Could BAE-EADS Give Boeing a Lift?

The U.S. giant is clearly concerned, but things could work out well

   
Could BAE-EADS Give Boeing a Lift?

EADS (PINK:EADSY) CEO Tom Enders recently sent a letter to his employees, assuring them that the proposed $45 billion merger between itself and BAE Systems (PINK:BAESY) is a perfect fit that will produce a more balanced business with an almost 50/50 split between its commercial aircraft and defense segments.

Boeing (NYSE:BA), of course, is concerned about how the merger would affect its ability to win defense contracts with a more formidable opponent in the ring. While it’s natural to have these concerns, it’s also possible the merger could turn out to be a good thing for Boeing.

Currently, Boeing is the second-largest contractor in the U.S. defense sector with 2011 government contracts of $22.1 billion. BAE Systems and EADS combined had $8 billion. With the exception of EADS’ UH-72 Lakota light-utility helicopters, it has struggled mightily when it comes to winning U.S. defense contracts. Adding the heft of BAE Systems, the ninth-largest contractor, will get it into the game.

The big question is: What will that game look like in the future? The U.S. defense budget in 2012 is $645.7 billion. By 2017, estimates suggest it will shrink to $611 billion.

Assuming Boeing’s numbers remain flat over the next five years, regardless of what EADS/BAE does, it will gain market share. In addition, you can be sure that Boeing will remind U.S. and European regulators about the rubber stamp they gave EADS/BAE when it takes its turn in the consolidation movement underway in the defense sector. EADS/BAE could be cutting off its nose to spite Boeing’s face.

While most of the emphasis on the potential merger has been on its benefits in the defense sector, don’t forget about commercial aircraft, where EADS has laid a beating on Boeing for the better part of the last decade.

However, Boeing appears to be ahead of Airbus in 2012 with 696 orders as of Sept. 18, compared with 384 for Airbus. Not surprisingly, single-aisle aircraft — Boeing’s 737 and Airbus’ A320 — account for 95% of the orders year-to-date. In a typical year, Airbus has taken 52% of the narrow-body orders. This year it looks as though Boeing is going to upset the applecart.

Boeing is doing particularly well in the Asia/Pacific market, where it expects to deliver more than 12,000 airplanes over the next 20 years. In February, Indonesia’s Lion Air ordered 230 of Boeing’s 737 at a cost of $21.7 billion, including 29 of its next-generation 737-900 ERs. China and India represent the second- and third-biggest backlog for the company. With Asia/Pacific expected to grow its share of the world’s GDP from 28% today to 36% in 2031, this is the battleground in the commercial aircraft industry.

In 2011, single-aisle aircraft accounted for 62% of the world’s fleet, and is forecast to rise to 69% by 2031. Boeing estimates that the Asia/Pacific region will require 7,990 and 3,230 new single-aisle and twin-aisle airplanes, respectively, in the next 20 years. With EADS busy working a deal with BAE, it’s possible it could drop the ball in a highly competitive industry. Market share is definitely up for grabs in Asia/Pacific.

It”s clear that both Boeing and EADS/BAE will be affected by this merger in ways we can’t even begin to contemplate. Before we put the cart before the horse, it’s important to understand how the existing shareholders of EADS and BAE feel about this whole situation. Both, it would appear, have some serious concerns.

On the EADS side, investors feel the progress made at Airbus is being squandered by merging defense assets that have few synergies. Furthermore, despite revenues that are more than double BAE’s, it will own just 60% of the merged entity.

On the other hand, some BAE shareholders feel its management is throwing in the towel at the absolute worst time to do so — when the defense sector is at the bottom of the valuation cycle. They believe it’s better to wait for the dust to clear on U.S. defense spending cuts before seeking any type of merger.

It’s important to remember that BAE owned 20% of Airbus as recently as 2006, when it sold its stake to EADS for $3.5 billion so it could focus on defense. Once the bigger of the two companies, BAE now is crawling back to its potential merger partner, hat in hand.

So why is any of this good for Boeing?

It’s in a real dogfight with Airbus. It needs to be at the top of its game if it wants to remain the best commercial aircraft maker in the world. Having its biggest competitor distracted by a merger that could take a year or more to complete should be music to its ears.

Besides, there’s no evidence that the combination of EADS and BAE equals more than two. Worrying about what it can’t control (although lobbying is more than likely) is simply wasted energy. As for EADS and BAE, be careful what you wish for, you just might get it.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 


Article printed from InvestorPlace Media, http://investorplace.com/2012/09/could-bae-eads-give-boeing-a-lift/.

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