A missile is fitted onto a Eurofighter Typhoon in Germany. BAE and EADS team… (Odd Andersen, AFP/Getty…)
Two European defense giants said they were in merger talks to create the world's largest aerospace company.
At a time when defense spending is falling worldwide, Airbus parent company European Aeronautic Defence & Space Co. and BAE Systems said a deal makes financial sense because of their synergy and collaboration on a wide range of projects.
Together, British-owned BAE and EADS, owned in part by the French, German and Spanish governments, would have annual sales totaling more than $94 billion, dwarfing current industry leader Boeing Co.'s $68.7 billion.
The potential merger would have broad effects across the defense industry, particularly for larger defense contractors such as Lockheed Martin Corp., Northrop Grumman Corp. and Boeing. BAE and EADS have divisions in the United States and frequently compete for U.S. defense work. Both firms also have suppliers in Southern California.
"If the deal is done, it doesn't mean the industry will face increased competition immediately," said Richard Aboulafia, an aerospace analyst with Teal Group Corp., a Virginia research firm. But the European giant would be "the largest and one of the most globalized defense companies on the planet."
In accordance with British law, the companies said they have until Oct. 10 to either announce a deal has been made or that they no longer intend to pursue a transaction. The deal would have to clear regulatory hurdles by a host of European governments as well as U.S. agencies.
"Discussions have therefore been initiated with a range of governments about the implications of the potential transaction," the companies said in a joint statement.
Under a proposed deal, BAE shareholders would control 40% of the combined group's stock and EADS shareholders would own 60%. The new company would have a market value of $49.1 billion.
For years, EADS has been hungry for more business with the Pentagon, the world's biggest buyer of military hardware. The potential merger would dramatically increase EADS' prospects.
Just last year, EADS lost a high-profile $35-billion Air Force contract to build a fleet of 179 aerial refueling tankers to Chicago-based Boeing. At the time, critics of the EADS bid questioned the awarding of such a large military contract to a foreign-run enterprise.
In linking with BAE, EADS would absorb a major U.S. hardware supplier. BAE received $6.9 billion in government contracts in 2011, according to the federal procurement database. That's in contrast to EADS' $751.9 million. Both firms have suppliers and manufacturing facilities in Southern California. In the U.S., BAE has about 35,000 employees and EADS has about 3,200.
If the deal proceeds, "EADS would truly make inroads" with the Pentagon, said Scott Hamilton, an aviation industry consultant and managing director of Leeham Co. in Issaquah, Wash. "This is a major strategic move. The combination will make a formidable Boeing competitor."
At an event in Washington, Boeing Chief Executive Jim McNerney noted the increased pressure of consolidation in the industry amid a tight defense budget environment. Although McNerney wasn't familiar with details of the possible EADS-BAE deal, he said it could be driven by "increased U.S. market access because of BAE's entity here. And the entity when it's put together does look a little more like us."
He also said he was confident in his company's future prospects: "I have a pretty deep and abiding faith in our company's strength, so I don't see this as something that is going to threaten us fundamentally."
EADS, through its Airbus unit, has touted its increased U.S. spending and expansion of its American supplier base in hopes of securing more U.S. business. The company said it spent $12 billion in investments and supplier contract work in the U.S. in 2011.
In July, Airbus announced it would build a commercial jet manufacturing facility in Mobile, Ala. The planes assembled there will compete directly with those made by Boeing.
But Tom Captain, principal and vice chairman of the aerospace and defense practice at financial advisory firm Deloitte, said the potential merger of EADS and BAE is being driven largely by austerity measures in Europe, which drove down defense outlays.
The two firms have a history of collaboration. They're partners with MBDA, a company that develops and manufactures missiles. They also team up to make the Eurofighter Typhoon, a modern combat aircraft used by various militaries.
But global defense spending fell 3.3% last year, according to a Deloitte study. And there are more cuts on the way, which doesn't bode well for BAE and EADS.
The companies nearly merged before. In 1999, BAE was reportedly considering joining what would become EADS. In addition, BAE once owned 20% of Airbus shares until EADS bought them out in 2006.
"Other companies are going to feel increased pricing pressure because the new company will be more cost competitive," Captain said. "A pan-European company has been discussed in the past and it makes sense."