BAE looks east after failed merger

BAE systems looks to be turning to the East for wealthy customers following the collapse of its merger with EADS
BAE systems looks to be turning to the East for wealthy customers following the collapse of its merger with EADS
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DEFENCE firm BAE Systems is expected to turn to wealthy customers in the East as it tries to bounce back from 
the collapse of its merger with Airbus manufacturer EADS.

The group, which has an 88,000-strong global workforce including about 5,000 
in Scotland, is looking for 
efficiency measures to protect its bottom line from the squeeze on defence budgets 
in the US and UK, which together account for more than 70 per cent of its sales.

The Typhoon fighter jet manufacturer’s management was forced to execute a tight manoeuvre last week as it sought to persuade BAE investors that the mega-merger it had spent weeks advocating was not essential to its future, while taking significant flack from analysts calling for a “plan B”.

Market and defence commentators suggested the firm was a sitting duck, and would be targeted by one of the large American firms now it had broken cover and was considered to be on the market. There was even talk that BAE, which also builds the Type-45 Destroyer and Astute Class submarines, would be broken up as rivals picked off its most profitable divisions.

Lack of visible revenue growth is the major problem for investors. Last week BAE warned of the uncertainty 
created by the US “fiscal cliff”, legislation that will force swingeing cuts to the defence budget unless an agreement to provide more funding is reached before the year’s end.

But chief executive Ian King quickly moved to reassure staff and the UK government, which sees BAE as a key part of its defence strategy, that the firm was in good shape. The day after the merger sank due to political deadlock between the UK, French and German governments, he published an open letter saying that, although he was disappointed, the firm remained strong and was seeking avenues for growth. It also stressed its pipeline of work, including updating armoured cars in the US and building replacements for Britain’s ageing frigate fleet.

Tina Cook, an analyst at Charles Stanley, said: “Plan B is business as usual.” She said the defence firm will return 
to its strategy of seeking cost savings and efficiencies as it tries to offset tough trading conditions. Already, such moves have delivered a margin improvement during the financial first half.

“The focus remains on close management of costs, including site rationalisation and headcount reductions.”

At the same time, Cook said the firm will seek to capitalise on its global customer base in order to reduce its reliance on the UK and US.

In an update last week, the firm trumpeted a series of deals to supply Typhoons to Oman and upgrade more than 130 F-16 aircraft for the South Korean military.

It is also negotiating an extension to its Saudi Arabian contract for aircraft and pilot training, which could be worth more than £7 billion over five years.

BAE is also selling minor business units in order to raise £200 million it has promised to add to its pension fund. Cook said the company has made clear that any acquisitions of its own were a low 
priority, with pension funding, organic investment and shareholder returns all taking 

She also said that BAE’s large US rivals were unlikely to be seeking acquisitions ahead of possible major defence cuts.

Rob Stallard, at RBC Capital Markets, agreed. He said BAE would be “a mixed bag” for a buyer anyway, with some prize growth assets such as its cyber and electronic warfare businesses, as well as some underperformers.

An American buyer would face competition concerns from the US Department of Defence, open itself up to political interference from the UK and upset Saudi Arabia, which would prefer to keep separate arrangements with its main British and American arms suppliers.

Other analysts have suggested that the EADS deal could yet be resurrected. BAE chairman Dick Olver has said that the firm would not look at the plan again unless it thought the political environment had changed.