The Pentagon Has A Little Transatlantic Merger List

It may O.K. defense deals--with a favored few

Americans tend to think of the U.S. defense industry as a slumping sector. A decade after the cold war's end, spending on missiles, ships, and planes just isn't what it was. But to European arms makers, their U.S. rivals look plenty healthy. The U.S. spent $45 billion on weapons last year, while Europe and Canada combined spent just $31 billion. Little wonder, then, that foreign giants from Thomson-CSF to DASA and BAe are rumored to be itching to buy American. And to many investors, such transatlantic mergers would make a lot of sense.

There's only one hitch. The Pentagon has a little list that could prevent certain deals from happening. According to Deputy Defense Secretary John J. Hamre, the U.S. Defense Dept. plans to classify international mergers as preferred, restricted, or forbidden. Where a particular deal fits in would be determined by the Defense Dept.'s assessment of its "security conditions," as Hamre puts it. So if Thomson-CSF should ever try to acquire Raytheon Co., for instance, top Pentagon officials would give the final yea or nay. The criteria are based mainly on whether a foreign defense contractor and its government have a clean track record when it comes to selling to bad guys like Saddam Hussein.

U.S. officials don't want to nix all deals. They realize that as Western military budgets shrink, global defense combos are needed to bankroll new weapons and sell arms within NATO and in emerging markets. Indeed, the Pentagon wants to ease the regulatory burden on some deals. But the Pentagon fears that even some NATO allies may not be trustworthy guardians of critical technology.

In November, Hamre suggested that Canada, Norway, Australia, the Netherlands, and Britain belong to the preferred class, while Russia and China are on the forbidden list. He doesn't name countries in the middle category, but Germany was conspicuously absent from the A Team. So was France, which is at odds with the U.S. over everything from export controls to trade with Iran.

REAL FRIENDS. The Europeans have already protested the apparent ranking of Washington's "real" friends--and they thought they had killed the concept. "They scrapped it," says Christian Poppe, a spokesman for DaimlerChrysler Aerospace. But Hamre insists that the Pentagon will stick to its plan, although he concedes that the task is perilous. "It is very complicated," he says. "We're changing an entire cold war paradigm."

One rationale behind Defense's approach was to encourage trusted British companies such as British Aerospace PLC and General Electric Co. to go on separate shopping sprees in the U.S. But the British are not rushing headlong into the U.S.: Instead, BAe and GEC's defense units propose to merge with each other. That would create an aggressive British titan that could grab contracts in Europe and emerging markets. The BAe-GEC alliance shows that even if the Pentagon offers incentives, it will have trouble shaping European defense consolidation from afar.

Existing links among European weapon makers pose another problem for the Pentagon. BAe and other British companies may still go shopping in the U.S. But many have ties to French companies that are not on the Pentagon's preferred list. "Is there an acceptable percentage of Frenchness, or are these companies already condemned?" asks Nick Cunningham, a Salomon Smith Barney analyst in London.

The Defense Dept.'s burden would be lighter if countries missing from the A Team beefed up their policies on technology transfer and export controls to get included. And Washington may hold out a carrot for doing so. James A. McAleese, a defense-industry lawyer based in McLean, Va., predicts that for the preferred group, "the next move would be a blanket waiver of security requirements," such as curbs on a foreign parent's control of its American defense subsidiary. In effect, the foreign companies would be treated like U.S. natives. But until the Pentagon's security concerns are met, it could face the ire of allies who want a slice of the fast-shrinking defense pie.

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