Hands -- And Arms -- Across The Sea

How the U.S. unit of Britain's BAE wins contracts with the Pentagon

In an effort to protect jobs and technology, Congress has tried to build a fence around U.S. defense contractors -- an endeavor critics have dubbed "Fortress America." But while the lawmakers were laying their plans, they overlooked something important: The British were coming. In particular, many missed the rise of BAE Systems PLC's American subsidiary. Thanks to its $4.2 billion purchase of United Defense Industries Inc. earlier this year, the foreign-owned unit has elbowed its way into the Top 10 U.S. defense contractors, ahead of such stalwarts as United Technologies (UTX ), L-3 Communications (LLL ), and Rockwell Collins (COL ).

BAE's dramatic ascent comes at a peculiar juncture for the U.S. defense industry. Many lawmakers insist that the government should purchase home-grown defense gear, limit foreign acquisitions of defense-related assets, and keep a tight lid on exports of even unclassified technology. Yet somehow, the Rockville (Md.) unit of BAE is always the exception. The United Defense deal was just the latest prize BAE has nabbed. In 2004 alone, it acquired five U.S. defense concerns worth $700 million. That has made the parent company -- a product of the 1999 merger of British Aerospace and GEC-Marconi -- the most powerful multinational in the defense sector. The company has far-flung operations ranging from Sweden to Saudi Arabia to South Africa, with the U.S. now accounting for 40% of the parent's $25 billion in annual sales. And 35,000 of the company's total workforce of 100,000 are in the U.S.

Defense experts say BAE's decision to separate itself from the European pack by focusing on the U.S. market was shrewd. "The U.S. spends more money by accident [on the military] than Europe does on purpose," jokes defense consultant Robert A. Basil of Potomac, Md. And increasingly, the U.S. military depends on global supply chains to keep troops in the trenches outfitted with the best technology at the best price.

That hasn't stopped Congress from trying to stem the tide. But BAE's Rockville unit probably has little to fear from "Buy America" requirements because so much of its military gear is made in the U.S. Nor is the increased scrutiny on foreign purchases of U.S. firms, sparked by a Chinese bid for Unocal, likely to hurt BAE. Even Senator James M. Inhofe (R-Okla.), who wants to make it tougher to buy U.S. companies, says the British are "totally different" from the Chinese.

The one big stumbling block for BAE's U.S. arm is lawmakers' refusal to ease curbs on technology exports. That has created a Kafkaesque chasm between London and Rockville, Md. "Economically, globalization is well under way, but politically, it's stagnated," says Michael D. Ryan, executive vice-president for government relations at Rolls-Royce North America.

The special status of BAE Systems Inc., as the U.S. unit is known, dates to the later years of the Clinton Administration. That's when the company became the only subsidiary of a foreign defense contractor to win a blanket "national-interest determination" from the Pentagon -- meaning it gets streamlined handling of approvals to work on classified contracts.

The strange thing is, the parent company doesn't enjoy the same level of trust. In fact, BAE's U.S. arm had to accept strict controls over what it can say to London. Headquarters receives a profit-and-loss statement, but U.S.-based officials may not discuss the details of many American programs. That has been a particular problem with the Air Force's big Joint Strike Fighter program. Although the British government is investing $2 billion in the aircraft, the British side of BAE has trouble getting information needed to carry out work. Londoners can't even offer technical support to their American colleagues without an export license -- a source of frustration for BAE Systems PLC Chairman Richard L. Olver. "We can't provide a solution if we don't know what the problem is," Olver griped in a speech in Washington in July.


On the other hand, distance from the head office can bring benefits to the subsidiary. Because of Rockville's special security status and track record, it can compete on contracts and buy companies with fewer hassles than other foreign units. That has enabled it to hit ambitious targets of 10% organic growth and 10%-to-15% growth through acquisitions.

The U.S. unit's chief executive officer, 64-year-old Mark H. Ronald, started plotting expansion in the U.S. back in the 1990s when he was a top executive at GEC-Marconi. His first bold move came in 1998, when he launched a $1.4 billion bid for Tracor Inc., an Austin (Tex.) company that performed a lot of hush-hush information-technology tasks for the intelligence community. To get the spymeisters' O.K., Ronald agreed to put former top intelligence officials on his board in the role of security overseers. The U.S. unit's directors today include Richard J. Kerr, former No. 2 at the CIA; retired General Kenneth A. Minihan, former director of the National Security Agency; and retired Marine Corps General Anthony C. Zinni, former commander-in-chief of Central Command.

Their presence may soothe the spooks, but it also trips alarms with various government watchdogs. If Washington, in effect, requires foreign-owned companies to hire former officials as a condition for doing business with Uncle Sam, there could be conflicts of interest. And "the revolving door almost becomes a good thing," fumes Danielle Brian, executive director of the Washington-based Project on Government Oversight.

Employing Washington insiders who meet often with Pentagon and intelligence agency officials has helped pave the way for acquisitions, BAE officials acknowledge. The company's track record also helps. In 2000, BAE wanted to buy a Lockheed Martin Corp. unit that included Sanders Electronics Ltd., a maker of super-secret electronic warfare gear. The Pentagon reviewed the U.S. subsidiary's compliance with previous security pledges and found that BAE does "as good or a better job than U.S.- owned companies," recalls Jacques S. Gansler, a top Pentagon official in the Clinton Administration.

Still, Congress aims to preserve some barriers against data-sharing with British companies -- including BAE's headquarters -- on a host of programs. During the runup to the Iraq War, British Prime Minister Tony Blair lobbied President Bush for a waiver of export-license requirements. In addition to the obvious benefits for British contractors, sharing data would make it easier for British soldiers and GIs to fight side by side, Blair argued, according to a British aide.

Bush proposed a waiver to Congress but couldn't line up support, even from the GOP. Blair was sorely disappointed, according to the British official -- and the prospects for change in the near future are dim. "There is no way [the waiver] is ever going to happen," says an aide to House International Relations Committee Chairman Henry J. Hyde (R-Ill.).

Gary A. Powell, Acting Deputy Defense Under Secretary for industrial policy, believes the desire to nurture purely American military supply lines is outdated. In a world where full-fledged combat can last only weeks, controlling an industrial base for a World War II-like surge capacity no longer makes sense. "We plan to fight with what we have," he says. More and more, that means gear made by BAE.

By Stan Crock

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