When EADS and BAE Systems tried to merge last year, CEO Tom Enders of the former, was keen to point out that the deal would deliver the much-needed strengthening EADS' defense business. Less than half a year later, he posits that smaller is better.

“Maybe it is not a bad time to have a smaller rather than larger defense business,” Enders said last week at an EADS event in Berlin. The comments reflect shrinking defense budgets as much as a reality check; on its own, EADS simply does not have the capability for large growth in the defense sector. And now it is time to sell the story that profitability matters more than size. If EADS takes that statement seriously, then Cassidian—its defense unit—can expect even more draconian cuts on top of its recent round of layoffs.

Cassidian's restructuring is ongoing and a strategic review will not be finalized before a new board of directors is in place by the end of March. However, Enders has hinted that Cassidian's current activities could be curtailed.

EADS as a whole recorded just under €12 billion ($15.6 billion) in defense revenues during 2012, only slightly higher than in 2011. But those results came in the face of a poor showing from Cassidian, which saw its earnings tumble by nearly 60%. The overall defense share in total revenues is around 20%, with Airbus dominating strongly.

“This company [EADS] will remain a major player in the defense business,” Enders insists. “And €12 billion is not a small amount; it [denotes] a stable business and means we are still No. 1 or 2 in Europe.” But he concedes that Cassidian still needed to restructure and that work is underway to make the division “leaner, more agile and more profitable going forward.”

“Defense is a very broad segment, so it is natural we look at areas where we know we have an advantage, and know we will make money,” Enders says.

Cassidian endured two sets of one-off charges of €198 million, booked in the last quarter of 2012. The €98 million came from the division's restructuring costs, part of the company's Transformation Plus program—aimed at reducing costs and improving competitiveness in the changing markets. The restructuring will see 850 personnel, mostly in management and administration, being laid off. Cassidian anticipates that the cuts will save €200 million a year by 2014. The remaining €100 million was paid as the company carried out the “de-risking” of its secure systems and solutions business portfolio.

There is some good news from Cassidian, however. Its order intake had risen to €5 billion in 2012 from €4.2 billion in 2011, thanks mainly to the Eurofighter and missile export business, while the Omani order for 12 Typhoons “is yet to be recorded” in the company's orderbook.

Cassidian's struggles are not reflected in other parts of EADS' defense business. Airbus Military reported a 90% growth in earnings from €49 million in 2011 to €93 million for 2012, although revenues were down 15% related to lower A400M and A330 MultiRole Tanker Transport revenues.

Eurocopter's military business also suffered slightly when it received a €100 million charge in fourth-quarter 2012 related to ongoing renegotiations over contracts for the NH90 and Tiger helicopters for the German government and NH90 deals for other nations such as Portugal.

However, earnings increased by 20% to €311 million, the second-best posting in the EADS group behind Airbus. Revenues at Eurocopter were up 16% to €6.26 billion, driven mainly by increased MRO activities through the Vector Aerospace business purchased by Eurocopter in June 2011, and from higher revenues from the sale of larger helicopter models such as the NH90 and the EC225/725 Super Puma models, even though deliveries were slightly down from 2011, with 475 aircraft sold in 2012 compared with 503 in 2011.

Much like its public relations “spin” on defense, EADS is also attempting to return to a normal relationship with governments, particularly Germany's. When Berlin blocked the BAE merger last year, EADS and German administrators barely communicated for a while. Now Enders is adopting the “charm offensive,” highlighting the indirect benefits of the aborted merger. He argues that the failed attempt to unite with BAE Systems paved the way for the most significant governance change since EADS' creation in 2000. “The old shareholder pact is resolved, the influence of governments is greatly limited,” he points out. “The new structure has been designed with one thing in mind: operate EADS as a normal company.”

With the new governance in place, core shareholder influence will be more limited than in the past, but Germany will also become a direct EADS shareholder for the first time and, with France and Spain, will hold a combined stake of close to 30%. Enders has always argued that governments should not be shareholders in EADS.

Enders has again changed the tone of his public statements: “Governments will always have significant influence regardless of whether they are shareholders,” he now says. In his view, the U.S. could easily be able to keep Boeing from merging with another company.

But perhaps the key lesson EADS has learned from the failed merger is that “there is no European defense. We are far away from it. That is a major lesson for us as an industry which needs more consolidation.”

The outlook on the commercial side is much better. Demand for the new A350 is such that Airbus is already looking at adding to production capacity, even though the aircraft has not yet been flown. Airbus sales chief John Leahy noted the industry's interest in the aircraft when he presented Airbus's Asia outlook in Singapore. “I'm happy to hear from John that he is bullish about the A350,” Enders says jokingly. But EADS has not yet decided to add production capacity. He concedes that the program is still “inherently risky, particularly in the phase ahead of us” and “that there is no room left in the schedule.”

One more strategic question that Airbus needs to decide, at least in the medium term, is whether to offer a second engine type on the A350. Pratt & Whitney is keen to present a geared turbofan to be developed for widebodies, but so far Airbus says it is happy with the Rolls-Royce Trent powerplant, and that any additional engine would have to be competitive with what is now available.

According to Enders, quite a few airlines have commended Airbus for going back to nickel-cadmium batteries on the A350s, given the current Boeing 787 grounding related to lithium-ion battery fires. He describes the decision as a de-risking effort rather than mistrust in the technology. “We have always had a Plan B, because we knew it was new technology. We de-risk our programs as much as we can.” Airbus does not rule out lithium-ion batteries on A350s sometime in the future. “We don't have the same supplier, it is a different chemistry,” he emphasizes.

MSN001, the aircraft slated to fly first later this year, will actually be equipped with lithium-ion batteries because there is not enough time to change the system ahead of first flight.

Referring to slow sales of the A380, Enders points out that “we need to sell more and we will.” He pins hopes on gaining more orders in Asia from new and existing customers and says the sales team is “adequately incentivized.” While not committing to a target for 2013, he says it “should not be too difficult” to exceed the 2012 performance, when Airbus just sold four of the aircraft.

Only 25 A380s are to be delivered in 2013, which has had a dampening effect on EADS' overall sales growth. But revenue growth is expected to pick up in 2014 along with higher A380 output. Airbus slowed down A380 production last year as a result of the wing rib feet cracks. European Aviation Safety Agency certification of the permanent repairs for the in-service fleet will be announced soon, but the modified new-production wings are not expected to be cleared until year-end.

Enders does not envision a price war between the Airbus A320NEO and the Boeing 737 MAX, but “it is pretty obvious our competitor is desperately trying to catch up with our successful NEO.” According to CFO Harald Wilhelm, there is some evidence of irrational pricing in some campaigns and Airbus might react on a case-by-case basis. Pricing is under more pressure for the current A320 version. And that is likely to increase the closer Airbus comes to the 2015 transition to the NEO.

This year, Airbus expects around 700 orders and 600-610 deliveries. Airbus reached 914 gross orders (833 net) in 2012 and delivered 588 aircraft.

EADS revenues were up 15% in 2012 reaching €56 billion. The operating profit increased by 29% to €2.1 billion and the net profit grew by 19% to €1.2 billion. Only moderate revenue growth is expected in 2013, partly because of fewer A380 deliveries. But the company targets a €3.5 billion operating profit. Management is proposing a dividend of 60 cents per share. That proposal has to be approved by the regular general assembly in May.