A version of this article appears in the July 7 edition of Aviation Week & Space Technology.

Farnborough is BAE Systems’ home turf, and the air show, which takes place there next week, has traditionally provided the perfect stage for the company to show off its products, political clout, commercial successes and strategic initiatives. Indeed, over the last 15 years, BAE has been the frontrunner of the aerospace and defense (A&D) industry when it came to making bold strategic decisions: the merger with Marconi in 1999, investing massively in the U.S. between 2000 and 2007, creating a defense electronics joint venture with Finmeccanica in 2003, exiting the commercial aerospace business in 2006 and attempting to merge with EADS in 2012.

Yet the overall feeling surrounding BAE today is one of a company that has run out of steam and is critically short of strategic options. In fact, several of its decisions seem to have backfired. They include the 2006 sale of its stake in Airbus (a business for which it was eager to pay a premium to reenter by 2012), the divestment of its share of Saab in 2010-11 (Saab’s market cap has doubled since then), and its multiple acquisitions in land systems, which is now one of the most distressed sectors in the defense industry. 

This dire strategic position is even more striking when compared with other U.K. A&D players such as Meggitt and Babcock International, which have been riding high in similarly difficult market conditions (see graph). One might therefore wonder if all the strategic moves made by BAE were as smart as they were bold. Indeed, a very rough analysis shows that between 2000 and 2014, the company’s revenues have increased by almost exactly as much as the total of its acquisitions (net of disposals)—that is around £6 billion ($10.3 billion). This tends to suggest the value created from all these acquisitions has been limited. The company has “captured” a lot of value, but has it actually “created” value?

In this regard, I will limit myself to two comments. First, value creation usually occurs when one fulfills a customer’s untapped need.

This process typically requires a company to significantly transform its underlying capabilities and the way it interacts with its clients. For example, the story of VT Group between 1996 and 2008 (before its breakup), moving away from its historical shipbuilding business and becoming a leader in outsourced government services, illustrates a true value-creation strategy. As far as BAE is concerned, there has been no such story. While there were high hopes that the British Defense Industrial Strategy of the mid-2000s would trigger a breakthrough value- creation process for both the Ministry of Defense and BAE, its implementation did not live up to its promise.

Second, creating value is not just a matter of becoming bigger. Of course, economies of scale are important in a highly capital-intensive industry but by definition economies of scale happen when a single product is manufactured in great quantities. It does not work when multiple products are made in relatively small quantities. That is, by and large, what BAE has been doing. Its top-line growth does not seem to have translated into value creation, as the economics of the business have remained essentially unchanged.

So what are the options for BAE? Like any other business, it must choose between two strategic postures: ride an existing wave or create its own. So far, BAE’s strategy has consisted of riding successive waves. It rode the Airbus wave until the winds started to shift, then it moved on to the “U.S. defense bonanza” and became a “pure play” U.S.-centric defense player, then it jumped onto the security wave, rebranding itself as a “defense and security” company for awhile. The proposed 2012 merger with EADS was an attempt at remounting the commercial aerospace wave. Today, there is no obvious wave to catch and the company is at loose ends. Therefore, the only way forward is for BAE to create its own waves.

Indeed, it is possible that in its current configuration BAE has reached the end of its journey, and that the only way to create value is to reshuffle its business portfolio, possibly breaking up the company in the process. In doing so, it could rediscover the front­runner status that made it famous in the first place, and plant the seeds for a new “star of the show” to emerge at Farnborough. 

Until then, we will have to make do with a lackluster performer. 

 

Contributing columnist Antoine Gelain is the A&D practice leader at Candesic. He is based in London.