An Aerospace Behemoth Lifts Off

EADS is racking up orders, but the outlook is bumpy

It was the year EADS stole the Paris Air Show. Not only did the European Aeronautics Defence & Space Co. boast the biggest, most elaborate digs of any exhibitor at the biannual trade fair. It also chalked up the show's richest defense deal--an agreement by nine European governments to spend up to $17 billion on a new military transport plane, the A400M. And on the commercial side, EADS's Airbus unit snared its fattest order ever, an $8.7 billion deal with International Lease Finance Corp. for 111 planes. Archrival Boeing Co. announced only a handful of orders and left the airshow with year-to-date orders totaling only 124, compared with 299 for Airbus. Already Europe's biggest aerospace company, EADS says that by next year it will surpass Lockheed Martin Corp. to become the world's No. 2 in aerospace, behind Boeing.

But EADS has hard work ahead. The A400M alone won't be enough to shore up its money-losing defense business, which has suffered from a decade of steady decline in European military budgets. At the same time, the global economic downturn and airline industry consolidation are darkening the horizons at its most profitable unit, Airbus. The commercial jetmaker faces at least a 20% falloff in new orders this year, as well as delays of dozens of earlier orders. EADS has a nice backlog of orders, and revenues are expected to rise 20% this year, to more than $25 billion, with pretax earnings up 15%, to $1.3 billion. But the expected weakness in commercial jets could start to weigh on the bottom line by next year.

That's why EADS is setting its sights on the U.S., which spends four times as much as all of Europe on defense research and development. During the Paris trade fair, EADS showcased its military reconnaissance and surveillance project with Northrop Grumman, talked up the idea of joining Boeing's air traffic control project, and even expressed interest in working on the Bush Administration's proposed national missile defense program. "We are pursuing cooperation wherever there are opportunities," says co-chief executive Philippe Camus.

"NATIONAL ISSUE." Pushing into the U.S. won't be easy, though. U.S. government controls on technology exports could limit the Europeans' access to defense contracts. And while the Bush Administration might welcome EADS's participation in missile defense in hopes of easing European opposition to the plan, company officials admit privately that EADS wouldn't have a significant role unless European governments agreed to cough up money for the proj-ect--something the governments are unlikely to do.

EADS's unusual management structure complicates its task. In theory, it has operated as an integrated company since the merger last July of France's Aerospatiale Matra, Germany's DASA Aerospace, and Spain's CASA. But it has two CEOs--Camus of France and Rainer Hertrich of Germany--and two headquarters, one in Paris and the other in Munich. Chairman Manfred Bischoff acknowledges that the company's 100,000 employees are still learning to work together. "Sometimes one is a Frenchman and the other is German, and they make it into a national issue," he says. "But we have to adapt to each other." One example: Senior German and French executives were summoned to Paris recently for a meeting. But the secretaries scheduled the meeting at the beginning of France's Easter holiday. The entire German team showed up from Munich, but only two Frenchmen attended.

Another big question is EADS's relationship with Airbus, in which it owns an 80% stake. Under CEO Noel Forgeard, Airbus is being transformed from an unwieldy consortium of partners into a streamlined manufacturer. Until now, EADS has given relatively free rein to Forgeard's team because Airbus generates more than 80% of EADS's operating profits. But if Airbus flies into serious turbulence, it's unclear whether EADS would be able to assert much stronger oversight.

These cross-currents and uncertainties make investors especially anxious about the eventual success of the A400M. Although Camus insists the A400M is a firm contract agreement and that the planes will be flying in 2005 or 2006, the political and logistical process of building the plane will be far from smooth. Because of EADS rules that allocate a percentage of manufacturing work to shareholders based on the percentage of ownership, the Spanish get to assemble the cargo planes. So they are building a factory in Seville to create jobs, rather than using an existing factory elsewhere in Europe. "The lack of progress on A400M is becoming an all-too-familiar example of pan-European procurement," says Christopher Mecray, a Deutsche Bank analyst.

Despite such challenges, EADS has come a long way since its creation almost a year ago. It has an order backlog of $160 billion. The company is on track to save nearly $600 million from merger synergies, chiefly from the consolidation of purchasing, and expects to boost margins to 10% by 2004. "We are absolutely confident that we will achieve this goal," Hertrich says.

Until now, EADS investors have had a smooth ride thanks to Airbus, which accounts for more than 80% of operating profits. EADS shares are trading at $21, close to their record high last fall--not bad, considering the downdraft that has hit global bourses.

But with U.S. airline passenger loads down 3% to 5% since the beginning of the year, Airbus expects to log no more than 400 aircraft orders this year, down from 520 in 2000. Already, 50% of Airbus customers are declining to exercise options for additional purchases. Trans World Airlines will probably cancel 44 orders. Financially troubled Belgian carrier Sabena will probably cancel orders for nineteen. Airbus commercial director John Leahy insists such setbacks are "manageable." But analyst Nick Cunningham of Schroder Salomon Smith Barney says that if the current downturn continues, airlines will start asking Airbus to delay delivery of planes they've ordered. That could start squeezing revenues by mid-2002.

All the more reason to strike out across the Atlantic. At Le Bourget, EADS and U.S. contractor Northrop Grumman Corp. shared a pavilion. "We know that we are too Europe-centered," says EADS chief strategist Jean-Louis Gergorin. EADS is especially interested in satellite ventures with U.S. companies, as well as mission aircraft. How about just scooping up a U.S. defense company? "We would do acquisitions only if we are welcome," he says. Spoken like a diplomat--which is what you need to be when you work for a company like EADS.

By Stanley Holmes and Carol Matlack in Paris

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