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:: May 2006 Letter ::

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Dear Fellow Zoo Fans,

How long does your typical European Brown Bear live? Every two years since 1998 my colleagues and I have visited Maxi, Schnute, and Tilo, the official Berlin bears residing between our hotel and ILA, the slightly under appreciated air show. Iíve come to think of these bears as more than playful forest creatures; they make great obvious metaphors too. Especially if youíre an industry analyst with nothing else to write about.

When we first visited the bears, Germanyís aerospace industry future looked great. The new Daimler Chrysler Aerospace (DASA) would play a dominant role in Europe. The Fokker structures biz was kaput, but the new Fairchild Dornier in Bavaria had a slam-dunk RJ business plan. The next step looked clear: DASA and BAe, having the most in common because they were fully private ďAnglo-AmericanĒ style companies, were going to walk off into the sunset, leaving the semi-socialist French in the lurch.

But somehow, the two companies grew apart. Just before ILA 2000 BAe merged with GEC Marconi, creating BAE Systems, a vertically integrated company of the kind that everyone once agreed should never be created. DASA went from Anglophile to Anglophobe, a move the French did not need to be persuaded to make. The result: EADS.

With each post-1998 ILA German industry looked less relevant. EADSís creation produced a continental champion with a strong German role, but it also left BAE free to pursue its own European dream: to get the hell away from Europe. EADS has done reasonably well, but thatís largely thanks to Airbus, which now faces serious product challenges. And by ILA 2002 it was painfully clear that Fairchild Dornier wasnít going to rescue Oberpfaffenhofen from relying on drunken Australian tourists for business after all. As for ILA, it tried to compete with the other shows as a Gateway to the East, but when people walked through that gateway they found rusting machine tools and unwanted MiGs. ILA and German aerospace were stuck in a holding pattern.

German aerospace today has two negatives. First, Daimler Chrysler, the cash behind Germanyís EADS share, plans to sell around half its stake, possibly reducing Germanyís power within the company. Second, Germanyís defense budget continues shrinking; the MoD appears to be buying weapons with IOUs.

Yet from the German standpoint thereís good news too. German defense spending might be anemic, but it plays a larger role in EADSís revenue than French spending, which also goes to Dassault, Thales, GIAT, and other big players. Also, as key programs such as Eurofighter, A400M, NH 90, and Tiger continue to transition from development to production they should be more profitable. On a macro level, predictions of Germanyís industrial demise have proven wrong. The countryís manufactured exports are twice as large as Franceís, and higher than the US level.

Politics play a big role. The Merkel Administration is doing rather well. By contrast, the Chirac Administration is degenerating into farce. As a US citizen, Iím not exactly on thick ice here. But the Chirac regime is beyond mere incompetence; itís firmly into banana republique territory (the big current scandal involves a bank with a name like a phone company; I do not plan to learn more). Worse, EADSís French leadership is hobbled by incestuous links with its government.

The German half of EADS, in short, brings good governance and parent government legitimacy. The effect of good governance (and good government) is tough to quantify in market share or EBITDA. But if youíre trying to sell to DoD and the US Government, itís extremely useful. Even better, if you need to tap into US equities or capital markets, especially to replace the corporate shares held by the current EADS stakeholders (Lagardere is selling too), good governance is an essential message for investors and bankers. Good governance, indirectly, could mean the difference between funding a new Airbus widebody family sooner and funding it later.

Good governance doesnít guarantee smart moves. In 1914 Germany was a well-run country that could do just one thing to not become the dominant power in Europe: go to war. In 1999 Airbus was a well-run company that could do just one thing to not become the dominant jetmaker by 2010: launch the A380. Again, the mind boggles with might-have-beens.

What else did I learn on my German trip? First, like most observers, I think Airbus will launch that new 250/350-seat jetliner family soon, probably before Farnborough. Second, they will ask for (and need) state aid to do this, effectively a state-funded package to rescue them from the state-funded A380. If the WTO rules against this desperately needed aid, the Europeans will likely ignore the ruling.

Therefore, the threat of a US-European trade conflict has ratcheted up a notch. EADS might again need to decide between public cash for Airbus and a shot at the USAF tanker contract. This is not an easy choice: to be a national champion or to be a global export player. BAE made that choice long ago, and distancing itself from Airbus is the latest sign that itís sticking to its decision.

Which brings us back to the metaphorical bears. They live longer than I expected. Iím looking forward to visiting them in 2008. And you can visit them too. Theyíre in a nice park right across from the Markische Museum, in the Mitte neighborhood. Around the block thereís a fine neighborhood bar/restaurant called the Marinehaus. Meantime, Teal updated reports for May include the F-35 JSF, 787, Hawk, C-130, MB.339, 328JET, and everything Sikorsky builds.

Yours, Mit Freundlichen GrŁŖen,

Richard Aboulafia

 

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