Big guns eye consolidation as BAE and VT target Babcock

Published on Sunday 26 March 2006 00:40

SHIPYARD workers are no strangers to the rigours of the marketplace or to changes of ownership, so the latest merger speculation in the City involving the country's biggest defence companies hardly came as a surprise.

BAE Systems' brief announcement after the stock market closed on Thursday night set the ball rolling for a possible joint bid with VT Group for Babcock International this week that could value the target company at 750m.

The brief statement noted that BAE and other major naval contractors have recognised for some time that a restructuring of the UK naval surface ship and submarine sectors would benefit both the Ministry of Defence and the industry. Various participants have discussed numerous combinations.

The background to these talks is the Defence Industrial Strategy, set out in the Defence White Paper published in December, clearly stating the government's view that there was a need for consolidation among shipyards.

Archie Bethel, managing director of Babcock Engineering Services at Rosyth, admitted something had been expected. "We have been in talks for a while about how you could consolidate the industry," he said. "This is an interesting first move. Once Rosyth was chosen as the location for assembling new aircraft carriers we probably came in the sights of BAE."

Babcock is the smallest player in the sector and therefore vulnerable, but it will not accept the takeover lying down. There has been no approach and BAE said there was no certainty an offer will be made.

But Babcock was clearly keen to emphasise just how far it had come in the past five years, transforming itself from an engineering conglomerate into a focused support services and asset management business employing 5,500, mainly at Rosyth and Faslane. It has generated substantial shareholder value, including an increase in Babcock's share price from 59p to more than 250p ahead of Thursday's announcement. The shares soared 16% on Friday to close up 45.5p at 315.5p as almost 12m shares changed hands.

Bridgewell Securities suggested Babcock could be worth between 340p and 360p a share, valuing the company at between 708m and 750m. BAE closed up 3p to close at 420p while VT rose 18.5p to 444.5p.

BAE's interest comes just a week ahead of Babcock's trading statement, when it is expected to report further progress on half-year results that met expectations. Underlying operating profit rose 21% to 25.2m.

In June 2004 it acquired the Peterhouse group which had earlier acquired Scots firm First Engineering. Should the merger with BAE and VT go ahead, it is likely that BAE will retain the marine activities at Rosyth and Faslane while VT will take the non-marine businesses, including First Engineering.

Babcock's current order book is valued in excess of 2bn and the real prize is the carrier work. As a member of the Aircraft Carrier Alliance, it will build the bow block and carry out detailed design for the two carriers.

BAE, which operates the Govan and Scotstoun shipyards on the Clyde and a submarine yard at Barrow-in-Furness in Cumbria, is by far the most significant player in UK warship manufacturing, responsible for the lion's share of the MoD's 6bn Type 45 destroyer programme and the 2.5bn aircraft carrier project The carrier alliance also includes VT, Thales of France, Halliburton and the MoD.

The impetus for a deal has come from defence secretary John Reid, who in December called for a more streamlined and efficient industry. But how that consolidation will be delivered has been left up to the private sector.

Richard Scott, naval consultant for Jane's Defence Weekly, says: "The MoD has said to the industry that the status quo is quite unacceptable. There is too much duplication, too many interests and management. It is looking for a consolidated industrial base in the UK that can address its requirements."

Merging the UK's shipbuilders should iron out some of the peaks and troughs which have cursed the industry throughout its history, according to Lisa Hillary-Tee, a spokeswoman for BAE Systems. "The troughs have been there because the industry has not been able to plan a way forward, so you get redundancies. In some cases people with skills go off to become taxi drivers and you can't get them back," she said.

But she insists a move for Babcock is not the only option available. "At this point we have not made a bid, it is simply something we are considering. This is one of several options to build a better way forward."

Paul Lester, chief executive of the company once known as Vosper Thorneycroft, is keen to grow its support services arm. Such a scenario would see the Portsmouth-based company maintaining Scotland's railways through a contract with First Engineering.

Other options include pooling all the UK's military shipbuilding into a new company. This could include DML, which runs the Devonport dockyard in Plymouth and has so far been left out of consolidation moves.

According to Scott, one obstacle to a deal could be an aversion on the part of VT Group to submarines, the mainstay of Babcock's business at Faslane on the Clyde. He says: "There are large overheads in submarines, and this is not something VT has ever done."

BAE has been shedding continental European businesses to concentrate on expansion in the US over the past few years. But the government's recent defence white paper effectively gave BAE the status of a national champion.

Scott says: "BAE feel much more comfortable about investing in the UK again. They feel much happier that they will be a major force."

BAE last year sold its avionics business, which employs 2,000 engineers and technicians in Edinburgh, to Finmeccanica of Italy. It may puzzle some that it is now moving into an older industry, though it has used cutting-edge technology for years.

Hillary-Tee says: "The perception of a low-skilled manufacturing business is wrong. We are talking about a very mixed industry. We no longer build ships as empty hulls, we fit a lot of the interior in the shipyards."