BAE Systems

Changing places

Oct 26th 2006
From The Economist print edition

Britain's national defence champion may soon be American

THE divorce has been so long in the making that few eyebrows were raised when Lord Drayson, the defence-procurement minister, said he was “relaxed” at the prospect of BAE Systems, Britain's biggest defence contractor, leaving the country. More important than who owns BAE, Lord Drayson told the Financial Times in an interview published on October 23rd, is where the company's skills and intellectual property reside.

Lord Drayson's comments are of more than passing interest to BAE, whose heritage can be traced back to the firms that built the Spitfire and Hurricane fighters that duelled with German aircraft in the Battle of Britain. The firm has long wanted to move to America where defence spending is almost ten times higher than in its home market (see chart). But it can do so only if the British government lifts a veto barring takeovers and foreign management of BAE established when the company was privatised in 1985.

Although BAE already sells more weapons in America than it does at home, it is shackled by a security agreement that requires its business there to be run by citizens of that country. Not even Mike Turner, the company's chief executive, is allowed to know the details of its most sensitive American contracts. This constraint is becoming untenable now that almost two-fifths of its sales are there.

And although the company is well rooted in America—its directors include Anthony Zinni, a former general, and Richard Kerr, a former deputy director of the Central Intelligence Agency—it still bumps up against protectionist sentiment. “The only way BAE can move its business forward is by becoming American,” says Paul Beaver, a defence analyst.

The company coyly says that it does not plan to become American until half of all sales are made there and Americans hold half its stock (it reckons they now hold about a third of the company), but it may not have long to wait. Last year it completed the $4.2 billion acquisition of United Defense, a maker of infantry carriers, to become the seventh-largest defence contractor in America. The purchase was cannily timed. More than $17 billion has recently been set aside by the defence department to repair and replace the tanks and vehicles that are being worn out by constant use in Iraq.

At the same time BAE is scaling back some of its businesses in Europe, where defence spending has fallen. This month it sold its 20% stake in Airbus, a troubled maker of (mostly) civilian jets, freeing up cash for more American acquisitions.

But the move presents its own risks. Although BAE tries to present itself as a local company in each of its markets, ownership still matters in the defence industry. In tying itself to America BAE may be forced to withdraw from other markets. For two decades it has been sustained by the flow of £43 billion ($80 billion) from the Al Yamamah contract to supply Saudi Arabia with jets. The order would probably have gone to American firms but for that country's powerful pro-Israeli lobby.

Moving abroad may also threaten its detente with the Ministry of Defence. After years of clashing with BAE over cost overruns the government has now begun treating it like a national champion of old, says Keith Hartley, who heads the Centre for Defence Economics at York University. The government may not be quite as generous when signing contracts if it becomes just another American contractor.

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