The inexorable logic of a BAE Systems and EADS tie-up

The British prime minister is taking a political risk by authorising talks on a merger between two of Europe’s biggest defence firms, but the deal could benefit both sides

Industry fills the strategy gap

While European Commission President José Manuel Barroso was outlining to the European Parliament his unifying vision of a European “federation of nation states” on Wednesday of last week (12 September), the Bloomberg news agency lobbed a grenade into the world’s stock markets.

It disclosed that two of the EU’s biggest and most politically sensitive companies, the Franco-German- Spanish defence and civil aerospace group, EADS, and the United Kingdom’s own defence juggernaut, BAE Systems, have been discussing a €38 billion merger. If completed, the deal would create a European giant to rival the American company Boeing.

Given the influence of the Eurosceptic branch of the UK’s Conservative Party, which is the dominant partner in the British coalition government, the idea that Prime Minister David Cameron would authorise these cross-channel merger talks, which he did, is stunning.

It was only nine months ago, at a European Union summit (8-9 December), that Cameron, pandering to his party’s Eurosceptics, isolated the UK from 25 of its EU partners, allegedly to protect another national champion, the City of London’s financial centre, from Continental meddling.

Yet now, despite being politically frailer, he is apparently ready to put BAE Systems, the company which makes some of the most secret weapons in the British arsenal, into a pan-European commercial envelope.

Wind the clock back 25 years to the winter of 1985-86 and it was just such a possible cross-border merger, involving the puny (indeed, collapsing) Westland helicopter company, a global minnow, which nearly forced the resignation of Conservative Prime Minister Margaret Thatcher. She got into a battle with her defence minister, Michael Heseltine, over whether the merger should be with an American firm (her preference) or a European one (his preference).

Although she was then at the peak of her considerable power, Thatcher’s finance minister, Nigel Lawson, says in his memoirs that she survived the Westland affair “only by the skin of her teeth”. One of the casualties was her industry minister Leon Brittan, who had to resign, a step that launched him on his distinguished career in the European Commission.

In the spirit of Thatcher, the Conservative backbenchers whom Cameron aimed to defang at last December’s EU summit are trying to derail this latest affront to their Eurosceptic sensibilities.

Concerns

From their perspective, they have reason to be concerned. BAE Systems is one of the largest pure defence companies in the world. In the past few years it has become the fourth or fifth largest defence contractor to the US Pentagon, no mean feat for a foreign-owned company.

This transatlantic link makes it a darling of a Eurosceptic British right still wallowing in the warm glow from Britain’s supposed “special relationship” with Washington, a relationship, incidentally, which Donald Rumsfeld, then the US defence secretary, dismissed with a rhetorical flick of his finger at the time of the second Iraq war.

A merger with EADS summons up all sorts of troublesome issues for Britain’s Eurosceptic Conservatives and their allies in the British media. They fear that BAE Systems might end up having to share some of its secret military technology, overlooking that Germany and France are also two of the world’s most advanced hi-tech engineering nations with their own, precious, security technology to match.

They worry, too, that a deal between EADS and BAE Systems might just be the thin end of the wedge. It might erode US-UK defence co-operation and lead to even stronger EU defence ties, not just in building weapons but also in deeper military and political integration of national defence establishments.

Britain’s Eurosceptics on the left and right are partly correct here. Indeed, one of the biggest attractions of the proposed merger is that it should promote greater and more effective defence collaboration in Europe. They choose to forget, however, that a stronger EU defence capability is precisely what Washington has been demanding as the United States ‘pivots’ towards Asia.

On whether a deal with EADS would make it harder for BAE Systems to win US defence contracts, there is already a strong head-wind, with the Pentagon’s budget shrinking fast and the US Congress favouring increasingly protectionist military procurement policies. This, and BAE Systems’ failure to find an alternative US or British partner, is why BAE Systems can see that it is now becoming so vulnerable financially, commercially and (critically) technologically.

The blunt fact is that in military – but not just military – terms, the UK, at best a medium-sized power, is too small to sustain such a wide-ranging defence concern as BAE Systems.

BAE Systems is engaged in building everything from fighter aircraft to nuclear submarines and needs ready access to research and development funding on a scale that the UK government and the British defence budget alone cannot provide.

Being part of a diversified group such as EADS, which includes arguably the world’s most successful company in the booming civil aviation sector, Airbus, is exactly what BAE Systems needs: especially now the foolish gamble it made in 2006 to sell its 20% stake in Airbus and put all its eggs in the defence basket, and too many in the US defence market, has backfired so spectacularly.

From the point of view of EADS, the attraction of getting access to at least some of BAE Systems’ technology, and perhaps better access to the US defence market, is only part of it: a deal with the famously free-market Brits would be liberating.

It would deliberately be designed in such a way as to help Tom Enders, its chief executive, loosen the political constraints and interference he has to endure as a consequence of being part government-owned. The most difficult relationship is with the French government, which has a 22.5% stake in the company, but it is matched by a similar, partially indirect, German stake.

Those links could yet be to BAE Systems’ advantage. For just as the link with BAE Systems might help EADS win business with the Pentagon, equally BAE Systems itself should find it easier to sell in countries in which French and German diplomatic backing is advantageous. Diplomatic clout is often what swings a defence deal.

Historically, Britain’s closest European partner in military terms has been France, not least because of Germany’s understandably ambiguous views on defence issues. Now, however, as Germany changes, the UK needs to strengthen its ties with Berlin, particularly as Berlin and Paris draw closer.

A BAE Systems/EADS deal is not only in the UK’s national and security interest, but also in the interests of the EU and the United States. It should go through, in spite of howls of pain from British Eurosceptics because BAE Systems has failed to find an alternative American or a British partner and because the company, which came close to financial disaster in 1991, will soon be too frail to fulfil its mission alone.

Stewart Fleming is a freelance journalist basedin London.

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