Tanks -- they're not just for Cold Wars anymore.
In fact, with Russian T-72s running rampant 'round the fields of eastern Ukraine, many people are wondering if main battle tanks -- the 60 to 70-ton armored beasts that generals once expected to joust in Germany's Fulda Gap -- might be needed to fight a "hot war" sometime soon. And if they are needed, will it be American tank-builder General Dynamics (NYSE:GD) building them ... or someone else?
Germany and France hold a shotgun wedding
Over in Europe, the renewed relevance of main battle tanks to modern warfare has spurred two of the continent's bigger rivals -- Germany's Krauss-Maffei Wegmann, or KMW, and Nexter Systems of France -- to contemplate a merger. Their goal: To take the best parts of KMW's Leopard 2 main battle tank, marry them to the advantages of Nexter's Leclerc, and produce Europe's next super-tank.
KMW's and Nexter's plan, as described in "Heads of Agreement" signed July 1, 2014, calls for the two companies to merge their operations under the ownership of a holding company -- probably based in the Netherlands. KMW is currently privately owned. Nexter, owned by the French government, would need to be privatized prior to the merger. At that point, the two firms would contribute their stock to the new holding company, receiving 50-50 ownership of the new, merged company in return. While the deal is not yet set in stone, an April 2015 closing date is anticipated.
But what would the new company look like?
Birth of a European tank-building superpower?
KMW and Nexter say their new firm will employ more than 6,000 workers generating nearly $2.7 billion in annual revenue. With $8.8 billion in backlogged orders for weapons systems to be built, the company would have enough work to keep itself busy for more than three years, right from the start.
The combined companies would offer their customers everything the modern armored army needs to roll, too: 155mm towed and self-propelled guns, anti-aircraft guns, and tracked and wheeled armored personnel carriers. The most famous products, though, would be France's Leclerc main battle tank (from Nexter) and Germany's Leopard 2 -- a 62-ton beast of a weapons system, featuring a 120mm Rheinmetall smoothbore cannon that can penetrate 22 inches of solid steel from a range of 1.3 miles. One of KMW's most popular products, the company has sold 3,200 Leopard 2s to 16 separate armies.
Around the world, the Leopard 2's chief rivals include General Dynamics' M1 Abrams ...
... Britain's Challenger 2, built by BAE Systems (NASDAQOTH:BAESY) ...
... and their Russian rivals, which include the T-72, T-80, and T-90 -- of which 1,700 have been built.
What it means to investors
So back to the initial question: Who will build the main battle tanks for Europe's armies going forward?
While defense spending in Western Europe and Central Europe declined 2.4% in 2013, Russia's Ukrainian adventure has defense officials from Poland to Finland to Norway -- and Estonia, Latvia, and Lithuania besides -- all talking up plans to boost military spending. So the $8.8 billion in backlog that a combined KMW-Nexter will start off with could be just that -- just a start.
What makes this merger really interesting, though, is that Britain's tank market is about to open wide up as BAE shuts down its last tank factory there later this year. If Britain can no longer build its own tanks, it stands to reason that the U.K. will soon be buying tanks elsewhere. So who will have the advantage in winning those tank contracts -- General Dynamics, or KMW-Nexter?
With Nexter still state-owned, and KMW a family business, accurate financial numbers are difficult to come by. At last report, S&P Capital IQ data showed both firms to be profitable, but exactly how profitable is hard to say. What we can say, though, is that General Dynamics is probably more profitable than its new rival.
General Dynamics' combat systems unit, while the company's smallest, is still twice the size of a combined KMW/Nexter at $6.1 billion in annual sales. The unit earns 14.8% operating profit margins -- better than BAE was earning on its tanks -- and is General Dynamics' most profitable military business. Meanwhile, the diversified nature of GD's business (which includes the even more profitable civilian Gulfstream unit) helps to ride out the ebb and flow of the cyclical defense industry. That's an advantage that KMW-Nexter will lack.
Long story short, while it's entirely possible that a KMW-Nexter merger will yield a new European "regional champion" in tank building, I wouldn't count on its producing a tank company that can roll right over General Dynamics.
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Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of General Dynamics. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.