European Aeronautic, Defence & Space Co.’s rejection for a $35 billion U.S. tanker contract threatens its goal to cut reliance on commercial aircraft and may force it to seek acquisitions at
home to build up defense operations.
EADS, based in Paris and Munich, relies on its Airbus SAS civil aircraft unit for two thirds of all sales. Chief Executive Officer Louis Gallois had aimed to balance that distribution by 2020, partly by gaining more access to the U.S. military market, the world’s largest. After Boeing Co. yesterday beat EADS on the tanker bid, achieving that goal may take longer, analysts said.
“It’ll be very difficult,” said Nick Cunningham, an analyst at London-based Agency Partners. “The U.S. accounts for 50 percent of defense spending in the West, and EADS has very limited access to that.”
EADS has sought for years to crack the U.S. defense market with orders and acquisitions. The company has failed to date to derive a meaningful portion of revenue from that region, with less than 2 percent of EADS’s military revenue stemming from the U.S. Gallois today called the tanker loss a “missed opportunity,” saying he would look elsewhere for growth.
Targeting Purchases
One option may be for EADS to consider acquisitions in France, where the defense market is fragmented, said Cunningham, who has covered the aviation industry for more than two decades. Among possible targets is defense electronics maker Thales SA, a maker of military electronics and security equipment, he said.
EADS, which had 42.8 billion euros ($60 billion) in sales in 2009, has several times in recent years expressed an interest in Thales, a 13-billion-euro company. The French government, which controls 27 percent of Thales, has rejected those overtures. Instead, family-controlled Dassault Aviation, which makes the Rafale combat jet, built up a 26 percent stake. EADS owns 46 percent of Dassault.
Gallois has said repeatedly that EADS would be willing to spend as much as $1.5 billion on an acquisition in the U.S. to help increase its footprint there. So far, the company, with about 10 billion euros in cash, has made very few purchases. Its biggest acquisition in the U.S. was Plant CML, an airport security business based in California, for $350 million in 2008.
Shrinking Budgets
The U.S. has become even more critical for EADS as home markets have begun to shrink. Spending in the U.K., where EADS has won numerous defense contracts including a tanker competition, will be reduced by 8 percent over four years, Prime Minister David Cameron said Oct. 19. As pressure increased last year to cut spending amid an unfolding European debt crisis, the German government ordered cumulative savings of 8.3 billion euros ($11.43 billion) in the defense budget by 2014.
EADS is best known for its Airbus aircraft, which include the A320 family of single-aisle jets and the A380 double-decker, the world’s largest passenger jet. Airbus leapfrogged Boeing as the largest maker of commercial aircraft in 2003, a lead the European manufacturer has retained to this date.
EADS’s tanker was modeled on its A330 wide-body aircraft, while Boeing’s successful bid used the older and smaller 767 jet. Airbus is also developing the wide-body, long-range A350 with 300 to 350 seats that is scheduled to begin service in late 2013, competing against Boeing’s 777 and 787 models.
Naked Run
Gallois said he was “disappointed” and “perplexed” by the Pentagon’s decision. Until the U.S. Defense Department debriefs EADS next week about the reasons for its choice, EADS won’t comment on immediate next steps, and whether it will seek to formally challenge the decision, Gallois said.
“I would have run naked down Fifth Avenue” if EADS had won the tanker bid, given the political obstacles in the Air Force to choose a French- and German company over a U.S. manufacturer for the tanker, said Sandy Morris, an analyst at Royal Bank of Scotland in London.
EADS had earlier been optimistic about its chances, given that its Airbus A330-200 was chosen as platform for the tanker in 2008. The victory was short-lived after Boeing successfully challenged the decision and forced a rematch.
While EADS has won some business in the U.S. military market, including a $2 billion contract to supply the U.S. Army with a fleet of light-utility helicopters, the tanker would have been by far the most prized order to date for the company.
The “contract loss is a clear disappointment given that it would have provided EADS with a greater US footprint, and therefore lower currency risk, and increased exposure to defence, a stated management ambition,” Morgan Stanley analyst Rupinder Vig said in a note to clients today.
To contact the reporters on this story: Andrea Rothman in Paris at aerothman@bloomberg.net.
To contact the editors responsible for this story: Benedikt Kammel at bkammel@bloomberg.net.
The U.S. Air Force is already on the defensive about its plans for the KC-X competition, with a former top procurement official questioning the source-selection methodology and Northrop Grumman/EADS asserting it has been put at a disadvantage by the disclosure of its pricing data to rival Boeing. The Pentagon last week dismissed complaints from a Northrop Grumman executive on the pricing data claim. But the issue is already festering, potentially spoiling the Air Force’s hopes to have a KC-135 replacement on contract by mid-2010. Discussions continue between Northrop Grumman CEO Ronald Sugar and top Pentagon officials, according to Randy Belote, the company’s vice president for strategic communications.
