Airbus: Birth Of A Giant

The inside story of how Europe's toughest bosses turned Airbus into a global star: EADS

On a rainy Paris afternoon last spring, General Electric Co. CEO John F. Welch walked into an unmarked building facing the Arc de Triomphe to pay a discreet call on his old friend and fellow corporate titan, Jean-Luc Lagardere. Welch was looking for very important information. Lagardere--at 72, the grand old man of French aerospace and publishing--was aiming to do two things so daring and unexpected that few believed either would be possible. One was a planned merger of the largest aerospace and defense groups in France, Germany, and Spain to make Europe's first global giant in the sector. The new company--potentially the biggest cross-border industrial tie-up in European history--would not only be a world leader in helicopters, missiles, and satellites but would also control the huge Airbus Industrie aircraft consortium. Would the merger work, Welch wondered.

The other bold project Welch wanted to know about concerned Airbus itself. Would it follow through on audacious plans to manufacture a 600-seat to 800-seat "superjumbo" plane--the largest commercial airplane ever imagined? Welch, who sells over $10 billion in jet engines every year, picked up a little plastic model of the plane, the A3XX, on Lagardere's desk. "Jean-Luc," Welch asked, "is this thing going to get built?" Lagardere, sitting behind an ornate desk, didn't hesitate. "We are going to do it, Jack," he told Welch. "We are not going to be a niche player in airplanes. We are going to be a full global player."

FLYING PALACE. A player. Precisely. On June 25, three months after that meeting with Welch, Lagardere and his partners in Airbus officially started to take firm orders for the A3XX, a plane that could take to the skies as early as 2005. This $220 million-plus flying palace will be spacious enough to feature sleeping quarters, shops, and exercise rooms. If it succeeds, the A3XX will break the monopoly on jumbo jets that the Boeing 747 has enjoyed for decades and would clearly cement Airbus as the 21st century rival to Boeing Co. Airbus is already on a roll: It is close to reaching its stated goal of winning 50% of the over-100-seat market. But if the A3XX fails--and Boeing claims that the market for "superjumbo" planes will be a mere 400 over the next 20 years and not the 1,700 claimed by Airbus--it would be a financial catastrophe for Airbus and its backers. After all, the program will cost at least $12 billion to develop--and as much as $20 billion by some estimates.

A big bet--but that's the kind of high-risk, high-reward game a real player goes after. And the Europeans are raising their bets again. On July 10, investors will have their first chance to buy shares in Airbus' new mother company, European Aeronautic Defence & Space Co.--the very entity that Jack Welch was so intensely curious about. As he should have been. This corporation--EADS for short--stems from the merger of Lagardere's Aerospatiale Matra, the Dasa aerospace unit of the German-U.S. giant DaimlerChrysler, and Spain's Construcciones Aeronauticas, or CASA. With $22 billion in annual sales, EADS overnight will become the third-largest aerospace and defense group on the planet. By product mix, it's the European equivalent of Boeing. Civil aviation, primarily Airbus, accounts for 75% of its sales.

EADS will be a powerhouse challenging longstanding U.S. supremacy in the air. For starters, its creation will force dramatic changes at Airbus. EADS, along with Britain's BAE Systems, is now converting the unwieldy and inefficient Airbus consortium into a conventional corporation. As a publicly traded company that controls 80% of Airbus, EADS must deliver on profits to investors or get hammered in the markets. And to do that, it will have to make sure that Airbus, its prime subsidiary, is consistently profitable, too. That means defying the pressure from European governments to stress jobs over profits. That also means making the huge A3XX a commercial success.

But Airbus is just part of EADS' formidable new arsenal. EADS will have leading positions in helicopters, missile systems, and space launchers. A program under way for a large military transport aircraft, the A400M, will almost surely break the U.S. hammerlock on that market and could lead to as much as $20 billion in sales. EADS is thus positioned to be a huge rival to Boeing and Lockheed Martin Corp. "There are very, very big stakes here," says U.S. Ambassador to France Felix G. Rohatyn.

The challenges facing EADS are formidable. But they overshadow one remarkable fact: that the most impressive achievement of all may have been putting EADS together in the first place. The largely unknown story of how a handful of Germans and French secretly brought EADS to life shows just how quickly Europe is coming together as an industrial and economic reality. And the highly complex merger required bosses like Lagardere and DaimlerChrysler chief Jurgen Schrempp to work behind the backs of politicians. In Europe today, says Lagardere, "industrialists are showing the way forward--are moving faster than the politicians."

Consider the players and the outsize egos, and you get an idea of the challenge. In Paris, Lagardere long nurtured dreams to build a European aerospace giant but never had the business or political clout to pull it off. Over in Germany, Schrempp was looking for a way to maximize his own group's huge aerospace interests, which he himself had put together in the early 1990s. Looming behind everything was the French government, the outright owner of much of the country's aerospace industry, a government whose leaders were determined to stay in the driver's seat.

TORTUROUS COURSE. The idea of a pan-European aerospace and defense company--one in which shareholder value was the main goal--seemed utter fantasy barely three years ago. Across the Atlantic, the U.S. industry was fast consolidating. Europeans knew their fragmented defense groups also had to combine to compete in the post-cold war world, but national jealousies and conflicting policies seemed insurmountable obstacles.

Schrempp's ordeal illustrates the torturous course that had to be navigated. He knew DaimlerChrysler Aerospace, which had a relatively small $8.9 billion in sales, needed to link up to stay competitive. But the climate in Europe was worsening: In mid-1997, French Socialists under Lionel Jospin swept back into power on a platform opposed to further privatizations, including 100%-state-owned Aerospatiale, the largest aerospace group in the country. Schrempp felt state involvement would make any potential deal with the French impossible, so he began serious talks to merge Dasa with British Aerospace PLC.

His move galvanized the French government like nothing before. Dasa and British Aerospace were both partners in the Airbus consortium. If they merged, France's Aerospatiale would be clearly outgunned and its traditional dominance of the Airbus partnership threatened. Casting aside his campaign pledges, Prime Minister Jospin secretly endorsed a bold plan to privatize Aerospatiale and merge it with Matra, a large defense contractor controlled by Lagardere. Jospin reasoned that since the government would retain a large stake, it could still pretty much call the shots. "We had to be as industrially strong as possible to stay in the game," remembers Frederic Lavenir, a key high-ranking Finance Ministry official who helped structure the merger.

The planned tie-up, announced to a surprised French public in July, 1998, threw together two extraordinary individuals for the first time: Lagardere and powerful Finance Minister Dominique Strauss-Kahn. They couldn't have been more different. The perpetually tanned Lagardere, a James Bond fan who put together Matra and the Hachette publishing empire, had resisted the meddling ways of France's Socialists for years. Strauss-Kahn was a long-time Socialist but was single-handedly moving the entire government toward the center. And he was ready to embrace a market solution to the Airbus issue.

Enter Schrempp. Just three weeks after the Aerospatiale-Matra merger was announced, the German executive met Lagardere for a lunch at the Frenchman's sumptuous 18th century townhouse in Paris' ultrachic 7th Arrondissement. During the meal, Schrempp dropped a surprise on Lagardere. He wanted to cut the French in on the BAE-Daimler deal. "Let's go for a Big Bang and do a three-way instead of a two-way deal," Schrempp suggested to Lagardere. Not only that, Schrempp wanted to move quickly--even before the merger between Aerospatiale and Matra was finalized. But Schrempp was fatally overreaching. The French couldn't move quickly enough, and the proposed deal lost its momentum. Much worse, in January, 1999, BAE spurned the merger with Dasa, choosing instead to link up with another British group. The Germans were now alone, and Schrempp was furious.

IN THE DARK. Within weeks, it became clear that a linkup with the French would have to be seriously reexamined. In late February, Schrempp and Lagardere met again in secret in Paris. By the meeting's end, an outline of a possible deal took form: an outright merger between Dasa and Aerospatiale Matra as soon as the merger between the two French companies was concluded. "The idea was to do something together and do it on an equal basis," says Lagardere.

But this time, Schrempp wanted no failure--or, if there was failure, no one was to know about it. After the collapse of talks with the British, the press had clearly labeled Schrempp and DaimlerChrysler as the losers. So Schrempp and Lagardere now quickly agreed that negotiations would have to be conducted in the utmost secrecy. Only three executives from each side would be involved. For the Germans, it would be Schrempp and two top DaimlerChrysler executives, Eckhard Cordes and Rudiger Grube. Lagardere would be flanked by Matra CEO Philippe Camus, who had helped rescue him from financial disaster in the late 1980s, and Jean-Louis Gergorin, Matra's brainy head of strategy who had been a top adviser to the French Foreign Ministry.

The French and German governments were kept in the dark. So were Dasa boss Manfred Bischoff, Airbus CEO Noel Forgeard, and the chairman and CEO of Aerospatiale, Yves Michot. Special high-frequency telephones Matra had developed for the French intelligence services were used for almost all important communications. And Schrempp himself came up with the code name for the top-secret project: Diamond. "Schrempp explained that this time, the merger would be indestructible," says Gergorin.

By the end of June, 1999, it was time to break the news to the French government, which retained a 48% stake in the privatized Aerospatiale Matra. On the evening of June 29, Lagardere was ushered into Jospin's hushed office in the Prime Minister's 17th century residence, the Hotel de Matignon. Only Jospin, Lagardere, and Strauss-Kahn were present. The Aerospatiale Matra chief revealed to a stunned Jospin the state of the secret negotiations with Schrempp. Neither Jospin nor Strauss-Kahn had had any idea that discussions were so advanced. "Jospin was almost speechless," remembers Lagardere, "but he was civil and polite."

As soon as Lagardere left, though, Jospin blew up. Aerospatiale Matra had only come into existence on June 11. Now, just 18 days later, Lagardere was proposing a full merger with the Germans. And, under the pact, the French state's role was to disappear. The Prime Minister "was furious about the idea of the government withdrawing totally from the company," remembers Strauss-Kahn.

But the politically astute Strauss-Kahn calmed down Jospin, who charged him in the following days with opening up back channels with the Germans. Soon, German Chancellor Gerhard Schroder himself was involved.

But the Germans played their cards badly. Since Schrempp desperately wanted to present a merger agreement to the DaimlerChrysler board in late July, he needed an answer from the French government no later than July 14. Unfortunately, that was Bastille Day. Jospin was offended by the German pressure and refused to give Schrempp an answer.

The deal looked dead: It couldn't go through without the approval of the French government. Yet, behind the scenes, Cordes, Camus, Gergorin, and Strauss-Kahn's aide Lavenir kept informal discussion on Project Diamond alive. They sensed that a deal could be salvaged.

Amazingly, their efforts began to pay off. Soon, the four were outlining the structure of a real integrated company, not just a holding company. Under French and German co-chairmen and co-CEOs, a slim, 450-person management company based in Paris and Munich would control five operating units. And from an industrial point of view, a merger would make a lot of sense: Annual cost efficiencies alone would amount to $450 million by 2004. "Industrially, we and the Germans agreed that the thing was beautiful," says Lavenir.

By early last August, Cordes, Gergorin, and Lavenir had met for a secret lunch at the French Finance Ministry to revive the merger. As the three were eating dessert, Strauss-Kahn called Lavenir's mobile phone to find out what had happened. A minute later, Camus was dialing Gergorin's cell phone from Disneyland Paris, where he was vacationing with his family.

The Germans were ready to accept a compromise and allow the French government a minority stake of 15%. Yet over in Stuttgart, Schrempp still wanted assurances that the French state's role would be limited. So on Sept. 22, Schrempp, by now the most powerful industrialist in Europe, walked into a private dining room on the seventh floor of the French Finance Ministry to work out a deal with Strauss-Kahn.

It was Schrempp who came up with the dealmaking solution: DaimlerChrysler, he suggested to Strauss-Kahn, could have a put option, allowing it to sell its entire 31% stake in EADS to Lagardere at the prevailing market price in the event of a major policy disagreement with the French government. Furthermore, Paris would only have a limited say on major acquisitions and strategy. It would have no power to stop plant closures if they were needed. Strauss-Kahn agreed. "The put option is there to put pressure on the French government if they ever want to exceed their rights as shareholders," says Dasa boss Rainer Hertrich, who is co-CEO of EADS.

FALSE RUMORS. By Oct. 5, it was time to push for closure. For the next nine days, officials from Aerospatiale Matra, DaimlerChrysler, and the French government and investment bankers from Goldman Sachs, Rothschild, and Robert Fleming worked around the clock. When the news flashed on Oct. 13 that Jospin and Schroder would be making an important joint announcement from the French city of Strasbourg on the German border, the rumors were that Daimler was going to announce a takeover of French carmaker Peugeot. Instead, the national leaders announced the birth of a new aerospace giant.

Now that EADS exists, the big question left will be whether it can work. The recent large defense linkups in the U.S. have shown that such mergers are necessary--but not sufficient--for increased competitiveness. Boeing itself has stumbled since its merger with McDonnell Douglas Corp but says it's ready to compete with the new Airbus. "Boeing has been working aggressively at improving our efficiencies and products," says Boeing Chairman and CEO Phil Condit. On a pro forma basis, EADS had some $940 million in losses in 1999--even though Airbus Industrie itself recorded an operating profit of about $1 billion.

However, the Europeans are confident. Cost efficiencies will boost profitability. They think there is much less overlap among the companies than among Americans who merged, and thus fewer conflicts to sort out. With Airbus charging ahead--its 476 new orders last year gave it a 51% market share--they don't have to think right now about unpleasant and possibly disruptive layoffs. Lagardere is keeping his vow to Welch: EADS will be a global player. Investors will be watching to see if it's also a winner.