Friday, May 4, 2007

Defense Market Report

Exclusive to HDS
BAE bailing out of Airbus

By James. H. Smith
April 10, 2006

If investors are nervous about the future for US defense equities, they should take solace from a decision by BAE Systems, Europe's largest defense contractor, to sell its 20 per cent stake in Airbus to parent company EADS to pursue acquisitions in the defense sector in the US.


The bailout is not unexpected, especially as shares in BAE and EADS are trading at high multiples. The BAE stake is estimated to be worth about US$4.3 billion.

Talks are at a preliminary stage between BAE and EADS about the selloff.

But the point is that, if BAE is bullish on the sector, investors ought to be less skittish about taking the plunge or hanging tight with what they own.

I did a CNN interview today and was asked why BAE would want to cash out.

The answer is easy. In addition to high multiples, the aircraft industry is highly cyclical. Airlines tend to order aircraft when they have cash but take delivery during the down cycle.

The aircraft business is not a game for boys.

Added to the stew is that, although Airbus more orders than rival Boeing in terms of numbers of aircraft ordered during 2005 - 1,055 versus 1,002 - those statistics are deceptive. Most of the Airbus orders were for single-aisle aircraft while a large percentage of Boeing orders were for more expensive two-aisle planes.

While Boeing posted a 49 per cent market share as measured by number of aircraft, the US manufacturer posted a 55 per cent market share measured by dollars.

Value of aircraft sold by both manufacturers amounted to slightly over US$200 billion.

On top of that, each manufacturer has a new fuel-efficient offering in the commercial airplane sector; Airbus has the A350, which so far has garnered 182 orders and commitments; Boeing reports 385 orders for its rival B-787.

Airbus will see the A350 enter service in 2010; Boeing will make initial deliveries of the B-787 in 2008 - two years earlier.

Airbus has also launched the A380 jumbo-jet. That goliath has seen only about 160 orders and the jury is still out on whether Airbus will make money on an aircraft that, because of its size, can only take off and land in less than 40 airports worldwide.

BAE Systems might have a crystal ball. Last year, the company spent US$4.2 billion to acquire US-based United Defense Industries.

BAE has demonstrated its commitment to the US defense sector.

When the largest defense company in Europe looks across the pond for investment, you can be fairly certain that it has done its homework.

While the Small Cap investor may not have the wherewithal to do the same kind of research into the defense market, you can be sure that BAE is not shooting craps.

Disclaimer
James Smith is an independent columnist for this web site. James Smith may hold long or short positions in any of the stocks mentioned in this article and those positions can change at any moment.