EADS/BAE Merger: Waves of Consolidation, Antitrust and Problems for Global Aerospace and Defense

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This proposed merger between EADS and BAE is going to be more than complicated. Frankly, we also wonder about the legality of such a merger and wonder how other defense and aerospace firms will not formally object to the deal. The combined deal will have many hurdles to overcome. It would be a combination of the European Aeronautic Defence and Space Company, which is the parent of Airbus, and the surviving company of the British Aerospace and Marconi Electronic Systems merger from the 1990s.

Investors are so far having a hard time accepting the deal as well. EADS shares fell 5.6% to 28.00 euro yesterday in Paris trading, and shares are down another 8% to 25.70 euro in local Paris trading today. BAE Systems saw its shares rise 10.6% to 363.6 pence in London trading on Wednesday, but shares are giving back much of those gains today with a drop of almost 6.5% to 340.10 pence in London trading.

In short, when stocks fall around a merger it is bad omen, and that is true regardless of the geographic location. If stocks are expected to still return 5% to 8% per year, then EADS just created a situation where any new shareholders who bought will have to wait two years or more just to get back to even.

Analysts do not like the merger either. Deutsche Bank downgraded shares of EADS overseas today due to an overhang and uncertainties due to a distractive and complex situation.Deutsche Bank did maintain a Buy rating on BAE. Citigroup has also downgraded EADS to Neutral on the risks associated with this merger. Barclays also keyed in and recommended taking profits in BAE Systems with the note that it expects EADS shares to struggle even if the deal could create value for both companies. Another firm, called Investec, recommended that BAE shareholders take their profits here and look for excess gains elsewhere as the BAE share price is likely limited. Societe Generale downgraded BAE Systems to a Sell rating on the gains seen already.

According to Yahoo! Finance, the respective market caps in dollar-converted terms from British pounds and euros puts the value at almost $18 billion for BAE and more than $27 billion for EADS. That brings a combined value of $45 billion or so. In comparison, Boeing Co. (NYSE: BA), which is a DJIA component, is worth some $55 billion. Lockheed Martin Corp. (NYSE: LMT) is worth just under $30 billion, and General Dynamics Corp. (NYSE: GD) is worth over $23 billion. Elsewhere, Raytheon Co. (NYSE: RTN) is worth about $19.1 billion and Northrop Grumman Corp. (NYSE: NOC) is worth about $16.7 billion.

As far as EADS is concerned, the share structure is complicated, with 50.14% ownership and voting rights tied to the French and Spanish governments and also Daimler; some 49.86% of the shares are considered the free float. With state ownership in play, we would throw out the caveat that it would seem likely that if the EU nations wanted the merger to go through then it is feasible that they would be able to “encourage” cooperation for approvals from the European regulatory bodies.

History is against this deal if the conspiracy of regulatory approval and cooperation is not considered. Will American and other NATO nations raise a flag over this deal? It seems likely. If you go back one decade or so you will recall that the European Union rather than the Department of Justice blocked General Electric Co. (NYSE: GE) from acquiring Honeywell International Inc. (NYSE: HON) based on antitrust issues. If the Europeans can block a merger of two U.S. companies, it is feasible that the opposite could be possible. S&P Equity Research has said now that the deal would face a number of regulatory hurdles. The U.S. military agencies might also raise issues about how to ‘ringfence’ the U.S. operations in order to protect sensitive information and technology.

If this EADS/BAE merger is somehow allowed, we would expect that the investment community will start expecting a chain-reaction of defense and aerospace mergers as companies will go from having two powerful government-backed competitors to one much more giant competitor that is government backed. Here are some of the U.S. companies that are all under $10 billion in market cap that could fit within the realm of takeovers with overlaps in aerospace and defense, listed by market capitalization rates:

  • Rockwell Collins Inc. (NYSE: COL) at $7.3 billion
  • TransDigm Group Inc. (NYSE: TDG) at $7.3 billion
  • L-3 Communications Holdings Inc. (NYSE: LLL) at $6.9 billion
  • FLIR Systems Inc. (NASDAQ: FLIR) at $3.1 billion
  • HEICO Corp. (NYSE: HEI) at $1.9 billion
  • Esterline Technologies Corp. (NYSE: ESL) at $1.8 billion
  • Alliant Techsystems Inc. (NYSE: ATK) at $1.6 billion
  • GenCorp Inc. (NYSE: GY) at $600 million

Aerospace and defense mergers are not easy, and they often face more strict approvals and oversight due to the sensitivity of the contracts that are (or can be) involved in. That being said, the past two decades saw significant consolidation in the sectors. Two ETFs in the aerospace and defense sectors are PowerShares Aerospace & Defense (NYSEMKT: PPA) and iShares Dow Jones US Aerospace & Defense (NYSEMKT: ITA), but the holdings are similar, as you would expect, and the trading volume is light on each.

We have not even touched on how future austerity measures and lower military and government spending are concerned around influence over politicians and foreign policies. That is another matter entirely.

JON C. OGG

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