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:: November 2000 Newsletter ::

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Dear Friendly Clients,

In last month’s letter, I threatened to write about the impact of General Electric’s proposed acquisition of Honeywell on the aircraft business. Well, here goes. It’s a good thing. That’s it. Next topic.

Okay, seriously, this merger has the potential to be a very good thing. Very simply, Honeywell wasn’t doing that great. By contrast GE has been the world’s single biggest manufacturing success story, for some very good and easily identifiable reasons. Jack Welch and company recognized that manufacturing, in and of itself, is a tough proposition in the post-modern economy. You will get crushed between vendors, who will demand more whenever they can, and consumers, who are always looking for the lowest price. Even when barriers to entry are high, just one competitor can make a manufacturer’s life miserable. And if you are in the aviation industry, you are faced with two difficult consumers—greedy airlines, and the cheapskate flying public.

Remember, I never went to business school. But even I can see that GE’s answer to the above problem has been to integrate manufacturing into a triad, with aftermarket services and financial services forming the other two legs. In this way, manufacturing makes a lot of sense. Boeing’s recent new business unit creations reflect a slightly belated (but still promising) recognition of this new paradigm (I do not apologize for using the word “paradigm”). If this triad approach is extended to Honeywell, it should start performing marvelously—the company has a large installed base, and builds stuff that requires lots of support.

As with all great ideas, the devil is in the details. Daimler’s 1998 acquisition of Chrysler was an excellent idea, with the latter company offering its corporate culture and the former company offering its quality and its reputation. This month marks the second anniversary of the acquisition, but I doubt that yummy chocolate cake will be served. Daimler Chrysler has lost over half its market value. Of course, learning corporate culture and techniques from an acquired company is a lot tougher than trying to impose it on an acquired company. Still, Jack Welch’s omnipotent presence will not be around at the new GE forever, and his successor had better be up to the task.

One thing we don’t think will be a big problem is antitrust. Originally, Honeywell was considering an offer from United Technologies, but from an antitrust standpoint, that was a heart attack on a plate. There is almost zero overlap between the GE and Honeywell product lines. There will be a greater consolidation of aftermarket services, but if the Feds really cared about that they would have stopped the GE aftermarket acquisition campaign years ago.

As for this theory of bundling (i.e., only selling subsystems as a package, thereby excluding any rivals) as an antitrust target, suffice to say I’m not a believer. Honeywell could have bundled for years, but didn’t. So, the government would have to take pre-emptive action to stop a problem that doesn’t yet exist—a weird new legal precedent (remember, I didn’t go to law school, either). Besides, GE cares too much about the performance of its individual units to hobble them with rules like that.

What else? Well, the new GE will have a very high rate of market capture, owing to its technology and capabilities. The cost savings that result from the merger, and a steady stream of aftermarket revenue from its large installed base will further increase the company’s competitiveness. Due to DoD’s increasing reliance on rebuilds and upgrades, a competitive mezzanine contractor has a lot to look forward to. For example, the new GE will be the almost guaranteed winner of DoD’s Common Engine Program. This enormous effort will provide replacement engines for the Sikorsky UH-60 and SH-60 and Boeing AH-64 fleets, with a first fielding scheduled for 2007. This program will be worth several billion dollars.

Then there’s that balance of power issue, between primes and mezzanine contractors. When the merger was announced, several chowderhead commentators (other than me, that is) said that since the new GE would build all the high value added bits of the plane (avionics, engines, landing gear, APUs, etc) it would be more important than the actual prime. This is nonsense. Final integration of a plane remains an arcane and lucrative skill. Ditto for selling and supporting the plane. However, there is inevitably some competitive tension between primes and subcontractors in the aftermarket arena; this merger will increase the new entity’s ability to compete for aftermarket and support work against the primes.

What’s in this month’s supplement? Our F-15 report forecast includes 40 “undetermined” planes now—either it will win the Korean FX competition (which could be good for up to 80 planes) or Saudi Arabia could take one last batch. The money-eating, wing-cracking F-2 continues to lumber along. We’ve updated the A3XX with a new forecast, reflecting the Singapore victory. The MD-11 is just about over, and you may want to fly in one before they all become FedEx and UPS conversions. We’ve removed the rather pathetic IPTN N-250 from the book, but keep your last copy if you like.

As for next month, we’ll update the F/A-18, E-3/E-737 AWACS, OH-58D, F-14, and AH-64. My apologies to non-military types. Call or e-mail with any requests, although please be forewarned that I will be on vacation from November 29 through December 12.

Yours, ‘til Someone Mistakes Us For A Mezzanine Contractor,

Richard Aboulafia
 

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