Russia Jumps into the Aerospace Race

With the nation's own aircraft industry in a sorry state, government-led VneshTorgBank has bought almost 5% of Airbus owner EADS

An opportunistic piece of financial speculation, or the first stage in an ambitious new strategic partnership? That's the big question after news that Russia's VneshTorgBank (VTB) has invested around $1 billion to acquire almost 5% of the European Aeronautic Defence & Space Corporation (EADS), the Franco-German aerospace concern that owns Airbus, the world's largest commercial aircraft producer.

Russia's leading business daily Vedomosti broke the news on Aug. 29, citing anonymous Russian government sources. According to the newspaper, the state-owned bank began purchasing EADS shares two months ago on the open market, and has now acquired a stake between 4.5% and 4.8%.

The transaction is a reminder of how high oil prices have filled Russian coffers, with more and more of that windfall now finding its way into investments abroad. And in part, VTB's interest can be explained by the attractive price of EADS shares.

In recent months the company has been beset by difficulties that have depressed its share price by some 40% since it peaked in March. Problems included delays to the development of its new A380 airliner, as well as management conflicts.


  But while VTB's purchase may well make good financial sense, it's likely that the Russians are not just interested in playing the stock market. VTB, which is 100% government-owned and Russia's second largest bank by assets, is known to work closely with the Russian government. And the government sources cited in the Russian media have made no secret of the wider strategic objectives behind VTB's purchase. These include the hope that, as an EADS shareholder, the Kremlin (acting through VTB) will be given some say in EADS's management.

True, in itself VTB's acquisition doesn't give the Russians any rights. Under the EADS charter, no one can join the board of directors without the consent of the company's two largest shareholders—Germany's DaimlerChrysler (DCX) and French aerospace and media group Lagardère. In practice, hopes of greater Russian involvement are likely to depend on talks between the respective governments.

The idea of Russian involvement in the consortium was already raised in December, 2004, talks between Russian President Vladimir Putin and then German Chancellor Gerhard Schröder. Russian media speculate that it may well be on the agenda of a three-way summit between Putin, Germany's Angela Merkel, and French President Jacques Chirac, scheduled to be held later this month. By instructing VTB to buy EADS shares cheaply over the summer, Russia seems to have been anticipating a subsequent deal—and getting a head start when the price was low.


  So why are the Russians so keen to get involved in EADS? Oddly enough, Russia's unprecedented investment abroad may have mainly to do with the needs of Russia's own struggling aerospace industry, says Elena Sakhnova, an aviation analyst at Moscow investment bank Deutsche UFG. "The main goal of the purchase [of EADS shares]: Russia doesn't have very good technologies in civil aviation, while Europe definitely has very good technologies. If Russia wants to be in this industry it needs to cooperate with either Europe or America."

It's surely no coincidence that Russia's interest in EADS comes at a time when Russia's own aviation sector is in the throes of an ambitious, state-led restructuring. The plan was approved by President Putin earlier this year and is set to be finalized in the coming months.

It will see Russia's various planemakers merged into a single aviation holding called United Aircraft. The aim is to pool financial resources and create economies of scale so that Russia's aviation industry will be able to compete internationally.


  The woeful state of Russia's commercial jet industry was underscored on Aug. 22 when a Tupelov-154 jetliner crashed near Donetsk, Ukraine, killing all 170 aboard. The accident prompted Prime Minister Mikhail Fradkov to call for increased investment to modernize the industry. "We do not have the right to lose our national aviation industry, that is indisputable," Fradkov said on Aug. 31.

The new aviation holding will be dominated by the state, which is set to be a 75% shareholder initially. But Russia is also keen to attract foreign partners that could bring the technologies needed to drag Russia's aircraft designs into the 21st century.

It's pinning its hopes on niche aircraft such as the Sukhoi Superjet (or Russian Regional Jet), a new short-haul passenger craft that the Russians believe has huge international market potential. Foreign partners already involved in the project include Boeing, French enginemaker Snecma, and Italian engineering concern Finmeccanica.

At the same time, Russia hopes that cooperation with global planemakers will give its industry a growing role in the design and production of parts for new long-range jets, currently being developed by Airbus and Boeing. That would help generate some of the billions of dollars needed in order to modernize aging production lines and develop new models like the Superjet.


  EADS is already set to acquire a shareholding in the new Russian aviation structure. In December, 2004, EADS bought a 10% stake in Irkut, a leading Russian planemaker that makes the Be-200 amphibian—another new Russian design with potential global appeal. Irkut's consolidation into the new holding means that EADS is set to get a stake of 3% or 4% in United Aircraft.

That share could well increase, especially if the Russians also increase their stake in EADS. For the Russians, the presence of the leading European player in their new aircraft corporation could open the way for both Western technologies and Western markets.

In return, EADS involvement would give it greater access to Russia's cheap yet talented engineers. What's more, it may also get the inside track when it comes to selling aircraft to Russia.


  VTB's investment comes at a time when both EADS and archrival Boeing are waiting for Russia's decision on a $3 billion contract for new jetliners for Russian national carrier Aeroflot. It's a reminder that, while Russia may not be comparable to some other global markets, it's still strong enough to have international planemakers drooling.

But there's a big risk for EADS here: Given current political tensions between Russia and the U.S., an increased Russian role in the company could jeopardize its efforts to snare rich U.S. defense contracts. EADS is vying with Boeing for contracts to replace the Air Force's aging fleet of refueling tanker planes, a deal worth tens of billions. But the European company faces a tough battle on Capitol Hill, and Russia's presence could make it even tougher.

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