Battle Stations

Can European contender EADS grab a big share of global defense contracts?

For a company that came into existence only two years ago, European Aeronautic Defense & Space Co. (EADS) has certainly packed a lot into its short life. Just how much was demonstrated at Britain's Farnborough International Airshow in late July, where EADS acted less like a toddler than a confident grown-up. The company showed off its products, from the newest addition to its Cougar family of combat helicopters to the brand-new A340-600 long-haul transport jet, the latest offering from its Airbus Industrie subsidiary. Then it inked a memorandum of understanding with American archrival Boeing Co. (BA ) to collaborate on the development of missile defense systems. "Little by little, we're establishing ourselves," says Philippe Camus, co-chief executive of the Franco-German-Spanish group.

But can Europe's aerospace leader be a serious contender in the estimated $150 billion global defense industry? No one contests the strong position EADS holds in commercial aircraft, where Airbus has been aggressively challenging incumbent Boeing. But its sales of military hardware have been sluggish. Defense aircraft and other gear make up only 20% of the group's 2001 revenues of $27 billion, placing it behind such giants as Lockheed Martin (LMT ), Northrop Grumman (NOC ), and Boeing itself.

The EADS bosses have embarked on a major defense push: In the uncertain post-September 11 world, that's where the money is. Defense spending is on the rise worldwide, with Washington leading the charge. The U.S. alone is projecting spending on procurement and research and development to rise from $109.5 billion in fiscal 2002 to $141.2 billion in fiscal 2007, according to DFI International, a Washington defense and aerospace consulting firm. In contrast, the commercial market is stalling, with aircraft orders down for the next few years.

There's more than just money at stake. EADS is the great strategic hope of many Europeans, who worry that Old World defense companies are being relegated to the role of lowly second-tier subcontractors. Babcock Borsig, Europe's last manufacturer of conventional submarines, is now controlled by American investors, while General Dynamics Corp. (GD ) recently snapped up Spain's largest ordnance maker. U.S. defense companies are also scoring major successes in selling to European military Establishments. Lockheed Martin's Joint Strike Fighter, for example, is starting to edge out the EADS-backed Eurofighter as the next-generation combat plane of choice for European air forces. "There is clearly an American attempt to break what's left of the European arms industry and consolidate absolute strategic dominance," says Pierre Lellouche, a member of France's ruling center-right party and an expert on military affairs. "EADS is the only decent chance for Europe to be somewhat on par with the U.S."

EADS has a double-barreled strategy to pump up its defense business, which it hopes will reach 30% of total sales by 2004. The group has set its sights on the booming U.S. market, while back home in Europe it is pinning its hopes on European governments reversing a decade-long decline in defense spending. Luckily for EADS, there is movement on both fronts--one reason why the company's stock has largely held up in value. The shares are trading at around $14 on the Paris Bourse, slightly below their initial offering price.

EADS is starting to make its presence felt in the U.S., where it already employs about 1,500 people. A major breakthrough came in June, when a consortium in which it plays a major role won an $11 billion contract to modernize the aircraft, ships, and communications systems of the U.S. Coast Guard. The payoff for EADS: as much as $2 billion in orders for radar components, helicopters, and other aircraft. "It's not the Pentagon, but it's a first step," says Camus.

The Pentagon treasure chest may not be far behind. Only a few European defense companies, such as Britain's BAE Systems, have managed to make inroads into the U.S. because of Washington's long-established preference for awarding major arms contracts to American companies. Now, though, with the Pentagon eager to involve Europeans as part of its broader defense and anti-terrorism strategy, EADS can leverage its status as the major player on the European Continent. That's the reason Boeing, the top contractor for the U.S. program to create a mainland missile shield, tapped EADS as a partner. Pentagon estimates put the cost of building a missile defense system at $48 billion through 2007. "There clearly will be room [for EADS]," says Boeing Chairman and CEO Philip M. Condit. "If you want systems to interoperate, you have to have people on both sides working on that problem."

EADS is also in a position to drum up some new business in its own backyard. Fresh from a resounding victory in June national elections, France's new center-right government is calling for a sizable increase in defense spending over the next five years. It has already boosted the defense budget by about $1 billion and wants to hike spending to at least 2.5% of gross domestic product by 2007, up from 2% now.

Germany's commitment to more weaponry is not as clear-cut. Eight European nations, plus Turkey, have committed to buying the Airbus A400M troop transport. But Germany has not come up with the cash to pay for its entire order, and Italy is having second thoughts. Without Berlin, by far the biggest customer, the A400M is a dead project.

Yet September elections in Germany are expected to usher in a new government coalition, resulting in a boost in defense spending and giving the A400M a new lease on life. "You can discuss if [military spending] is sufficient or whether it should be more," says Rainer Hertrich, the German co-CEO of EADS. "But one thing is for sure, budgets for security and defense are increasing again--and this is backed by public opinion." It all gives the phrase Fortress Europe an entirely new meaning. EADS is eager to build the ramparts.

By John Rossant in Paris, with Stanley Holmes in Farnborough

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