European Aeronautic, Defence & Space Co. (EADS), the parent company of Airbus SAS, and BAE Systems (BAES.L) have announced merger talks. A merger between these two European aerospace giants would create the world’s largest defense and aerospace company, surpassing Boeing (NYSE:BA). The combined entity will have revenues exceeding $100 billion compared to $69 billion of Boeing in 2011.  The merger has been widely seen as consolidation being driven by the declining defense spending in the U.S. and Europe. However, more importantly it will make EADS a formidable player in the U.S. defense sector through BAE Systems, and herein lies the biggest challenge to Boeing from the potential merger. As U.S. defense and allied businesses constitute nearly 30% of the overall value of Boeing.
We currently have a stock price estimate of $75 for Boeing, approximately 5% above its current market price.
Consolidation driven by declining defense spending in the U.S. and Europe
Boeing’s chief executive, Jim McNerney said, “It does reflect a global consolidation that is beginning to happen”, on the ongoing merger talks between EADS and BAE Systems.  The U.S. defense spending is facing spending cuts of $500 billion over the next 10 years and all major European nations are also cutting down on defense spending in the wake of euro crisis and the accompanying austerity measures.
BAE Systems, which has a much greater focus on the defense sector compared to EADS shall benefit from the growth anticipated in the commercial aviation industry through its merger with the latter. And, EADS will gain greater defense capabilities to better compete with Boeing in the defense sector.
Merger will increase competition for Boeing in U.S. Defense contracts
According to a study by Bloomberg on top 200 defense contractors to the U.S. government, Boeing is the second-largest contractor after Lockheed Martin (NYSE:LMT) with U.S. defense sales of $22.1 billion in fiscal year 2011. BAE Systems is the ninth-largest with $7.3 billion in U.S. defense sales, and EADS stands far behind at the 100th position with $684 million in sales. Needless to say, a merger will create a more formidable competitor for Boeing.
In addition, both BAE Systems and EADS operate in the U.S. defense sector under special security terms with the U.S. government. While, BAE Systems supplies light combat vehicles, Bradley fighting vehicle, Paladin howitzer and naval guns to the U.S. military. EADS just makes UH-72 Lakota light-utility helicopters for the U.S. Army. Further, EADS’ inability to compete effectively against Boeing for U.S. Defense contracts acted as a catalyst for its interest in BAE Systems. Its loss to Boeing in the last year’s closely contested refueling airplanes contract in which the U.S. Air Force sought 179 refueling airplanes might well have acted as the final push.
All in all, Boeing which has lost to EADS in nine out of the last ten years in commercial airplane orders, will have to face a more formidable opponent in U.S. Defense contracts. As, a merged EADS-BAE entity will have the expertise, size and good track record in commercial as well as defense aviation businesses, a feature that only Boeing possesses in the current global aerospace industry.Notes:
- Boeing Says EADS Seeking U.S. Growth With BAE Merger, September 13 2012, www.businessweek.com [↩]
- Boeing says not threatened by EADS-BAE merger talks, September 12 2012, www.cnbc.com [↩]