Aerospace|defense: does Russian Investment in EADS|Airbus make sense?

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Manufacturing News, Source : The Manufacturer US
Published : 23 Oct 2006 14:30

Vneshtorgbank, a state-owned Russian Bank, has taken an equity position of a little over 5 percent in EADS, the parent of Airbus – buying up shares in the open market. Why? And what does this mean for the global aerospace industry, and for the rivalry between Airbus and Boeing?

The obvious answer is that the Russians are using their new petrodollars to invest in industries important to them. Clearly they are seeking closer ties to Western aerospace companies, given the difficulty in going it alone, perhaps drawing their newly consolidated United Aircraft Company closer to Airbus. Also, by being a large investor with a stake similar to that owned by the Spanish government, there is an implied obligation to place work share in Russia. Lastly, Vneshtorgbank may view EADS shares as a bargain, taking advantage of equities that they perceive as undervalued, given the 25 percent devaluation of shares after the A380 delivery delay and challenges in management continuity.

But it is not a one way street. Airbus has a 10 percent stake in Irkut, the Russian maker of Sukhoi fighter jets. Finmeccanica is an investor and major participant in the new Russian Regional Jet. Finally, Boeing has over 1,300 engineers in Russia providing substantial development work for the new 787 Dreamliner. These companies are taking advantage of Russia’s highly experienced and low-cost labor pool.

The Russian investment in EADS of approximately $1.2 billion was obtained on the open market, thus does not translate directly to a cash infusion into EADS and Airbus in particular. However, Airbus could use the cash, given the over-budget performance on the A380 launch, the estimated $10 billion needed for the A350XWB redevelopment, let alone the need to respond to Boeing’s expected next-generation single aisle airplane – necessitating a replacement for Airbus’ A320 in the next 5 -10 years. Airbus has State launch aid available to them, but is hesitant to use it due to a pending WTO trade dispute case. Airbus appears to also have unused debt capacity at its disposal, but a major shareholder with ever-growing financial capacity and the desire to participate is an opportunity that Airbus could avail itself of.

The more informed answer to the question is that a minority investment in EADS by the Russian government is not the start, but a continuance of a trend that has been playing out for years. The trend is continuing its pace from fractionalization to rationalization and alliance making in the global aerospace & defense industry. Some examples:

• The original Airbus consortium of private industry and the governments of Spain, Germany, France and the UK

• The United Space Alliance as well as the pending United Launch Alliance partnership of Lockheed Martin and Boeing

• Boeing outsourcing of some of its design authority and manufacturing of major components to Kawasaki, Mitsubishi and Fuji Heavy industries

• The recapitalization of US Airways by Airbus, Air Canada Maintenance, credit card companies and private equity investors

The reason for this trend is that there is not enough market for several Prime contractors to exist. The risk of not capturing market share is too great. Also, customer countries typically have enough influence to capture work share, and equity investments over time can achieve that. In the world of fewer prime contractors, less differentiation in product, higher risk of losing market share on large orders, and the trend toward major subassembly outsourcing, it behooves the Russian aerospace industry to get aligned with American and European prime contractors. The Russians are investing in EADS because they want to participate in the global A&D market, thus need to be more closely aligned with the existing mega-players:. it is easier and more fruitful to get on their platforms, than to compete with them.

What it means for Boeing is that their investment in the Russian engineering center and outsourcing certain components does not mean the Russian airplane market should be taken for granted. For Airbus, taking on a new investor with expectations of work share means more interference from government entities, which must be managed carefully to minimize duplicate manufacturing and final assembly facilities which would drive the product cost up.

Tom Captain, is a Principal and Senior member of Deloitte Consulting’s Aerospace & Defense industry practice, based in Seattle, WA.

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