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 (
). 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
price estimate of $75 for Boeing
, approximately 5% above its current market price.
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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
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.
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 (
) 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
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