BAE Systems hit by defence cuts

BAE Systems, the biggest manufacturing company in Britain, was dealt a major blow today when the government awarded the first phase of a £4bn contract to build new armoured cars for the British army to America's General Dynamics. The move jeopardises the future of the firm's armaments factory in Newcastle and 600 jobs. The deal is for armoured reconnaissance vehicles to replace Britain's ageing Scimitars – seen as vulnerable to roadside bombs – using better protection and with added firepower. General Dynamics had previously said 10,500 UK jobs would be safeguarded or created over the 10-year deal, if it won the contract, and Bob Ainsworth, the defence secretary, made the point that the US group's bid contained 73% UK content within the supply chain and the assembly, integration and test facilities at the company's Defence Support Group at Donnington. For BAE, which spent £50m over five years developing a contender for the deal, based on upgrading its existing CV90 tank, these are dog days as it faces swingeing defence spending cuts by the US and British governments in the wake of the global banking crisis. Big-budget US projects have already been axed as the Obama administration curbs military spending, which doubled during the Bush years. Among them are the costly F-22 fighter plane, a new communications satellite, shipbuilding programmes and missile development. Further job losses are inevitable. As BAE derives half its £20bn of annual revenue from the US, this is unwelcome news. Britain is also gearing up for big cuts, with both of the main political parties preparing to slash defence spending by up to £10bn after the election in May. Analysts anticipate cuts to the BAE Harrier and Tornado fighter jet fleet, an early phasing out of Nimrod MR2 reconnaissance aircraft , and a reduction in orders for the new US F-35 fighters . Such ruthless cost-cutting means BAE could lose tens of millions in revenue. "BAE faces a challenging period as government seeks to rein in public spending," said Peter Felstead, of Jane's Defence Weekly. "Plans for new aircraft carriers, warplanes and ships are vulnerable at a time when there is cross-party consensus that military spending is too extravagant." Difficult backdrop The difficult backdrop has not been lost on the City: BAE's share price is down 20% over 18 months and Goldman Sachs has published a note claiming BAE's earnings could stagnate until the middle of this decade . According to Goldman Sachs' defence analyst David Perry, profits at BAE's land division look set to halve by 2012 after the US cut funding for several vehicle programmes. Perry said he expected news about the F-35 to get worse. The programme leader, Lockheed, warned recently that it would share the burden among partners, including BAE, after the Pentagon withheld $614m (£410m) in performance fees. Ed Steed, an analyst at Execution Noble, said BAE was not well positioned to withstand an era of reduced defence spending as it was heavily exposed to so-called platform products: "Big-ticket items such as ships, aircraft and submarines, where the spotlight tends to fall during a defence review." "Projects where BAE is involved such as F-35 and Typhoon are far advanced but governments around the world are likely to reduce planned orders or abandon plans to place new [orders] at a time of budgetary restraint," he said. BAE has also suffered a number of setbacks on a second front: competition for new weapons contracts. Today's news that it had lost the armoured car contract follows last year's failure to win the $281m US government contract for armoured battlefield vehicles. That deal was clinched at the eleventh hour by its Wisconsin-based rival Oshkosh Defense and was the first time that BAE has suffered a major contract loss in North America since it launched the last phase of its US expansion strategy two years ago. BAE is now the fourth-biggest defence contractor in the US market. To hedge against uncertainty in the US and UK, BAE is expanding in India, Australia and Saudi Arabia, where defence spending is expected to rise; and it aims to boost its presence in niche product areas such as cyber-security and unmanned aircraft. When the company's results were announced in February , Ian King, chief executive, said he expected combat aircraft to take over from land vehicles as the main driver of growth. He expects land systems to fall 30% by 2012, following contract setbacks, and because of retrenchment as the US and Britain withdraw from Iraq and Afghanistan. But Howard Wheeldon, a strategist at BGC Partners, said he remained positive about BAE. "It is a past master at being able to adapt to changed circumstances. These may be worrying times but the company is well positioned, as it has a diversified product portfolio and international interests," he said. Analysts at Exane BNP Paribas expect "a flat performance over the next couple of years" but note that about 30% of BAE's income depends on maintenance and support programmes for projects that still have many years to run. BAE rebutted suggestions that it faces a rocky period ahead, saying: "We have a large order book and programmes such as Typhoon continue to deliver a strong performance. During the year, £3bn of new support contracts were awarded. "In the US, our high-technology capabilities within our electronics, intelligence and support business continue to be in demand." BAE is also battling an image problem, after US and UK bribery and corruption inquiries ended with it paying £255m in fines to the US department of justice (DoJ) after admitting to irregularities over the sale of fighter planes to Saudi Arabia and eastern Europe. In a court filing, the DoJ claimed that BAE transferred millions to Swiss bank accounts controlled by an agent, with a high probability that a payment would go to a Saudi Arabian official in a position of influence. In the past, there have been allegations that BAE had a £60m slush fund to underpin the Saudi al-Yamamah arms contract , which has been worth £43bn over the past 20 years. BAE has denied the allegations. In Britain, the Serious Fraud Office (SFO) dropped an investigation into BAE's Saudi business after intervention by the Blair government in 2006. But the company must pay £30m after agreeing to plead guilty to a lesser offence of failing to keep accurate accounting records for its activities in Tanzania. Although the UK National Audit Office investigated al-Yamamah, the conclusions are shrouded in secrecy. The Ministry of Defence said: "The report remains sensitive. Disclosure would harm both international relations and the UK's commercial interests." Anti-armaments campaigners have accused the government of a cover-up. King has tried to draw a line under the corruption investigations by stating: "The company regrets and accepts full responsibility for past shortcomings. The firm has systematically enhanced its compliance policies and processes." Francis Tusa, of Defence Analysis, said: "If you ask people what they think of defence companies, they would be extremely cynical and assume that dodgy stuff is going on all the time. Of course, that doesn't make it right." Rita Clifton, chair of the branding agency Interbrand, said: "No one expects a defence company to be a hearts-and-flowers organisation. Customers are primarily concerned about product quality and service but reputation can be a factor when potential clients are shopping around in a highly competitive marketplace. And image matters in the wider public and political arena. BAE cannot afford to rest on its laurels."