ALEXANDER CAMPBELL / LONDON & CHRISTINA MACKENZIE / PARIS
Mergers and consolidation may have strengthened Europe's aerospace industry, but it still struggles to compete with the USA
A walk down the chalet line at the last Paris air show would have given heart to those who believe that only by combining its aerospace resources can Europe hope to compete with the USA in the global market. Three new names were making their debuts: the biggest, EADS, was a historic merger of the major aerospace manufacturers in Germany, France and Spain; Thales was the renamed Thomson-CSF, boosted by its recent acquisition of the UK's Racal Electronics; and MBDA was a combined missile house, owned by Alenia of Italy, BAE Systems of the UK, and EADS.
At last, said the advocates of closer European industrial integration, here were aerospace giants that could hold their own on the world stage with the US powerhouses - companies such as Boeing, Lockheed Martin, Northrop Grumman and Raytheon, whose fortunes were bolstered by regular cheques from a US military customer that accounted for four in every $10 spent on defence throughout the world.
Since then, the Euro-enthusiasts have been further encouraged by the industrial launch, after years of wrangling, of the Airbus Military A400M transport, the flight of the first production examples of the troubled Eurofighter Typhoon, and a funding agreement on the Galileo satellite navigation project. Meanwhile, Europe's great multinational aviation success story, Airbus, has cut metal on its most ambitious product, the A380-800, and has outstripped its rival Boeing in aircraft orders.
But despite this wave of mergers and takeovers, the largest aerospace companies in the world are still overwhelmingly US-based. So must the drive for European consolidation continue?
Top-level mergers in the USA over the past decade have seen the number of prime contractors halve. The pace has slowed, with the 2002 deal between Northrop Grumman and TRW expected to be the last merger between US prime contractors; in 1998 monopoly concerns blocked a proposed merger between Lockheed Martin and Northrop Grumman. Europe has seen a similar succession of mergers in the past 10 years, the largest being the formation of BAE Systems in 1999 and the creation of EADS from Aerospatiale-Matra, CASA and DaimlerChrysler Aerospace (DASA) in 2000.
Merger pressure
Further top-level mergers are imminent in Europe's still-depressed satellite sector. EADS has now bought out BAE's 25% stake in Astrium, giving it complete control of the satellite joint venture, and is holding talks with Alcatel on a possible merger or alliance between the two companies' space and satellite operations. Alcatel chairman Serge Tchuruk says his company does not want to leave the satellite sector, hinting that a joint venture between Alcatel and Astrium may be the preferred option.
Either way, the companies are under strong French government pressure to act. The French defence ministry says there is a "strong risk that both companies will collapse" if no way is found to encourage a closer relationship between them. While wholly or partly state-owned companies like EADS might appear insulated from the market forces driving consolidation elsewhere in the industry, this is less and less the case. European Union rules on subsidies and state support are now enforced more rigorously.
The best examples of this trend are in the airline industry, where EU competition rules discouraged governments from offering support for collapsing carriers, and have brought governments in Italy and Greece under harsh scrutiny for their attempts at assistance (Flight International, 29 October-6 November 2002). MTU chief executive Klaus Steffens believes pro-EU sentiment may also lead governments to encourage consolidation. "There is a political will to bring Europe together, and this has to support European mergers," he says.
Graham Chisnall, strategy director of aerostructures manufacturer GKN Aerospace Services, believes Europe's politicians want to see European companies match or surpass US manufacturers, as Airbus has outdone Boeing. He predicts this will force market discipline - including politically painful mergers and takeovers - even on partly state-owned or state-influenced manufacturers.
The next wave of European consolidations is likely to take place among medium-sized enterprises. "There has been no major consolidation in the aerostructures sector," says Chisnall. "It is still quite a fragmented business. Over the next four to six years, it should consolidate into a small handful of larger structures companies, with turnover of $2-4 billion."
One reason is that new aerospace projects are now rare. "The 1990s was an unprecedented period of development," says Rolls-Royce's president of civil aerospace, Mike Terrett. "Rolls-Royce developed one new programme every year for 10 years. Now the pace has changed to one every three years."
Close Brothers industry specialist Andrew Cunningham says: "The lumpy revenue stream will inevitably stimulate more consolidation," adding that only large companies will be able to survive the blow of losing one of these rare opportunities. Larger projects also make risk-sharing necessary. Programmes such as the Airbus A380 required subcontractors to invest up to 40% of the development costs (Flight International, 20-26 May). One way round this is for subcontractors to merge, growing until they can take a significant share of risk without endangering their balance sheets.
St‚phane Albernhe, partner at Roland Berger Strategy Consultants, says small companies that are expected to make a large outlay on research, creating a cash-flow problem, "should go and find venture capitalists willing to invest in their company" - although this may lead them to look outside Europe, as in the case of the US Carlyle Group's interest in buying into FiatAvio.
Despite these pressures, not all companies are keen to acquire. John Hughes, chief operating officer of Thales' aerospace arm, says the group is not in a "feeding frenzy" looking to acquire more companies, although "if the opportunity were to come along, we'd take a look". He says neither this year nor next is likely to be easy, and Thales's business has to reflect the situation of the airframe manufacturers Airbus and Boeing.
Terrett says further consolidation is unlikely at the top level of the engine industry. "We partner with virtually everyone, and partnerships have a tendency to be long-term. Corporations that compete also collaborate in other areas. This complicates matters when you are considering how to merge."
There are also government barriers to further mergers, even within Europe. Despite repeated commitments to a strong industry, "golden share" arrangements are almost universal in the military aerospace industry, and remain outside the purview of competition regulators.
US prospects
The world's largest aerospace market - the USA - is naturally attracting interest from European players, and while a big transatlantic merger such as Boeing/BAE "gets emotional and difficult", says Chisnall, "there is a constant churn of smaller acquisitions in the USA that is below most people's radar". Almost all US defence spending stays in the USA, so only European companies with a presence in the USA have a real chance of cashing in on recent increases in US defence spending.
While taking over other companies in Europe is a possibility, says BAE Systems chief executive Mike Turner, "we will have to acquire in the USA". He points to Finmeccanica's planned broad alliance with Boeing announced earlier this year (Flight International, 28 January-3 February). "The Italians see the future as transatlantic, as we do."
In recent months, markets have focused on the reverse - BAE's acquisition by a US company. Boeing is most often mentioned, and Turner confirmed in April that the two manufacturers had been in talks "about a way forward together", although he said BAE's share price - hit by management errors that delayed several high-profile military contracts - was too low to provide "a good starting point for discussions".
ABoeing/BAE merger would encounter many obstacles. The UK government still holds a golden share in BAE that would allow it to veto any merger. BAE's insistence on its Britishness when it comes to bidding for UK defence contracts implies that such an argument still carries weight with the government, which might not be happy to see the heart of the UK aerospace industry fall into foreign hands.
Second, BAE may have to relinquish its stake in Airbus - raising the question of whether EADS may be willing or able to take it on, or to permit a flotation or a sale to a third party. Third, EU authorities would be unhappy to see one of Europe's leading aerospace manufacturers pass into non-European hands.
Speculation centres around Carlyle buying MTU, which may be the next DaimlerChrysler unit to go in the German/US company's continuing rationalisation, and combining it with FiatAvio. Steffens, while not confirming the MTU/FiatAvio merger, says that the "deep co-operation" and the "natural compatibility on programmes" between FiatAvio and MTU could make the companies' partnership a "nucleus of consolidation".
Private capital
Cunningham believes that Carlyle and the rest of the private equity sector are well placed to invest in aerospace. "Private equity firms have the capital to do it at the moment… [they will] pick up distressed companies cheap at this point of the cycle."
Although the potential FiatAvio/MTU merger shows aero engine manufacturers are not immune from the forces affecting the rest of the industry, the sector has its own peculiar structure, which means that, in general, consolidation will take a different form. Europe's engine makers have collaborated on making engines for helicopters such as the AgustaWestland EH101, Eurocopter Tiger, and NH Industries NH90, and on military aircraft such as the Sepecat Jaguar and Dassault/Dornier Alphajet. But they did not form a consortium to manage any of these projects.
The lesson seems to have been learned. The Europrop International (EPI) consortium - 28% of which is held by each of MTU, Rolls-Royce and Snecma, and 16% by Spain's ITP - won the competition to supply the engine for the A400M (Flight International, 13-19 May).
Snecma chief executive Jean-Paul B‚chat says Europrop is "a unique occasion to create a European engine group". Although the EPI partners are concentrating on the TP400-D6 engine and have not yet identified any future programmes on which to work, he says the collaboration can "serve as a basis for other programmes".
Steffens agrees that "there has to be some consolidation", but disagrees with B‚chat on the form it will take. "The companies will work closer together, but there will be no EADS in aero engines. Engines are always transatlantic - the expense of developing engines is only justified if they are present in the Boeing and Airbus worlds."
Outside the engine sector, Alenia Spazio is holding talks with Astrium and Alcatel "to see if we can co-operate", says Roberto Testore, chief executive of Alenia's parent company, Finmeccanica. Testore says future European restructuring is likely to take place in the electronic warfare sectors as well as the space business.
Finmeccanica is interested in expanding AMS, electronic systems joint venture with BAE. "We are seeing if we can increase this alliance to include aerospace," says Testore, adding that the expansion would help compensate for low Italian defence research spending and blocks on US technology transfer.
Many of the problems inherent in mergers, such as national security constraints, would be avoided by continuing with the tradition of setting up consortia to manage projects, along the lines of earlier examples such as Airbus, Eurofighter, MBDA, Panavia, and Sepecat. But collaborations are difficult to manage. The Galileo satellite navigation programme almost succumbed to disputes between Germany, Italy and Spain over who should lead the project.
German budgetary constraints delayed development of the Eurofighter Typhoon through the 1990s and more recently the A400M, and disagreements between the UK and French partners slowed the introduction of the Jaguar in the early 1970s. Even the early history of Airbus was full of arguments between the various national and industrial partners.
Costly duplication
In addition, Europe's status as a loose group of nations puts industry at a serious disadvantage compared with the single US market. Dr Keith Hartley of the Centre for Defence Economics at York University says: "EU defence industries are characterised by the duplication of costly research and development programmes and small-scale production for small national markets so that firms fail to obtain economies of scale." While the US armed forces are ordering thousands of Joint Strike Fighters, European air forces are ordering a few hundred Saab Gripens, Typhoons or Dassault Rafales.
But Hartley warns that the obvious solution - more collaborative development programmes -…has other disadvantages. "Collaboration is inefficient…costs of collaborative development compared with national alternatives can be…almost twice as high for four nations [for example, Eurofighter]." But aerospace companies are unlikely to face these problems again on such a scale, says Turner. "There just isn't the money in Europe for joint ventures any more. It is not realistic to look for a follow-on from Typhoon."
Although there is general agreement that European industry cannot hope to rival that of the USA, chief executives across the continent seem ready to adapt in the face of trouble - whether relatively short term, as in the downturn in commercial aviation, or longer term, as in defence spending. Le Bourget 2003 is likely to see continued commitment to strong European industry, with fewer - but larger - European exhibitors presenting their latest responses to a market that will, by then, finally be on an upturn.
Source: Flight International