Collapse of BAE, EADS merger stalls downsizing of defense industry

A new round of consolidation in the defense industry does not appear to be on the horizon now that the $45 billion merger of BAE systems and EADS has fallen apart, analysts say.

The deal between BAE and EADS would have created the world’s largest defense and aerospace company and likely spurred rivals to assess their own merger opportunities.

“This merger means a lot less for the U.S. market because it collapsed,” said Loren Thompson, a defense analyst for the Lexington Institute who advises BAE and some of its competitors.

“If it had gone forward, it would have put pressure on big U.S. defense contractors to get into the consolidation process, but now that pressure is removed,” Thompson said.

The end of the talks between BAE and EADS also could signal the end of a push in Europe to create a massive European defense-aerospace firm that would compete with Boeing and Lockheed Martin across the globe.

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The last round of major defense industry consolidation occurred in the 1990s as defense budgets declined under the Clinton administration. The merger talks between BAE and EADS sparked speculation that another merger frenzy was at hand.

“We expect that the merger talks have now triggered at least consideration of a new round of business realignments within the global aerospace and defense industry, the immediate effects of which could include counteroffers for BAE from other large defense contractors,” Moody’s Russell Solomon wrote last month.

Analysts say the deal never really got to the point where it had the full attention of the Pentagon, although BAE representatives did meet with DOD officials. The Pentagon has been wary about further consolidation reducing competition in the industry.

But one of the biggest questions after the merger failed Wednesday is whether other companies will now jump in and try to acquire BAE.

Much of the speculation has centered on Boeing, which is a direct competitor with EADS’s Airbus in commercial aviation.

But several defense analysts said that seems unlikely, as Boeing sees more growth on the commercial side than the defense side with budget constraints in both the United States and Europe.

“Politically it’s very complicated, and I don’t see much in it for them,” said Richard Aboulafia, an aviation and defense analyst at the Teal Group.

Thompson said BAE is not an attractive target for a takeover attempt because the dividend it’s paying shareholders is higher than most big defense firms.

At the same time, Aboulafia said Boeing is likely happy that the merger failed because it means their biggest competitor in the commercial market is not making inroads into the United States.

Other potential U.S. defense companies that have been cited as potential suitors for BAE, such as Lockheed Martin or General Dynamics, could run into competition issues with the Pentagon, analysts say.

In Europe, where the deal was derailed because the three governments involved with the companies — Britain, Germany and France — could not reach an agreement, the end of the merger talks puts the idea of a European defense giant on hold indefinitely, if not for good.

Sources close to the talks said Wednesday that Germany effectively scuttled the deal when it was not satisfied with the agreement over how big a share the governments would have in the combined company.

“I think what BAE leaders learned from this process is there’s too many political constraints to create an effective pan-European enterprise,” said Thompson. “What that says to me is that if they try another big strategic merger it will be with a U.S. company.”

For EADS, the merger’s failure was a setback for CEO Tom Enders, as the company has sought to expand into the U.S. defense market, where it has little presence now.

Still, EADS shares rose more than 5 percent in trading Wednesday, while BAE shares dropped 2.5 percent.

“We will need to review our Group strategy and defense activities in particular,” Enders wrote in a letter to EADS staff, Defense News reported. “However, one thing is already clear: There will be no turning back to where we started from.”