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Op-Ed: Will BAE Find Greener Grass in the US? |
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(Source: defense-aerospace.com; published March 8, 2005)
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by Giovanni de Briganti
defense-aerospace.com
PARIS --- With its surprise bid for United Defense, a major US manufacturer of armored vehicles, BAE Systems has firmly committed to two strategic directions: it has entered the army equipment market in a major way, and it is accelerating its shift away from Europe towards the United States. It is not clear that either of these directions will prove advantageous to the company in the long run.
BAE’s past forays outside of its core military aerospace business can hardly be considered successful, whether in the car industry (with Rover), in shipbuilding (with the Barrow, Scotstoun and Govan shipyards) or even in civil aerospace, with the Regional Aircraft business it was finally forced to shut down. And its record with mergers and joint ventures (think GEC Marconi or the recently-dissolved joint ventures with Italy’s Finmeccanica) is hardly immaculate.
With last year’s purchase of Alvis, and its Swedish subsidiary Hagglunds, BAE is now betting the farm that it can make good money making armored vehicles, a sector that has been in the doldrums for well over a decade.
Despite all the hype about leading-edge electronics, the armored vehicle industry remains first and foremost devoted to low-margin metal-bashing. Even on more promising programs like the US Army’s Future Combat System (FCS), United Defense will mainly build the vehicles themselves, leaving its partner Boeing to manage their high-margin electronics content. And the future of the FCS program is far from being assured.
Apart from the FCS, United Defense has a poor product line: its Bradley fighting vehicle design is nearly 30 years old, its M-113 is over 50 years old, and its most compelling product, the M-109 self-propelled gun, is being pushed into irrelevance by modern precision-guided weapons, both air-launched and ground-launched.
Of course, United Defense has other products, like the AAV7, the M-88 recovery vehicle and a range of naval guns, but these are niche products that are unlikely to provide short- or medium-term profits of any significance. It also owns a small shipyards unit.
The fact of the matter is that United Defense does not have a “killer product” that can guarantee its future prosperity; it doesn’t even have a foothold in the only segments of the industry that offer decent prospects: light and heavy wheeled armored vehicles, and tanks.
Similarly, BAE’s headlong flight to the United States, where it makes money but where it still is only a second- or third-rank supplier, is questionable, and appears to owe more than a little to CEO Mike Turner’s inability to get on with his main customer, Britain’s Ministry of Defence.
Turner is understandably miffed at having lost the Royal Air Force’s £ 13 billion Future Strategic Tanker Aircraft contract to EADS, and both the British Army’s Watchkeeper UAV contract and part of the Royal Navy’s future aircraft carrier program to France’s Thales and to Halliburton. But is that reason enough to pull out of the UK, and indeed of Europe?
In recent weeks, BAE has sold half of its stake in Sweden’s Saab – thereby unadvisedly freeing the company to compete its Gripen lightweight fighter against BAE’s own Eurofighter Typhoon on export markets such as Brazil – and has sold a large part of its defense electronics business to Italy’s Finmeccanica.
Now, it is investing heavily in the United States, where it hopes to make more money thanks to the Pentagon’s “cost-plus” contracts. BAE Systems North America employs over 27,000 people at sites across the U.S and in the year ended 31 December 2004 generated $5,078 million in sales, or about 20% of BAE’s total.
In its interim results statement, BAE said its return on sales in the United States was 8.4 percent, while its UK defense business generated 2.2 percent, with several major programs being “zero margin” (the Astute submarine, the Type 45 destroyer) or “zero profit” (Eurofighter).
BAE might well be right in thinking that, in general terms, the United States offers the better prospects for a defense manufacturer. But the problem here is that BAE’s North American business is mainly a subcontractor or a vendor, precisely the category of supplier whose margins regularly get squeezed between the prime contractor and the customer. BAE has no significant prime contract in the U.S.
The rush to possibly greener pastures across the Atlantic may also make it untenable for BAE to maintain its 20 percent stake in Airbus, which in 2004 contributed profits of £ 196 million to its bottom line. It is unclear that EADS, the other Airbus partner, will look kindly on BAE’s shift towards the United States, home of EADS’ and Airbus’ main competitors. And keeping the Airbus stake will be impossible if BAE finally buys, or merges, with a major US contractor, as it has been trying to do for several years.
But the crucial question is this: if BAE cannot successfully compete in its domestic market, where it still is the dominant player, what makes its chiefs believe it will compete more successfully in the U.S., the most competitive market of all, where it will be but a minor player?
BAE has lost the biggest defense contracts awarded by the UK, and has virtually destroyed its relationship with the UK Ministry of Defence, its domestic customer. It has now entered the low-margin armored vehicle business. It is gradually pulling out of Europe, in the hope it will prove more successful in the United States.
This does not seem like a coherent industrial strategy for a company that still likes to claim it is Europe’s biggest defense group, and raises serious questions about how it will be able to live up to its promise to “deliver growing returns” to its shareholders in the long run.
-ends-
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