Sept 13 - The potential merger of EADS and BAE Systems, Europe’s two largest aerospace and defence companies, is likely to be rating positive, Fitch Ratings says. This is because of the expected improvement in the combined entity’s business profile and unlikelihood of deviation from the conservative financial strategies of both existing companies. But the transaction faces numerous and significant obstacles in the coming months, which may result in watering down of the deal and its desired benefits.
The tie-up between the two companies, both rated ‘BBB+', has sound industrial logic. A combined EADS/BAE would not only be the largest A&D company worldwide by revenue, but would also have an almost even split between commercial and defence activities, mitigating the cyclicality of the former and the present pressures faced by the latter.
The combined group could also benefit from cost synergies (notwithstanding short-term integration issues), improved pricing power and a reduced FX mismatch resulting from BAE’s large US dollar footprint. The overall financial profile of the combined entity may also prove beneficial for the rating, in light of the historically conservative capital structures of both BAE and EADS.
However, with so many stakeholders with conflicting interests involved at both companies, the final outcome may not be the emergence of a pan-European A&D giant to rival Boeing within the sector. The companies will require the approval of regulatory bodies in key customer countries like France, Germany, the UK, US and Saudi Arabia. Considering the complexity and security sensitivity of some defence contracts, this may prove to be a long and arduous process, potentially involving the ring-fencing or outright sale of some assets.
Shareholder approval may also be hard to obtain because this will sometimes involve governments that are also defence customers of the two companies. EADS’s share register is dominated by the French and German governments, each of which control 22.5% of the company, while the UK government has a golden share in BAE Systems - which was put in place precisely to influence key strategic decisions like the merger under consideration.
Further potential distractions resulting from trade union actions may create an additional challenge to the successful and timely closing of the transaction.