Finmeccanica Left Out as EADS-BAE Merger Tests Alliances

Within 24 hours of the biggest merger plan in aerospace history being unveiled, Finmeccanica SpA (FNC) executives hunkered down in Rome to consider the fallout.

Europe’s third-largest aerospace and defense contractor summoned advisers and strategic planners to the Italian capital, where Finmeccanica is based, to study how the proposed $45 billion combination between European Aeronautic, Defence & Space Co. (EAD) and BAE Systems Plc (BA/) would ripple through the industry, people with direct knowledge of the meeting said.

The shakeup at two of its closest allies and rivals coincides with Finmeccanica’s largest overhaul yet following a record loss last year, a corruption probe, and a power struggle with a former chairman. At stake is Finmeccanica’s future role on the Eurofighter warplane and MBDA missile programs as well as Italy’s position in defense electronics and cyber security, where it would compete with the new industry leader.

“A potential merger should increase the sense of urgency at Finmeccanica and amongst Italian politicians to implement the restructuring and divestment plan and improve execution and cash flow to improve Finmeccanica’s competitiveness in an even more challenging environment,” said Rami Myerson, an analyst at UBS AG (UBSN) in London.

A first review with in-house strategists was followed by a second meeting over the weekend with external advisers for a more expansive analysis, said the people, who asked not to be identified because the examinations weren’t public.

Moving Shares

Shares of European defense and aerospace companies oscillated in the days after EADS and BAE announced their proposed merger on Sept. 12 as investors studied the consequences, with Finmeccanica falling 5.4 percent the next day. Prior to today, the shares had fallen 2.6 percent since the merger announcement. They slipped a further 1.4 percent to 3.8 euros as of 11:36 a.m. today, leaving the Italian company with a market value of 2.2 billion euros ($2.9 billion), about a 10th of EADS’s.

The Italian company responded with a statement on Sept. 13 that the planned combination presented an “important step in the consolidation of the European defence industry,” and that industrial cooperation between the three would continue. The company declined to comment beyond the release.

Combining BAE and EADS, the parent of civil plane maker Airbus, would leapfrog Boeing Co. (BA) as the world’s largest aerospace company with sales nudging $100 billion and assets spanning civil jets, warplanes and nuclear submarines.

Dreamliner Cooperation

Finmeccanica holds 25 percent in missile maker MBDA and would see its minority role exacerbated if EADS and BAE, each the owner of 37.5 percent, are brought together. In Eurofighter, led by Italian-born Chief Executive Officer Enzo Casolini, the combined EADS-BAE shareholding is 79 percent, with Finmeccanica’s Alenia Aermacchi owning the rest.

The Italian company rejected a 2000 offer to buy a 5 percent stake in Airbus. Today, Finmeccanica cooperates with EADS mainly in the ATR joint venture making turbo propelled airliners. It also supplies components to Boeing’s 787 Dreamliner and worked on the Airbus A380 superjumbo.

Finmeccanica CEO Giuseppe Orsi has targeted 1 billion euros in non-aerospace and defense asset sales to reduce 4.66 billion euros of debt. The Italian state-controlled company is also seeking to improve profitability by merging its defense electronics units, which may support efforts to join European industry consolidation.

‘Insecurity’

“I can see that the prospect of EADS and BAE merging might induce a sense of insecurity at Finmeccanica but I don’t think they need to feel that way,” said Nick Cunningham, managing partner and aerospace analyst at Agency Partners in London. “Still, they should start thinking about where the strategic future is.”

Finmeccanica will probably focus on increasing ties with rivals in Europe also left outside the new group, while joining the merger is unlikely for competition reasons, Myerson said. Finmeccanica’s AgustaWestland helicopters compete with EADS’s Eurocopter businesses, the world’s biggest rotorcraft maker.

One “logical deal” would be combining Finmeccanica and Thales SA (HO), Cunningham said. Neuilly-sur-Seine, France-based Thales cooperates with Finmeccanica in making satellites and in space services. While an outright sale to Thales would be unlikely because of the Italian government’s reluctance to let a strategic business fall into French hands, stronger ties between the two companies may emerge, Myerson of UBS said.

Disaster Looming?

Italy’s Treasury holds a stake of about 32 percent in Finmeccanica. Prime Minister Mario Monti is seeking to push through measures to block takeovers of defense contractors and other strategic state-controlled companies. The Italian aerospace conglomerate in 2008 bought U.S. defense electronics maker DRS Technologies Inc. to seek more contracts with the Pentagon and be less dependent on the Italian defense budget.

EADS’s proposed merger with BAE would mark the second time in recent years that Finmeccanica risks being left behind in the push for closer European ties. Two years ago, the French and U.K. governments signed a cooperation agreement. While German and Italian ministers have also discussed closer ties, a merger between EADS and BAE would shift Germany’s focus to the U.K. and France and potentially make it harder for Finmeccanica to win business in those three countries.

A merger of EADS and BAE “spells disaster for the rest of the industry that becomes even more sub-scale overnight,” said Thomas Picherit, an aerospace and defense analyst at Alphavalue SAS in Paris, who recommends investors buy Finmeccanica shares. “This merger implies an agreement of the U.K., French, German and Spanish governments. These governments are likely to bundle their orders in the future.”

To contact the reporters on this story: Robert Wall in London at rwall6@bloomberg.net; Andrea Rothman in Toulouse at aerothman@bloomberg.net

To contact the editor responsible for this story: Benedikt Kammel at bkammel@bloomberg.net

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