BAE's British roots sprout trusted American faces in U.S. defense landscape

WASHINGTON Fri Sep 14, 2012 2:09pm EDT

A BAE Systems sign is seen outside the company's Warton site near Preston, northern England, in this file picture taken October 1, 2009. REUTERS/Phil Noble/Files

A BAE Systems sign is seen outside the company's Warton site near Preston, northern England, in this file picture taken October 1, 2009.

Credit: Reuters/Phil Noble/Files

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WASHINGTON (Reuters) - Around the United States, Britain's BAE Systems (BAES.L) is widely seen as just another powerful U.S. defense contractor, unlike European aerospace group EADS EAD.PA, which is always firmly identified by its French, German and Spanish roots.

With nearly 40,000 employees in states like Virginia, Texas, Pennsylvania and New Hampshire; outreach programs at myriad U.S. universities, and its own savvy lobbyists, BAE's British origins seldom merits a mention.

Now that the two companies want to tie the knot, the question is, whether BAE will be able to extend its hard-earned reputation to EADS, or whether the relationship with EADS could complicate its own business relationships in the United States.

Analysts and industry executives said BAE, which announced on Wednesday that it was in advanced merger talks with EADS, has firmly established itself in the U.S. defense industry landscape over the past decade through a series of strategic acquisitions and rigid adherence to tough security procedures.

Thousands of its employees hold government security clearances and BAE is a member of the Aerospace Industries Association, the U.S. aerospace and defense industry's largest trade group, which has steadfastly refused to admit EADS because its shareholders include foreign governments.

Linda Hudson, chief executive of BAE's U.S. unit and a member of the parent company's board, said her company had a unique special security agreement that allowed the U.S. unit to work on the highest level U.S. national security programs.

"It creates a very interesting and complicated dynamic because in essence, our parent can't tell us what to do," she said, adding that the security agreement limits the amount and type of information that the British parent can get about the U.S. unit's work.

Details of the proposed merger are still being worked out, but BAE's statement on Wednesday made clear that it intends to continue the special security agreement and extend it to include EADS. EADS also has a special security agreement, but does not work on similarly sensitive programs, analysts and industry executives said.

Special security agreements give companies more flexibility than more restrictive proxy deals, like the one used for DRS Technologies Corp when it was taken over by Finmeccanica SpA (SIFI.MI). One big difference is that a proxy board must be made up solely by U.S. citizens.

Two sources familiar with the merger plans said the U.S. government might seek to carve out some BAE business and put it under a proxy agreement, but gave no further details.

Rob Stallard, an analyst with RBC Capital Markets, said BAE's strong relationship with the U.S. government was the product of a slow and deliberate strategy.

"BAE's moves to become a significant presence in the U.S. defense market have been clever. Rather than trying to do a mega deal, which could have been blocked, it has done a series of smaller acquisitions that, put together, add up to a sizeable portfolio," said Stallard.

Washington's close ties with Britain also played a role in BAE's naturalization as a quasi-American corporate citizen, as has its significant role on the Pentagon's biggest weapons program, the $396 billion F-35 Joint Strike Fighter, analysts said.

BAE's first big acquisition was to buy Sanders Associates, which makes electronic warfare equipment, from Lockheed Martin Corp (LMT.N) in 2000, followed by the 2005 acquisition of United Defense Industries, maker of the Bradley Fighting Vehicle. Then in 2007, it acquired Armor Holdings, the largest maker of armor for military Humvee vehicles.

Over the years, it integrated those acquisitions and established BAE as a powerful brand, analysts said.

BAE generated $14.4 billion in revenues in the United States last year, ranking it among the Pentagon's top 10 contractors. During the height of the Iraq and Afghanistan wars, it rose to the No.5 spot due to its work on a variety of ground combat vehicles, including mine-resistant trucks.

EADS' U.S. sales totaled $1.4 billion last year.

"BAE's employees are almost all American, their board members are almost all American and their relationships are almost all American," said Loren Thompson, a Virginia-based defense consultant and sometime adviser to BAE's U.S. unit.

He said U.S. military officials had a positive view of BAE given its successful execution on many big programs. He said the success of a merged EADS-BAE group in the United States would depend on the structure of the special security deal.

The Obama administration's emphasis on encouraging collaboration with U.S. allies and boosting competition could enhance the deal's chances, he said, noting the Pentagon had already granted EADS permission to compete on its own in the 2010 aerial refueling competition ultimately won by Boeing Co (BA.N).

"BAE can't get any bigger in the U.S. military until it has more financial resources, so putting these two companies together broadens the range of competitive options," he said.

(Additional reporting by Soyoung Kim in New York; Editing by Matt Driskill)

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