Analysis: BAE-EADS Merger One Year On: Mission Accomplished
(Source:; published Sept. 13, 2013)

By Giovanni de Briganti
PARIS --- Nearly a year after BAE Systems and EADS first acknowledged they were discussing a merger, and eleven months after the merger was finally blocked by Germany, reality has disproved many, if not most, of the arguments put forward by its supporters.

At the time, conventional wisdom held that EADS could not survive on Airbus civil sales alone, while interference from the French, German and Spanish governments was sure to force bad managerial choices that would ultimately prove fatal. Furthermore, the company’s lackadaisical dividends policy would increasingly rebuff potential investors and shareholders alike.

The merger with BAE was designed to fix these seemingly intractable problems, so its failure at the behest of German chancellor Angela Merkel was denounced by its backers as an industrial catastrophe that would cripple Europe’s largest aerospace and defense company.

The paradox is that, one year on, EADS has achieved most of what it wanted to achieve, without having to go through the merger. Conversely, it has since become clear that a merger would not have fixed BAE’s problems, which are getting worse as its excessive dependence on Saudi Arabia highlights its long-term vulnerability.

And it also has become clear that the doomsday scenarios brandished to support the merger were little more than guess-work, hyperbole or scare-mongering, with little or no foundation in fact.

Unavowed goals

Tongues have loosened over the past year, and it is now openly acknowledged by insiders and observers that, for EADS, the merger with BAE was a way to cut loose from excessive oversight from three governments; to win the freedom to run the group as a private company capable of competing on an even field with the biggest aerospace and defense players in the world; and to deal with its shareholders as it wished.

While much of what was true in Sept. 2012 remains true in Sept. 2013, most of these goals have been achieved, and EADS’ status and governance has been turned upside down, without a merger.

EADS management, led by CEO Tom Enders, has managed to reduce the shareholdings held by the French, German and Spanish states to less than a blocking minority. A year ago, in the summer of 2012, the French government and the German government, directly or indirectly, each controlled 22.35% of EADS shares, while Spain’s state holding company, SEPI, held 5.5%, giving the three governments an absolute majority of 50.2%. A shareholder pact ensured they would act in concert to protect their vital interests.

The new governance rules pushed through by Enders have changed all that. As of June 30, 2013, the stake controlled by the French government had been reduced to 11.96%, Germany’s share was down to 10.69% and the Spanish state’s to 4.12%; together, the three governments now control only 26.7% of the shares and 27% of the votes – not even a blocking minority – and their shareholder pact has been dissolved, although they can still together veto some operations, such as a hostile takeover.

Enders also has consolidated his hold on the company by renewing the board, by reshuffling top management, and by launching an expensive share buy-back plan to boost shareholder returns. He has spent €6.3 billion of EADS’ €12.2 billion cash pile since December 2012, and tightened his hold on the company to the point that it will now change its name to Airbus, just as he had proposed a few years ago. And corporate headquarters are now in Toulouse, as we wanted, instead of being split between Paris and Munich.

None of this would have been possible pre-merger, and it is remarkable that these radical changes in corporate governance went through without a whisper of complaint from shareholders, governments, analysts and the media, giving the impression that Enders somehow managed to hypnotize stakeholders.

The contrast is all the more stunning when compared to the long and overwhelming media storm that followed the original leak that the two were discussing a merger.

Financial results for 2012, and for the first half of 2013, also demonstrate that Doomsday has been put off for some time yet, at least for a stand-alone EADS. While the civil market – where EADS was too strong for some - goes from strength to strength, the bottom keeps falling out of the military market, where BAE was supposed to contribute its strength to the combined company.

This is why, less than a year later, EADS is riding high, its share price is comfortably up, and it is throwing off cash like never before, under the aggressive leadership of CEO Tom Enders who, far from having been thrown to the wolves for mismanaging the BAE merger, has since cemented his hold on the controls and ejected possible competitors.

Although its net profits and its dividend continue to increase, BAE is losing revenue and orders, and the cash it is still generating comes from radical cost-cutting rather than from its core business.

Financials show diverging paths

The two companies’ financial statements for the first half of 2013, released in mid-summer, clearly show how their performance is diverging – as indeed it was bound to – as EADS rides the civil aviation and helicopter boom while BAE as rides the defense bust caused by sequestration in the US and Coalition defense cuts in the UK.

In fact, a single figure illustrates the divergence: EADS’ H1 order intake, at €97 billion, is about ten times larger than BAE’s total turnover for the same period, £8.4 billion.

During the first half of 2013, EADS posted revenues of €26 billion (+6% year-on-year) while its EBIT increased by 21%, to €1.6 billion. Its net profit amounted to €759 million, up 31% year-on-year, and its order intake was up a stunning 241% over the first half of 2012, to €97 billion – that’s almost two years of sales of the entire group.

During the same first half, BAE Systems posted revenues of £8.4 billion, up just 1% year-on-year. Its EBITA declined 6%, to £865 million, and its January-June net profit was marginally down, to £750 million. BAE booked £4.8 billion’s worth of new orders during the first half, £2.7 billion of them from Saudi Arabia alone. This shows its over-dependence on three large military customers, two of which – UK and US -- are chopping defense spending like never before, while Saudi Arabia now haggles like any other customer, as BAE wistfully noted in its half-year statement: “Conclusion of discussions with the Saudi Arabian government on price escalation under the Salam Typhoon programme has not yet been reached.”

Comparison of 12-month yield: BAE closely tracks top-ranked EADS, despite stagnating sales and a 6% drop in operating profits. (Source: BAE Systems)

Nonetheless, despite lower profits, BAE still increased its interim dividend by 3%, to 8 pence a share, while EADS boosted its own interim dividend by 24%, to €1.22 per share.

Yet, despite the divergence in performance and long-term prospects, BAE shares are performing as well as those of its main competitors, as shown in Fig. 1 above. In the year to July 27, 2013, BAE’s share price very closely tracked that of EADS. This shows that investors prize short-term dividends and dividend stability above all else, which is something of a problem for companies whose programs run over decades.

This led one noted investor website to observe that “while revenue has fallen 21% during the past three years, net income has expanded 2.5%, [as BAE] has been aggressively cutting costs at the same time….this slimming down raises a red flag as [while] net income has remained relatively static, [the] market where it was once dominant is shrinking -- not a good sign for a buy and forget investment.”

The similar trend in both company’s performance is not only due to BAE artificially boosting its returns; it also is due to the fact that, ten years on, EADS still has trouble in translating its brilliant sales and technical performance into profits, and continues to lag its competitors in this all-important metric.

Airbus, the business which accounted for €19 billion of total group H1 revenue of €26 billion, has an EBIT margin of 5.8%, just over half of the 11% operating margin posted by Boeing Commercial Aircraft in the same period.

EADS’ helicopter unit, Eurocopter, posted an EBIT of 5% during the first half of 2013, while AgustaWestland, the helicopter unit of Italy’s Finmeccanica, posted an EBITDA of 15.7% -- three times as much.

This is only to be expected, as EADS was constructed from a variety of companies and businesses from not only its domestic markets – France, Germany and Spain – but also Britain, Italy, Finland, Poland, and others. This explains why rationalizing and restructuring the company is so long and complex a process – in fact, no other defense company has ever attempted to merge units from so many foreign countries.

A second recurring problem at EADS is the underperformance of its defense division, which was recently renamed Cassidian and will soon become part of the new Airbus Defence & Space.

Shortly after taking the top job at EADS, Tom Enders fired the then head of Cassidian, the wholly Germany-focused and prospective rival Stefan Zoller, and appointed a new CEO, Bernhard Gerwert, whose steady hands were intended to safely shepherd the company during the merger period.

Ostensibly, the change was intended to restructure Cassidian, but in fact it was mostly seen as the price of having lost India’s massive MMRCA fighter competition to France’s Dassault Aviation, mainly because of mishandled Eurofighter marketing. The fact that Zoller made no secret of his ambition to challenge Enders as EADS CEO probably did not contribute much to his job security, either.

But, despite these changes, Cassidian’s financial performance has hardly improved in the past year, and its marketing missteps continue: for example, it was eliminated from South Korea’s $7.5 billion fighter competition on Aug. 19 because it didn’t follow the bidding rules and wanted to impose its own proposals – which Cassidian however denies.

Cassidian’s financials are not improving, either. During the first half of 2013, its revenues were up 4% but order intake was down fully 27% year-to-year, while its reported EBIT was 3.8%, lower than its competitors.

The future Airbus Defence & Space, which will absorb Cassidian, will have a projected turnover of €13.7 billion – but an EBIT of only €547 million, or barely 4%, mainly thanks to the space and missiles businesses.

What next?

Although the boom in commercial air travel may seem endless, trees do not grow to the sky, and so EADS will have no alternative but to diversify to ensure it has a second leg to stand on once – or even if – the world economy dives into a recession (Euro collapse? Stagflation? War with China?) and airlines begin falling over themselves to cancel orders for new aircraft they no longer need and can no longer afford.

The question is whether EADS should diversify in the related field of defense, where there is some opportunity for cross-fertilization, in support services for military or government customer, or whether it should invest in other fields, such as financial services or consumer products. Some years ago, when both companies were riding high, a celebrated UK defense official wondered why BAE shouldn’t merge with Microsoft. Is such a sector-straddling merger out of the question for EADS?

Or, given the discount that hobble the share prices of holding companies, would it not make better financial sense for EADS to sell off a minority of the more profitable operations, and invest the resulting cash pile in other economic sectors?

Over the past year, Tom Enders may have removed the biggest pebbles in his shoes, but he still must decide in which direction he will walk the company during the next decade.


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