What a Blockbuster Defense Merger Would Mean for Boeing

For defense contractors, the U.S. is the place to be. With all the talk about reduced spending and cuts in the defense budget here at home, the U.S. remains the largest market in the world for manufacturers of war-related goodies. That, according to Boeing (NYSE: BA  ) CEO Jim McNerney, is the reason behind the proposed super-merger between French-based EADS (parent of commercial airline builder Airbus) and BAE Systems. The combination, should it come to pass, would instantly become the largest company of its kind in the world, with 220,000 employees and nearly $100 billion in annual revenues.

The deal
At first glance, the marriage between EADS and BAE would appear ideal. EADS, via Airbus, essentially runs the European commercial aerospace market and has been the leading plane manufacturer in the world for nine years running. BAE is also an undisputed leader, but in the highly coveted defense market. EADS has long desired a bigger presence in the profitable U.S. defense marketplace, and it thinks BAE is the answer.

Boeing hasn't quite locked up the U.S. defense market, but it's certainly one of the heavyweights. Nearly half of Boeing's $68.7 billion in revenues last year came via defense operations; $22.1 billion from the U.S. alone. That's second only to rival Lockheed Martin's (NYSE: LMT  ) nearly $44 billion. But this is where things get a bit interesting for Boeing. BAE Systems was a close third in 2011's U.S. defense contract revenues with $29 billion; a mere $1.6 billion less than Boeing.

Though McNerney stated that he doesn't "...see this (the merger) as something that's going to threaten us fundamentally..." the ramifications could be dramatic, should it come to pass. Why? Because the combined companies would put EADS in a more competitive position in the defense contract bidding process, right alongside its proposed spouse, BAE.

The impact
Boeing is well on its way to pushing Airbus aside as the No. 1 commercial plane builder in the world in 2012. Thanks in large part to the outstanding success Boeing enjoyed at July's annual industry air show in Farnborough, England, it took a commanding lead in the airplane manufacturing race. Interestingly, its EADS's reliance on the commercial market -- and Boeing's consistent wins in that arena -- that is at least part of the reason for the merger. A stronger position in the defense marketplace for EAD translates to less reliance on the sometimes fickle commercial aerospace market.

But all is not rosy for the two European aerospace behemoths, by any means. Analysts for BAE and EADS are nearly unanimous in their concerns regarding the merger talks. The biggest roadblock to a successful combination is the difficulty EADS and BAE would have melding the two disparate businesses. The lack of "synergies" between the two will pose a huge problem. Then there are the political ramifications to consider. According to analysts at Deutsche Bank, similar megadeals involving global entities "...have shown themselves difficult to manage, and we seriously doubt whether the political backdrop in Europe would allow anything like full synergy generation."

Should the merger come to pass, what will the impact be here and abroad? Expect to see additional mergers, particularly across the pond, in an effort to compete with what would be the mother of all aerospace companies. That's not likely to be the case domestically however. Both Boeing and Lockheed Martin may not be in the $100 billion revenue club as the combined EAD and BAE would be, but at $69.7 billion and $46.5 billion respectively, they're hardly small potatoes.

And let's not forget General Dynamics (NYSE: GD  ) , especially as it relates to defense contractors. At $25.5 billion in revenues, General Dynamics placed fourth in 2011's U.S. defense spending sweepstakes.  

Forming the largest aerospace company in the world will impact the industry across the globe, there's simply no denying that. But, for the major players here at home and Boeing in particular, it's a matter of continuing to do what they've been doing: landing commercial contract after commercial contract, generating a healthy mix of defense and commercial revenue business, and paying shareholders a solid, if not outstanding, 2.5% dividend yield. Assuming those things continue, Boeing remains a solid opportunity for investors, no matter the outcome of the EADS/BAE talks.

As closely tied to defense spending as Boeing and others in the aerospace industry are, the election year ramifications add yet another layer of risk. Defense budgets always seem to be the target of spending cut discussions. What, if any, effect will this year's election have on aerospace companies? Take a look at the Fool's complete discussion of this issue in our free report, "Stocks That Could Skyrocket After the 2012 Presidential Election."

Fool contributor Tim Brugger currently holds no securities positions, including any mentioned in this article. The Motley Fool owns shares of Lockheed Martin and General Dynamics. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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5/27/2016 4:00 PM
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