific technologies.
Two key issues affecting any prospective acquisition are exchange rates, in the case of a transatlantic deal, and pension deficits. This second hidden cost, says Wood-Hill, could scupper a deal if the acquiring company would have to take it on from a target company.
But PwC's Hampson says there is at least a "trickle" of signs that distress company sales are going to start happening in aerospace. With markets as depressed as they are, no company is likely to get a proper price if it is sold so, he says, any company going on sale now raises questions about what might be wrong with it. Why, unless you were getting desperate, would you sell a good company today? asks Hampson.
As for the nature of targets, Hampson notes that companies are wary of what he calls "naked diversification" - that is, with no underlying logic. But they will be looking to buy into technology or market niches, and to expand into adjacent markets. The great example of that at the moment is homeland security, where "there's a head of steam getting up" among defence companies, who are good at managing complex projects.
Hampson says they also benefit from a tacit government view that their move into this space is a good idea, and that, compared with defence procurement, governments are generally less concerned about national ownership than about capabilities, although he points out that there is no evidence of any government pressure for homeland security consolidation.
Another factor making homeland security an attractive investment for aerospace companies is, perhaps obviously, government spending on that sector. Shortly after 9/11, the USA created its Department of Homeland Security, but there was little new spending to go with it. That has changed and there is a "definable amount of money" going to homeland security capabilities. The budget situation is similar in countries such as Germany, Italy and the UK.
Edwards adds that defence companies have a natural place in homeland security, as projects tend to involve lots of hardware with embedded IT, such as sensors.
As for the health of the civil aerospace market, the solidity of airliner orderbooks is key, says Hampson, who says: "We've known for several months that Boeing, Airbus and Bombardier are sitting on a lot of bad news." The airframers and airlines, he says, are waiting for each other to move first when it comes to hard statements about orders - and hence rates of production - but he expects "some sober messages about the quality of the orderbook over the summer".
It may be unlikely that much, if any, bad news will emerge at the Paris air show, but Hampson believes it has got to happen by August and airlines' summer season passenger levels are likely to be a "trigger point" for going ahead with fleet renewal or putting it off.
Possibly less optimistic is Ernst & Young's Wood-Hill, who says airlines' order cancellations and deferrals have only just begun: "We're only seeing the start of it. Nobody's buying new aircraft." Wood-Hill points to falling demand for air travel and, ultimately, a limit to the number of deliveries for which Airbus or Boeing can supply vendor financing.
The result, he says, will be narrowbody airliner production rates in the mid- to high-20s a month, down by 10 or more from their recent peaks.
When asked how long it might take for the civil airliner market to stabilise, Wood-Hill's analysis is compelling. He notes that leading indicators such as employment and gross domestic product are all down and even if they picked up, would take a long time to work their way through to economic growth. And, as there can be no recovery of airline profitability until there is wider economic growth and no significant number of airliner orders until then, "we're in this for the long haul", he says.
Wood-Hill says aerospace companies need to make two key moves. One is to develop their business models around a "more resilient" mix of civil and defence customers.
But the other is to ask themselves from where future demand growth is likely to come. India, he believes is one of the few countries with significant defence procurement plans. And, to get into India, the easiest approach is to form a joint venture with a local company that supplies Hindustan Aeronautics.
China, he says, is obviously not possible in defence, but on the civil side is probably going to be the first major market to recover. So, a winning strategy for Europeans would probably be to build satellite capability around the Airbus plant at Tianjin.
The Italian major's $5.6 billion buyout of defence electronics company DRS Technologies was the world's biggest aerospace deal of 2008 and the latest in a number of acquisitions that have doubled its turnover since 2002. Critically, the DRS deal dramatically expands Finmeccanica's presence in the USA, where it is already making high-profile marks with its supply, through Lockheed Martin, of AgustaWestland AW101 helicopters as the platform for the new VH-71 presidential helicopter. That project may yet get the axe owing to cost overruns, but there is no question that Finmeccanica has transformed itself into a global player. And, the DRS deal moves it firmly into the fast-growing homeland security market, where US spending is growing.
Buying Airbus's Filton wing components manufacturing operation turned GKN into a solid tier 1 supplier and tied it to the airframer in a strategic supplier relationship that looks likely to affect both companies for years to come. For GKN, a main challenge since completing the Filton deal in January has been to transform the operation from a cost centre, as it was under Airbus, into a business in it own right.
Senior vice-president business development and strategy Frank Bamford says the ultimate goal of becoming a tier 1 design-and-build partner was two or three years away when the deal closed, but the company expects now to achieve that sooner, as potential non-Airbus customers are starting to see inside what had been a closed Airbus shop. More immediately, Bamford is predicting that the first outside customers will be signed up by the third quarter of this year.
The model for Filton is GKN's acquisition of Boeing Integrated Defense Solutions' St Louis, Missouri facility. There, GKN took over an all-Boeing operation but today sells 35% of the output to other customers.
In the meanwhile, GKN has £175 million ($278 million) of investment over five years lined up for Filton to make composite wing components for the Airbus A350. Filton will become a focus of GKN's composite materials capability with the objective of securing for GKN - and the UK - a key design and assembly role in the next generation single-aisle aircraft that will ultimately replace the A320.
The GKN Filton deal has been Airbus's only real success so far in a key aspect of its Power8 restructuring plan. By outsourcing much of its production to partners, Airbus had hoped to cut costs and shift its own focus away from assembly and more towards being an aircraft architect and integrator. The Filton deal was supposed to have been matched by sales of French and German manufacturing sites, with Latécoère and MT Aerospace playing the GKN role at those facilities. But those deals fell through - owing to deteriorating economic conditions and, possibly, French-German politics - so Airbus instead spun the sites off into two wholly owned subsidiaries, Aerolia in France and Aerotec in Germany.
That will not save any money in the short term, but if those two subsidiaries can learn to work as though they were independent suppliers rather than merely Airbus cost centres, they may succeed in pulling in third-party work. If they get to that stage, Airbus will presumably be able to sell them as standalone businesses and achieve its Power8 objectives.
The privately held French airframer is at the mercy of the economic downturn when it comes to its Falcon business jet business, but on the Rafale fighter side it has turned what might prove a spectacular coup in its €1.57 billion purchase of a one-fifth stake in and effective control, alongside the French government, of Thales, from Alcatel-Lucent, which is focusing its holdings on communications.
Through Thales, Dassault is already starting to field a fully modern electronic scanning radar in the Rafale, which might tip the balance in its favour in a number of export sales tenders now up for grabs. So far, only the French air force flies the Rafale. The real trick going forwards will be for Dassault to combine Thales's expertise with its own (notably in flight-control systems) to make some major strides in the electronics capabilities that are increasingly the key performance ingredient in military aircraft.
One of the most intriguing recent deals is Safran's acquisition of an 81% stake in General Electric's GE Homeland Protection affiliate, which makes tomography-based detection systems for hazardous or illicit substances in baggage. The deal makes Safran's Sagem Sécurité a significant global player in airport security.
Three aspects of the deal are noteworthy. It moves Safran more strongly into the homeland security market. It also gives the French group a greater US presence, to better sell into the world's biggest defence and security market and also spread its financial risks out of the eurozone.
In addition, Safran and GE are already longstanding and happy partners in the CFM aeroengines business they share. Is there more to come between these two?
The UK-based group is another European moving further into both the US and the homeland security market. Building on its 2008 acquisition of US weapons systems, planning, analysis and research services company Sparta for $416 million, last month came the $36.25 million acquisition of Argotek, which provides "high-end information assurance services to the US intelligence community".
TESTING THE GOVERNMENT-AEROSPACE CONNECTION
NOWHERE HAS the aerospace industry ever operated truly independently of the state. Significant aerospace companies are invariably held up by politicians as national champions, and military procurement links the two sides in a key customer-supplier relationship. And, whether production is military, civil or both, the welfare of these major employers is rarely far from the minds of politicians sensitive to the impact of mass job loss or creation.
In Europe, of course, today's major aerospace companies have mostly been formed by politicians from state companies, now often partly privatised but still connected to government by shareholdings if not actual management oversight.
Hence the current economic climate, which has fuelled a political drive to support economies and bail out key industries, is likely to see the government-aerospace connection severely tested. Aerospace, unlike airlines, is so far faring reasonably well in recession, but the industry is already calling for taxpayer support. Speaking in his capacity as president of the Aerospace and Defence Industries Association of Europe (ASD), Cobham chief executive Allan Cook in April publicly called for "European institutions and national governments across Europe to not only maintain but to increase the investments in our industry, and in particular to increase their level of financial support for research and development activities".
Defence budgets are under pressure across Europe and in the USA, but the heavy toll taken on equipment in Afghanistan and Iraq should at least maintain the natural subsidy of replacement spending. And governments are also looking for new types of equipment to support counter-insurgency operations, so there is some consensus that defence budgets will hold up during this recession.
© Eric Vidal/Rex Features
But governments are not free to lavish cash on defence companies. Ian Giles, a competition lawyer at the London firm Norton Rose, says tenders and procurement may fall under European Union rules on procurement and state aid and, unless they are contracts purely for military purposes, have to be transparent and without favour to national companies.
Companies that may see a rich defence order from their home government as a boost in hard times have to be careful that the deal does not become a liability as they could face damages actions if procurement rules are not followed, or they could have to pay money back if a contract is granted contrary to state aid rules, says Giles.
Generally, he says, the European Commission is diverting a lot of attention to state aid issues. The financial sector, and now others, is benefiting from a short-term relaxation of EU state aid rules on loans and credit access as Brussels tries to streamline procedures. Officially, he notes, the EC is saying it's "business as usual" in state-aid regulation, but in practice there is some flexibility.
But, he adds, the EC clearly does not want to see an aerospace subsidy race and will make sure that loans and credit guarantees meet certain conditions to ensure they do not distort markets.
One exception to state-aid rules is cases where a deal is deemed necessary for military purposes, but Giles warns that this is a hard test to meet.
One-off restructuring aid to save national champions is often do-able, however, and Giles points to support for Alitalia and Olympic Airways as examples, although this is a "complex area".
Ultimately, state aid faces a higher test than the Brussels hurdle. Bids to save jobs and national champions raise, especially in the current economic environment, the spectre of protectionism. And that, says Giles, can push matters to the World Trade Organisation level, where law largely gives way to politics.
And protectionism, he says, is "high on everyone's agenda at the moment."