The spectacular ascent of British Aerospace

David Bowen reports on the resurgent group that carries the hopes of its European partners
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The Independent Online
British Aerospace is coming of age. It is 20 this year and, after a disturbed childhood and an angst-ridden adolescence, it finally seems to have sorted itself out.

The company's share price is almost pounds 13, against pounds 1 in 1991. In the past year its scrapbook has been filled with an unwonted string of positive press stories and comments. And last week as Airbus - in which it has a 20 per cent stake - announced it was going to become a self-contained company, discussion centred on how BAe would be compensated for the vastly superior performance of its factories compared with those of its German and French partners.

But it is early yet to be transported with patriotic joy. BAe may be more efficient than its partners in the Airbus consortium, but they are allies, not rivals. The real danger comes from across the Atlantic, where mergers have created monstrous aerospace and defence companies that will press efficiency to its limits.

In 1995, Lockheed teamed up with Martin Marietta to create a $23bn turnover company. Before Christmas, Boeing said it was gobbling up McDonnell Douglas - combined sales, $48bn. Then on Thursday, Raytheon announced it was buying Hughes Aircraft from General Motors; its combined sales are $21bn.

BAe is certainly more efficient than the other Airbus members - its cost base is 40 per cent lower than Aerospatiale's, for example. But with a turnover of pounds 6bn, there is absolutely no way it can match the cost structure of the United States giants. In the past, that might not have mattered too much, because the Americans concentrated so hard on home orders. But that is set to change. As Sir Richard Evans, BAe's chief executive, has pointed out: "They are promoting their products in export markets as never before."

Sir Richard has been hammering away for the past 18 months in an effort to get BAe's partners to stir their stumps. "The European response simply cannot wait for the emergence of a common foreign policy," he told the Confederation of British Industry's conference in 1995.

Sir Richard has become the uncrowned king of European aerospace, his authority coming from the success of his operation - and increasingly he is listened to. Airbus's biggest shareholders, Aerospatiale and Daimler- Benz subsidiary DASA, are all too aware that their inefficiency means they make a loss on the same business that fills BAe's coffers, and that they have much to learn from the British.

But it would be silly to suggest that Sir Richard has had more than a marginal impact on French and German policy. Rather, says Pete Deighton, an analyst with the investment bank Merrill Lynch, "politicians realised what they would have to do to achieve European monetary union - they saw the budgets wouldn't go on supporting subsidies."

As a result, the French government has merged Aerospatiale and Dassault in preparation for privatisation and has finally allowed BAe to merge its missile interests with Matra's. Aerospatiale has been talking to Lockheed Martin, and in Germany, according to NatWest Securities analyst Nick Judge, "Daimler-Benz is starting to take the concept of shareholder value quite seriously." He cites as evidence its decision to allow the loss-making subsidiary Fokker to collapse.

Sir Richard accepts that British Aerospace still has a way to go. The conversion of Airbus from a rigid groupement d'interet economique into a jointly-owned commercial company that can make its own decisions is, analysts hope, just the first stage in a massive restructuring of the European aerospace industry. The next will be to sort out the military aircraft side.

"I'm not sure how it will happen," says Mr Deighton. "But BAe will be the focus." Mr Judge suggests that the military divisions of BAe, Aerospatiale, DASA and CASA (the Spanish Airbus partner) will come together under the wing of Airbus, which will presumably have to change its name. "In five years' time there could be one huge defence company," he says. "We will be buying shares in European Aerospace, not British Aerospace."

BAe says it does not know how the industry will be reshaped but insists that something must happen. "There has to be the same sort of consolidation as there has been in the US," a spokesman says. "But it will take much longer in Europe."

All this might suggest that BAe is some sort of super-company, a world- class operator rippling, if not with muscle, with excellent management. That is over-egging the pudding. Rather, BAe has belatedly become a reasonably- run industrial company; it has just about caught up with many British manufacturers that went through their pain in the early Eighties. No one would suggest that it is yet a case study in excellence awaiting its place in the Harvard Business Review.

Why then has its share price done such remarkable things? Here we can point to a superman - at least in the eyes of the City. Richard Lapthorne joined as finance director in 1992 and applied a much-needed dose of common sense. "He worked out what the company's real costs were," Mr Deighton says, pointing out that BAe had never really got to grips with the details of aircraft finance. Five years ago an analyst commented that BAe was "far too complex to really understand - the share price just goes up and down on odd bits of news". Now, analysts feel it is eminently comprehensible - a sign of Mr Lapthorne's powers of persuasion and perhaps that BAe really has got its act together.

British Aerospace was created in 1977 with one of the last throws of the socialist dice by Industry Secretary Tony Benn. It was a state-owned "national champion" gathering the British Aircraft Corporation, Hawker Siddeley Aviation and several other companies and subsidiaries. It did not stay state-owned for long: half its shares were sold in 1981, the rest three years later. But privatisation did not bring efficiency. Not only was it cushioned by cost-plus contracts from the government, it was riven by divisions between the old pre-nationalisation groups. Managers still thought themselves "Hawker men" or "BAC men" 10 years after BAe's creation.

The company did, however, have many good military products, including the Harrier jump jet and the Rapier missile. In 1986 Dick Evans added a $2bn gloss by landing Al Yamamah, a deal that made BAe virtually responsible for Saudi Arabia's air defence. The group expanded on the civil side too, taking a stake in Airbus and launching its 146 regional jet in 1984. The 146 was a great success at first: small US airlines emerging from deregulation queued to buy "the world's quietest jet".

Only three years later, cracks were beginning to show. The weakening dollar had pushed civil aircraft into the red and in 1988 the group announced a loss of pounds 150m. That was just the start: the end of the Cold War caused havoc with defence markets and only Al Yamamah kept the company solvent. Not surprisingly Richard Evans, its architect, rose to the top.

In retrospect, the management of BAe for the next few years looks like something out of Alice in Wonderland. On the one hand there were sensible efforts to cut costs: consultants started to swarm over BAe's many plants and were shocked by what they found. "If you compare their products with the environment and attitudes in the factories," one said in 1991, "it is quite surprising they manage to turn anything out." The attentions of the consultants had results: the lead time to build the ATP turboprop was cut from 120 to 40 weeks, for example. But there was managerial resistance to really deep cuts. By 1991, one consultant said, only 30 per cent of what was possible had been achieved.

It was the other path that led to Wonderland. Professor Roland Smith, the chairman, used every trick he knew to sort out what he saw as BAe's fundamental problem - its weak balance sheet. His great coup was to buy Rover Group from the government for a knockdown price (it later emerged that a secret deal with the Trade and Industry Secretary Lord Young had reduced the price even further). He also bought Royal Ordnance, the state munitions company that was sitting on a mass of valuable land; Ballast Nedam, a Dutch builder; and Arlington Securities, a property company.

The group was starting to look increasingly like Daimler-Benz, which had moved from motor cars into aerospace, washing machines and a plethora of other areas. It was difficult to spot much industrial logic in either company.

In 1991, BAe's skeletons started rattling out of the cupboard. The first clue came when Professor Smith asked his merchant bankers to organise a rights issue to rescue the company's finances. Rover was a continuing drain on cash, while BAe's accounting naivety had brought disaster to the civil aviation division. Complex leasing arrangements meant BAe had to keep up the lease payments on an aircraft if a customer went bust; and in the hard times of the early Nineties, many 146-owning US airlines had indeed gone under.

The rights issue was the low point and stirred rumours that GEC must be about to gobble BAe up. Professor Smith was forced out and Richard Evans took full control: chairmen have come and gone, but the group has essentially been an Evans-Lapthorne show ever since.

As so often happens, crisis triggered real change. BAe sold many of its assets, including Ballast Nedam, the corporate jet division and, in 1994, Rover Group. Almost incidentally these sales gave the group a focus: it became a civil and military aerospace company, nothing else.

Its attempt to dig itself out of its civil aircraft hole was less successful. The original idea was to form a joint venture with Taiwan Aerospace - after much toing and froing, the Taiwanese pulled out. As often happens when the threat of the hangman looms, however, the division suddenly found it could cut costs massively and was allowed to survive. It has now been folded into a joint venture with Aerospatiale and Alenia of Italy.

As BAe's share price rose, it moved out of the clutches of GEC and despite the odd reverse (such as its failure to buy VSEL in 1995) it has had far more good news than bad. It has secured the second Al Yamamah contract as well as a clutch of deals in South-east Asia (including work from Indonesia that has brought controversy as well as dollars). The company received a pounds 300m windfall last year when Orange, the mobile phone firm in which it had a 32 per cent stake, was floated.

British Aerospace's real strength was that as it improved, its European counterparts did not. The Franco- German response to the threat from the US was to create what Mr Deighton calls "carve-ups" - joint ventures covering spare parts, helicopters and missiles. "It was the blind leading the blind," he says, pointing out that these ventures did not address the key issue of inefficiency.

The key question now is one of culture. Will the Germans and French really be able to change their spots, or will their corporatist instincts reassert themselves as soon as the pressure lifts a little? On that depends the future of British Aerospace. Strangely, we may know things are going well if the company ceases to exist.