Raise your hand if you remember "The Muppets."
Really? OK, so since I'm showing my age in this column, a brief bit of background may be necessary to accompany that title above. Once upon a time, there was a show populated by puppets, called Muppets, on CBS. The show was titled, imaginatively enough by the standards of the time (c. 1200 A.D.), The Muppet Show. One of the skits that popped up on The Muppet Show from time to time was Pigs in Space, an intentionally bad parody of prehistoric sci-fi fare like Star Trek and Lost in Space.
Which is about all you need to know to (a) "get" the above title, and (b) get us to the meat of this article: Over in France, they're working on forming a similarly bad parody of American aerospace titans Boeing
La situation
Here's the deal. Right now, two companies perform the bulk of the satellite construction work in Europe: European Aeronautic Defense & Space (better known as "EADS") and Alcatel
Just as Airbus Industrie was set up in 1970 to bolster flagging European efforts to compete with American aircraft manufacturing companies, Europe now feels compelled to quash free market competition by merging its only two competing satellite manufacturers to compete for satellite sales.
Which brings us to the third French company in this story: defense titan Thales. According to a story run by TheWall Street Journal last week, Europe's political leaders/captains of industry have decided that Thales will acquire the satellite businesses of both Alcatel and EADS, incorporate them into Thales, and emerge on the other side of the merger as France's outer space manufacturing champion. This news builds on the April announcement that Thales would buy Alcatel's satellite operations separately in a deal scheduled to close later this year.
So far so good, right? Competition is fine when you're winning, but once you've begun losing, socialism and a planned economy don't look so unattractive, especially if you're looking from the banks of the Seine. After all, up until the A380 fiasco broke, Airbus was doing a pretty decent job of competing with Boeing for worldwide passenger jet sales. One might expect the same thing to result from France's latest corporate menage-a-trois.
Love a la francais
Except for one thing: Thales (remember, it's Thales that will be running this show) doesn't make satellites. Aircraft systems, yes. Air traffic-control equipment, yes. Military hardware, yes. But satellites, no. So from the get-go, this whole merge-and-conquer plan seems to be getting off on the wrong foot. It sounds sort of like taking Hardee's and Burger King, merging them and putting them under the management of the folks at Whole Foods -- on the theory that these are all, you know, food companies -- and expecting the conglomeration of entities to compete effectively against McDonald's.
For this reason, right from the outset, I'm inclined to doubt that this high-tech mishmash will prove to be greater than the sum of its parts. But before making a final conclusion, I think it behooves a Fool to find out just exactly what those parts are.
|
Net Profit Margin |
Return on Equity |
|
|---|---|---|
|
Thales |
3.3% |
16.1% |
|
EADS |
4.9% |
11.6% |
|
Alcatel |
5.5% |
13% |
Now compare those numbers with Boeing's and Lockheed's:
|
Net profit margin |
Return on equity |
|
|---|---|---|
|
Boeing |
3.5% |
18.7% |
|
Lockheed |
5.6% |
27.9% |
From this perspective, the merger might make sense. The European "team" currently averages about the same profitability as does the U.S. "team" -- 4.6%. However, right now, none of the European aerospace majors compares well to U.S. rivals on returns on equity. Simply put, the U.S. companies are better managed. But what if you could take the higher average profitability of EADS and Alcatel and put it in the hands of the best management of the three: that of Thales? Then you might have yourself a contender.
Frogs in space
The above tables give us a good view of the "forest" at these five companies, but perhaps not the precise trees we should be looking at. Remember that EADS and Alcatel won't be joining Thales entirely, but only contributing satellite-construction divisions. What we'd really like to see, to determine whether this merger makes sense, is how profitable and how well-run EADS' and Alcatel's satellite divisions (called "Astrium" and "Alcatel Alenia Space," respectively) are.
Unfortunately, after reviewing both companies' financials, I'm unable to find specific financial data on either one. Using the next best thing, though, I examine the mixed "space" division revenues from each of the four satellite makers. That still includes revenues from rockets and related products and services, but it appears to be as far down as one can reasonably drill. Here's how the numbers look:
|
"Space" Revenues as a % of Total Revenues |
"Space" Pre-Tax Profits as a % of Total Pre-Tax Profits |
|
|---|---|---|
|
EADS |
8% |
2% |
|
Alcatel |
30%* |
22%* |
|
Boeing |
5% |
28% |
|
Lockheed |
18% |
20% |
*Alcatel lacks even a separate "space" division. Its space-based revenues appear to be included under the "Private Communications" division.
Firmwide, on a net margin basis, EADS and Alcatel are each more profitable than Boeing, and nearly as profitable as Lockheed. But extrapolating the above data indicates this doesn't hold true for the firms' respective space businesses. Both European companies' space divisions contributed "light" profits in relation to their proportion of total revenues (which, incidentally, suggests why EADS and Alcatel want to divest their space divisions.)
The reverse is true for Boeing and Lockheed, where the space divisions are more profitable than the firms as a whole. After two years of generating losses, Boeing's space division generated disproportionately large profits last year. At Lockheed, the space division outperforms more modestly, but has done so for three years running.
Foolish takeaway
Thus, it seems the Thales-EADS-Alcatel merger is not a recipe for putting better management in charge of more profitable businesses (which would be a win for the European competitors) after all. On the contrary, EADS' and Alcatel's satellite divisions are relatively less profitable than those companies as a whole. And Thales, albeit a more efficient allocator of capital than EADS or Alcatel, knows nothing about building satellites -- which could render its expertise in other industries moot.
When viewed from this perspective, the anticipated merger looks much less threatening to Boeing and Lockheed. My advice to Boeing and Lockheed investors? Don't worry. This frog won't hop.
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Fool contributor Rich Smith does not own shares of any companies named above. If he did, he'd have to tell you so. Fool's honor.
