View from City Road: BAe needs a history lesson

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The Independent Online
British Aerospace has been talking to VSEL about a get-together for the best part of a year so it was only to be expected that it would be able to come up with at least a passable case for the agreed pounds 478.5m takeover.

Ever since the deal was first leaked a few weeks back, BAe has been busily briefing an initially sceptical City on its merits. Equipped with a disorientating array of full-colour flip charts and graphics, we were yesterday treated to the full frontal assault. Analysts came away wholly convinced. Unless GEC comes in to break up the party, which looks unlikely at this stage, the deal looks virtually done.

The case in favour runs something like this. VSEL needs BAe's experience and clout as a project manager and prime contractor. VSEL's position as a fabrication yard and subcontractor for submarines is assured, but without BAe it could not hope to secure the prime contractor's role for the upcoming Batch 2 Trafalgar contract. By the same token, nor could BAe, which has bid separately for Trafalgar. With BAe's lack of experience in naval work, the MoD would never have worn it. By default the prime contractor's role was heading towards GEC with VSEL in the junior position. Moreover, BAe's international marketing organisation ought to give VSEL a fighting chance of winning foreign contracts and perhaps some surface-vessel work too.

There are also strong financial attractions in the deal for BAe. VSEL's cash position will at a stroke reduce gearing at BAe from the present 39 per cent to 10 per cent. BAe emerges recapitalised and with its debts largely paid off. There is some earnings enhancement too, though only for tax reasons.

A marriage made in heaven then? Hardly. BAe's acquisition record is little short of abysmal. This takeover seems to have more logic to it than some previous ones, but BAe still has problems aplenty in its existing businesses. Management time might be better spent addressing them rather than empire-building. Though the broad thrust of the strategy being developed by Dick Evans, chief executive, looks sound, there seems a touch of hubris in his vision of prime contracting pursued 'by land, sea and air'.

History also teaches that defence contractors are not the sort of companies that should be bought for their cash. Fixed-price contracts of the type governments now like to secure can easily go wrong. You have to ask yourself why both VSEL and the MoD are so keen on this transaction. Part of the answer must be that the price of Trafalgar and other contracts is to be squeezed to a level that makes them highly dangerous as money- making propositions, only really feasible for companies of the size to weather the losses. The City seems to be sold on this deal, but don't say you were not warned if a few years down the line BAe blames a poor financial showing on problems with its core Trafalgar contract.