Industrial M&A Recoils: EADS-BAE Talks End

Last month, we discussed the return of industrial M&A in the space sector with the announcement of the acquisition of U.S. satellite manufacturer Space Systems Loral (SS/L) by Canadian manufacturer MDA Corp. The plan this month was to discuss the pending acquisition by EADS, the European consortium and parent company of Astrium, manufacturer of the Ariane launch vehicles and of civil airline maker Airbus, of U.K. aerospace and defense manufacturer BAE. However, on October 10, EADS and BAE abandoned their merger talks in the face of German government opposition, leaving EADS without the strategic entry into the U.S. market that it had sought, and BAE without the diversification from the shrinking defense budgets that it needed. The debacle in retrospect provides an opportunity to assess the obstacles to rationalization of the E.U. aerospace market compared to that in North America.

The EADS-BAE deal had compelling economic and strategic logic. EADS, for all that it is prominent as the parent of Astrium, now probably the most vertically integrated company in the satellite sector, is heavily dependent on its Airbus division and the civil aviation sector overall. Airbus is locked in a stable duopoly with U.S. manufacturer Boeing, which is also a major satellite manufacturer and participant in launch services, especially for the U.S. military, and U.S. defense contractor. The continental European defense sector does not offer EADS a market large enough for it to thrive and EADS has been notoriously unable to access the U.S. defense market. BAE, by contrast, has almost unique European aerospace and defense contractor access to U.S. defense procurement (nearly half of its revenues are derived from Pentagon procurement), but needs diversification to hedge against the shrinking U.S. Defense Department budget. The two companies’ situations are strategically complementary.

Strategic logic, however, counts for little when governments have a say in company governance, for the simple reason that they have different agendas from the fiduciary duties that are supposed to drive corporate boards of directors and officers. The French and German governments also are shareholders in EADS, which has been hampered for years in its governance by an uneasy Franco-German entente, in which a representative of one country held the Airbus top post and a representative of the other held the EADS chairmanship. The EADS chairmanship is currently held by Thomas Enders, a German that apparently failed to convince German Chancellor Angela Merkel, who is facing an election early next year, that the deal would not cost German jobs, control and prestige. In fairness to Enders and Merkel, that conclusion was reached after decades of French out-maneuvering of Germany in the preservation of “national champions,” protection of state-ordered industrial policy and other French interests.

EADS and BAE had notified the German, French and British governments about the planned merger in July, and received provisional approval to negotiate. Ironically, reduction of German and French state interference in the combined companies’ operations was a specific goal of the merger. When news of the merger talks became public following leaks, a common aspect of the European M&A market, the governments were under public scrutiny in reviewing the prospective deal. Although the French and U.K. governments apparently supported the deal (with the French government’s support contingent on maintaining a call right to buy an EADS stake held by French aerospace company Lagardere that would give it a 13.5 percent stake in the combined company and the U.K. government wanting state stakes capped at 10 percent each), the German government’s opposition, unless sufficient concessions to state control over issues relating to jobs, national security and factory locales were made that would negate the deal’s original logic, was sufficient to scuttle the project. Reportedly, the two companies realized that the governments, especially Germany’s, were unwilling to allow the creation of a merged company that could operate as a fully commercial entity, free of state control, and with that, the logic of the deal collapsed.

Both companies must now regroup. Both have exposed to investors their intrinsic weaknesses: EADS, its dependence on Airbus, a cyclical civil aviation market and weak defense offerings; and BAE, its dependence on diminishing Pentagon procurement. European governments have again demonstrated fundamental resistance to allow “national champions” to compete as commercial companies.

Owen D. Kurtin is the principal of New York City-based law firm Owen D. Kurtin PLLC and a founder and principal of private investment firm The Vinland Group LLC. He may be reached at [email protected].