EADS's Best Hope Goes Up in Smoke

For now, EADS will find it tough to win more U.S. sales

When the European Aeronautic Defence & Space Co. was formally cobbled together in mid-2000, it was meant to be united Europe's answer to America's giant aerospace and defense groups. Instead of a patchwork of national companies, the Old World would at last have a publicly traded transnational colossus to deal on equal terms with the likes of Boeing (BA ), Lockheed Martin (LMT ), and Raytheon (RTN ). Not only could EADS -- which manufactures Airbus commercial planes as well as missiles, helicopters, and advanced defense electronics -- compete with the Americans, it could now cut deals with them, too. So when the group, which logged $33 billion in sales last year, won a rich, multiyear subcontract in early 2002 to supply equipment to the U.S. Coast Guard, it looked as if the Europeans were about to grab a healthy helping of the U.S. government's $70 billion defense procurement budget.

But with the Atlantic Alliance all but in tatters over Iraq, the fact that EADS is largely a Franco-German concern is dashing hopes that it can win U.S. customers to bolster its flagging defense business. Philippe Camus, EADS's French co-CEO, acknowledged as much in an interview: "For sure, penetration of the [U.S.] defense market may become more difficult," says Camus.

That's a concern, because the commercial side of EADS's business -- the traditional moneymaker -- is also showing signs of strain. On Mar. 10, the company reported a $330 million loss for 2002, vs. a $1.4 billion profit the year earlier. Executives singled out the deep downturn in the civilian satellite-building and launching business as the main culprit. Before the global telecom market tanked, EADS's space business accounted for around 10% of overall revenues.

Senior managers at EADS headquarters in Paris and Munich have other reasons to fret. The commercial airline industry is facing its most serious crisis in history, which could dent demand for its Airbus airliners. EADS owns 80% of the Toulouse (France) planemaker, which last year supplied 60% of group sales and virtually all profits.

But no matter how poisoned the political climate is between Washington and Paris, few believe that Airbus could be shut out of the U.S. market altogether. Around 40% of Airbus procurement is from U.S. companies, from engines to onboard electronic systems. That is especially true on the 555-seat superjumbo A380, due to start flying in 2006. Yet Airbus could well lose orders as carriers in the U.S. and elsewhere reel in spending to compensate for sagging passenger volumes and rising fuel prices.

Still, with 303 deliveries of Airbus jets scheduled for this year and an order backlog of 1,505 planes -- compared with rival Boeing Co.'s 1,140 -- Camus can say with some confidence that his company "will be the leading force in commercial aerospace in the future." But will it be a force in defense, too? At a time when toting an Evian bottle is virtually seen as a disloyal act in Washington's corridors, EADS's prospects for clinching lucrative Pentagon contracts look particularly slim. Already, some U.S. legislators have been working to disrupt the upcoming Paris Air Show, the international aerospace and defense trade fair, where some of the industry's biggest deals are inked. "In the past there may have been a small possibility for a French firm or a Franco-something firm to get work in the U.S.," says Virginie Banet, European defense industry analyst at Deutsche Bank. "Now, there is no way at all."

With transatlantic defense deals no longer on the table, EADS will likely refocus itself on Europe. "We're at a turning point in European defense," says a top executive. "This is the time when a lot of cards are going to be redistributed." EADS is in pole position to benefit from any consolidation in the European defense industry, an area where the Old World has lagged the New.

The betting, in Paris anyway, is on an eventual linkup of EADS and Paris-based Thales, Europe's largest defense electronics group, with $12.6 billion in sales. Talk is that the cash-strapped French government is looking to unload its 32% stake in Thales. There are good grounds for such a union, which EADS quietly backs. The two companies have few overlapping business lines, and the combined group's annual sales would narrow the gap with Boeing, the No. 1 aerospace company. "There's the basis for a very formidable French-based competitor," says the CEO of one European aerospace group that has worked with EADS.

And who is to say that transatlantic relations won't get back on track once all the tensions surrounding Iraq subside? Camus, for one, thinks it's only a matter of time before tempers cool and EADS is back at work with American companies. EADS already has links with Boeing and Northrop Grumman Corp. (NOC ) Call me an incorrigible optimist, but I think cooperation is good for taxpayers on both sides of the Atlantic, good for joint programs, and good for global stability," he says. Thales, after all, has a two-year-old joint venture with Lexington (Mass.)-based Raytheon Co. to exploit global demand for global battlefield radar technology, as well as command and control systems. If EADS pulls off a merger with Thales, it will have the heft it needs to compete if la détente follows la rupture.

By John Rossant in Paris, with Paul Magnusson in Washington

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