Last updated: October 10, 2012 8:16 pm

BAE left to take care of deal fallout

BAE systems©BAE Systems

For BAE Systems and its management, the only development more dramatic than their proposed €36bn union with EADS may turn out to be the deal’s failure.

Many analysts and industry executives believe BAE is not only out of good options but that its attempt to tie up with EADS has left it dangerously exposed and facing the wrath of its investors – and its most important customer, the US.

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Ian King and Dick Olver, respectively BAE’s chief executive and its chairman, have also been tarnished because of their inability to persuade even BAE’s most loyal shareholders of the wisdom of the deal. Many investors and analysts now believe both men’s jobs are on the line.

For BAE, the future looks dimmer than it did before news of the proposed deal surfaced.

“We think that BAE’s willingness to do such a deal now implies a lower degree of confidence in the company’s ability to achieve all of its large export opportunities in the reasonable timeframe expected by many investors,” says Sash Tusa at Echelon, the independent analyst.

Mr Olver on Wednesday insisted there was no reason to change BAE’s management team, and investors are unlikely to want to further destabilise the company by pushing too quickly for a change of leadership.

But investors have already called for a review of BAE’s strategy – a move Mr King says is not necessary.

“What’s next is Plan A, that we deliver on our strategy that we articulated before,” Mr King told the Financial Times on Wednesday, disputing any need to change tack.

Many analysts and investors believe BAE might now just have to ride out alone the storm of the economic downturn, the end of the wars in Afghanistan and Iraq and the cuts in US and European defence spending.

The most extreme change in strategy could involve the company being broken up into pieces; its important US arm, source of 43 per cent of its revenue, being spun off or sold; and the rest of the company – businesses in the UK, Australia and Saudi Arabia – left to limp along.

The emergence of a new suitor for BAE from among the big US defence companies is another possibility some have noted, arguing that the deal’s collapse leaves BAE vulnerable.

One senior UK official said BAE would remain “in play”, noting: “The risk for BAE is it has made clear that it does not have a long-term future without some kind of tie-up.”

Lockheed Martin and General Dynamics are said to have already approached the Pentagon to see whether such a proposal would be acceptable. Few people who have closely followed the defence industry believe it would be. The US defence department’s long-held view has been that the number of its biggest suppliers has shrunk enough after the consolidation of the late 1990s that created Lockheed and Boeing, the country’s largest defence contractors.

A person close to Lockheed on Wednesday said it would not be interested in bidding for BAE. “We’re looking at focusing on our customers and our cost-reduction issues,” he said.

The US government’s opposition to further consolidation in the US defence market may have eased somewhat as spending cuts have prompted companies to begin lay-offs, but BAE’s size – it is the world’s second largest defence company after Lockheed and a top 10 supplier to the US government – remains an insurmountable hurdle, say analysts.

“The Pentagon has warned against consolidation and we would not expect a potential bid from any other US competitors,” says Ed Salvesen, analyst at Brewin Dolphin Investment Management.

The UK government is also unlikely to sanction such a deal because a US owner would not guarantee that some of BAE’s most sensitive UK projects – such as nuclear submarine building – would remain in the UK. Bankers say they have for years tried to make a transatlantic union work and BAE has looked at, and dismissed, a tie-up with Boeing and, more recently, with Northrop Grumman.

Mr King says he does not expect another suitor and that none has so far approached him. But people close to the deal say EADS could spend the next three months – with the blessing of BAE – lobbying the German government and then have another go at BAE early next year, especially given that most of the non-political details of the deal have already been agreed.

For now Mr King will have to articulate a convincing strategy to his customers – particularly the US and UK governments – and his investors.

“They will be under enormous pressure to explain what Plan B is and they’ll be punished if they don’t,” says Guy Anderson of IHS Jane’s, the defence industry analysts.

Many fellow industry executives and analysts sympathetically note that decisions made by Mike Turner, Mr King’s predecessor, meant that the BAE chief “found himself completely exposed to two defence markets [the US and UK] just before they went belly up,” as Mr Anderson puts it.

They argue BAE does not need to throw in the towel at what may be the bottom of the defence cycle, nor that its future without a deal looks as grim as Mr Turner and others have argued.

Even BAE’s closest competitors envy its broad international portfolio, its ability to generate cash and a loyal following of investors drawn to the steady dividend.

For all the criticism of BAE that the EADS deal has unleashed, many investors, industry executives and analysts believe that, rather than a dramatic change in direction, the company needs a management that is better at articulating its strategy.

Additional reporting by Robert Wright and Anousha Sakoui

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