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For BAE Systems' Mark Ronald, The Past is
Prologue
If a recent article appearing in the Financial
Times is any indication, the run of U.S. acquisitions
activity by BAE Systems plc (LSE: BA.L) may not be
over.
Indeed, words from Mark Ronald, the respected
head of BAE's $11 billion, 45,000-employee business,
suggest that the company is toying with the
possibility of making a deal which could eclipse the
$4.2 billion acquisition last year of United Defense
Industries (NYSE: UDI).
"We can grow by bolt-on acquisitions," Mr.
Ronald tells the newspaper, "Yet we look at things
over $1 billion and I guess $10 billion, maybe even
$20 billion. At some point [this] wouldn't be
completely out of the question."
There hasn't been a U.S. defense/aerospace deal
over $10 billion in four years — not since
Northrop Grumman's acquisition of TRW in 2002. And
prior to that we'd have to cast back a decade to the
1990s for examples. And even that storied decade
only furnishes three examples of "ten-baggers": the
$15.5 billion Honeywell/AlliedSignal deal in 1999, the
$17.5 billion Boeing/McDonnell Douglas deal in 1997,
and the $10 billion Lockheed/Martin Marietta deal in
1995.
In the entire history of the industry there has never
been a $20 billion deal (at $45 billion in size, the
GE/Honeywell deal would have broken the mold,
and perhaps for that reason... didn't).
So when a man with an illustrious track record
mentions the possibility of doing something that's
never been done before, we tend to view the matter
in the same way we'd view advice given to budding
playwrites: if your audience is shown a gun hanging
above the mantle in Scene I, they had better see it
fired before the curtain falls.
Is that overstating the matter? Read Mr. Ronald's
words, and decide for yourself: "My own view,
obviously not shared by everybody, is that there
probably is not a limit to what we could buy."
With his 65th birthday looming, Mr. Ronald is now
entering the span of years in which successful
dealmakers are often looking for one last opportunity
to take down that gun and go elephant hunting. It
was during these years that GE's Jack Welch set his
sights on Honeywell (with results which should not
detract from the rest of his storied career). It was
during these years that Norm Augustine made
arrangements for the future of Martin Marietta. And
it was during these years that Frank Lanza took L-3
Communications to greatness, although that process
would have to be characterized as a steady march
rather than a single great leap.
Operating at these rarified levels, failure can
come as readily as success. The GE/Honeywell deal
we've already mentioned. Other mega-flops have
included Lockheed Martin's abortive bid to acquire
Northrop Grumman in 1998 and General Dynamics'
attempts to buy United Defense (in 1997) and
Newport News Shipbuilding (in 1999 and again in
2001). Even in those years, prior consolidation
activity had all but closed the window against further
mega-deals.
But BAE Systems is just the kind of company that
could slip in through that window, even in these more
constrained times. As the Pentagon's seventh-ranked
contractor, even a $20 billion deal would make it only
roughly the same size as Lockheed Martin. And then
there's the company's programmatic mix-heavy on
defense electronics, IT, and services. Politicians and
regulators tend to focus on companies with big-
ticket, high-profile programs. BAE has relatively few
of those — so if opponents were going to rise
against a mega-deal, they would have to find
different ground upon which to rally.
Two Footprints, One Headquarters
The "Special Relationship" between the U.S. and
the U.K. notwithstanding, that ground would almost
certainly be the company's foreign ownership. Here
BAE is vulnerable on both ends of its trans-Atlantic
tether. In the U.S., the company has done all the
right things in terms of how it acquires, integrates,
and operates sensitive defense properties. But if the
company were to seek entry, say, into the Top
Three of U.S. defense contractors, it might find that
its unique ocean-straddling stance put it in the
sights of politicians who are dead-set against the
military dimension of the U.S.-U.K. "special
relationship." If enemies of George Bush see an
opportunity to tie a bloody scalp to their belts, they
will not hesitate to do so. The regulators might
yawn, but if the politicians begin to fulminate, look
out.
In the U.K. BAE Systems faces a different set of
problems. The company's relationship with the
Ministry of Defence (MoD), already somewhat
strained by its perceived tilt towards the U.S., could
reach a breaking point if a deal with a U.S. giant
suddenly reduced the company's U.K. business to
less than half of revenues. In the Financial Times
article Mark Ronald waves off concerns about the
company's trans-Atlantic balancing act. His words,
which are quite emphatic, are worth reprinting in
full: "I just don't think it matters. There are some
companies where nobody knows where the hell their
headquarters are. Governments are primarily
concerned with national security and jobs.
"If push came to shove, I am not convinced the
government is really going to care whether we are in
Stirling Square [BAE's London head office], New York
City, Brussels or somewhere else."
While we are staunch supporters of the U.S.-
U.K. "special relationship", we do think that a
company which was 75 percent American and 25
percent British would be forced to choose where its
headquarters would be. And when that choice was
made ‐ and it would almost have to be made in
favor of the U.S. ‐ the perquisites painfully won
in the Defence Industrial Strategy (DIS) could go
glimmering in an instant. While BAE Systems' U.K.
footprint would remain as large as ever, many British
politicians
would focus on where the company's head was
located, and would agitate for a reduction of the
company's quasi-monopolistic hold over the U.K.
defense marketplace. (Which would represent a
golden opportunity for up-and-comers like Cobham,
Meggitt, Ultra Electronics, and VT Group ‐ and,
yes, for EADS, Thales, and Finmeccanica ‐ to
fill the vacuum left at the center of Britain's defense
marketplace.)
So our hunch is that a transformational deal like
a $20 billion U.S. buy would require a transformation
in the company's somewhat cavalier attitude about
its unique place in the industry's firmament. Do we
think the company is capable of undergoing such a
transformation? Absolutely. And do we think the
company has the will to make a deal of this size
happen?
Well, that's the $20 billion question. One early
indication will be whether the company makes the
fateful decision to unload its somewhat depreciated
stake in Airbus SAS. That would provide it with
several billion dollars worth of wherewithal. And then
we would pay close attention to the company's
potential merger partners in the U.S. for clues about
their strategic receptivity.
Three Potential Mega-Partners...
The company basically has three candidates in
the "transformational acquisition" category. They are
(in alphabetical order) General Dynamics, L-3
Communications, and Raytheon.
M&A rumors have persistently linked BAE Systems
to all three U.S. firms — and to none more
than General Dynamics. The companies' submarines
businesses are already genetically linked, the fit in
land systems would be good (maybe a little too good
‐ remember what happened when GD tried to
buy
United Defense, which is now part of BAE), and the
combination of the two companies' IT businesses
would move them solidly into the industry's first
tier.
L-3 Communications, a bit of a dark horse, joined
this group with the death of Frank Lanza. Three of
L-3's four segments would fit well with BAE Systems
— but its largest, Specialized Products, would
not. Still, the company could monetize the business
(as Northrop Grumman did with Litton's Components
business), a move which would go a long way
towards making a deal possible.
Finally there's Raytheon, with whom BAE has long
enjoyed a good relationship. Raytheon's missiles
business would be a particularly nice fit at a time
when the MoD has targeted missiles technology for
growth. Once Raytheon sold its corporate jets
business (and BAE Systems withdrew from MBDA
Missile Systems) the fit would be exemplary.
So... three strong prospects, three opportunities
for corporate transformation. But any mega-deal is
unlikely in the current strong marketplace, since a
deal must first and foremost be affordable and
enhancing to earnings.
...And the Current Target Set
The company remains alert for opportunities in
the $2 billion-and-under category-Mr. Ronald says
that "There are in order of 20 possible targets out
there but they are not for sale."
Mr. Ronald identifies defense electronics as a
market segment of special interest to the company
right now. His reason for doing so harks straight out
of the down-budget 1990s: as budget cuts begin
chipping away at big-ticket U.S. defense programs
(like the F-35 Lightning II), customers will be forced
to meet new requirements by upgrading their existing
platforms. If a rising tide does indeed float all boats,
this line of thought says, then a receding tide will
affect different boats in different ways. Where BAE
Systems is concerned, says Mr. Ronald, dawning
budget realities could mean that the future holds
more deals like the company's buy of Sanders in 2000
(and, one wonders, perhaps fewer buys of platform
makers like United Defense?)
Mr. Ronald sees neither deal has having been as
important as an earlier deal: the 1999 acquisition of
Marconi Electronic Systems from GEC. That deal put
the "Systems" in the company's name, and laid the
foundation for future moves in the electronics
sphere. Significantly, Mr. Ronald says that work
remains unfinished: "We have 12 years' experience of
this going back to the Marconi days but we are
looking to bring it together in a more unified way."
Companies that could help BAE Systems Inc.
achieve a more unified product offering in the area of
defense electronics would include ITT and Rockwell
Collins.
And beyond defense electronics are areas where
the company has continuing strategic ambitions.
These include homeland security, commercial
aerospace and government IT services.
On one point Mr. Ronald does not equivocate:
the North American business, which has grown 250
percent during the past five years, has more
strategically-fueled growth in front of it. "We are
only at the level of $11 billion," he says. That's a
revenues figure any other U.S. subsidiary of an
international defense firm would look at with envy.
For Mark Ronald, it's the point of reference against
which the company's future greatness will be
measured.
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