So, BAE and EADS are getting hitched? While the timing is a surprise, it's no shock that two Tier One prime contractors have decided to pair up given dwindling military budgets in the West. It's also a move thought likely to spark a tide of new alliances within a woefully fragmented and inefficient European defence industry. Chemring (CHG) is already in the firing line and other London-listed favourites like Cobham (COB), Meggitt (MGGT), Ultra Electronics (ULE) and Qinetiq (QQ.) could also find their days as independents numbered.
Whether or not BAE and EADS ever tie the knot is largely irrelevant. "At a minimum we expect that announcement of the discussions between BAE and EADS will ignite a new phase of business realignments within the industry," says credit ratings agency Moody's.
Carlyle's raid on Chemring last month pre-dated the mega-merger, too. And, unlike others, the private equity firm is clearly undeterred by November's US presidential election and possible sequestration early next year. "Consolidation is long overdue," says Edward Stacey, defence analyst at Espirito Santo. "We've seen budget cuts and there's more to feed through, but industry obviously thinks it has enough of an idea what the impact of the downturn will be and of fair value."
Carlyle has jumped the gun and more cautious trade buyers may hold fire. Merger activity has slowed to a crawl this year after a flurry of activity in 2011. But the Americans - having made a fortune exiting Qinetiq in 2007 - know what they're doing, and are clearly undeterred by Chemring's recent profits warning. Getting the bid deadline extended to 12 October suggests they're serious. We'll see.
That said, trade buyers may yet decide that some assets are too tempting to leave alone. Meggitt's enviable exposure to the booming aerospace cycle - currently about half group sales - may be hard to resist. Likewise, Cobham's aerospace and security business and Ultra Electronics' long and diverse list of niche technologies. Qinetiq is in play, too, given the Ministry of Defence's decision earlier this year to dilute its so-called "golden share". Privately, chief executives admit that consolidation is inevitable. Of course, most would rather be buyers themselves, but are realistic and duty bound to put any attractive offer to shareholders. That may happen sooner rather than later.
