Following three decades of steady consolidation, defense companies in Europe appear ready for another round of acquisitions. The bigger players will keep swallowing up the smaller ones. But larger deals will need governments to push hard to create a truly pan-European defense industry.
Larger acquisitions in Europe's defense industry would need a robust economic case, a favorable financial environment, and aligned political stars. The first two have already been satisfied. European military spending has been declining for decades, but the crisis in Ukraine has driven it to increase. According to analysts at Bank of America, this has increased military stocks and is expected to boost operating margins by an average of 1.3 percentage points by 2025 at the top ten defense groups in Europe. The average net debt to EBITDA ratio of these companies is extremely low, and it is predicted to stay that way until 2025 due to recent strong cash generation.
There is a compelling economic reason for further consolidation. Joint procurement and cheaper prices would benefit fewer, larger players. Additionally, they would have a stronger competitive edge against international manufacturers of weapons, particularly American companies like RTX and Lockheed Martin.
The economies of scale are also readily apparent. According to a McKinsey analysis, European militaries presently employ fifteen different types of battle tanks, compared to the United States' one type. The United States' top guns have access to only seven fighter jets, whereas the air forces use twenty distinct models. In comparison to the United States, Europe possesses five times as much weaponry overall.
Small, add-on acquisitions have been the primary means of consolidation in the past. Just in 2023, the British company Cobham Aerospace Communications was purchased by the French defense electronics business Thales (TCFP.PA) for $1.1 billion, and the American company Imperva was purchased for $3.6 billion. Ball Aerospace, located in Colorado, was purchased by the UK's BAE Systems (BAES.L) in August for a cash price of $5.5 billion.
However, individual EU governments have the final say over larger mergers, often through outright ownership of shares. Berlin controls 25% of defense electronics company Hensoldt, the Italian government owns 30% of Leonardo, and Paris holds 25% of Thales and Dassault Aviation. However, the strategic objectives and equipment requirements of EU member states have frequently differed, with the nuclear arsenals of France and the UK setting them apart in one class.
Europeans have so far favored collaborative projects rather than building regional champions, such as teaming up on future fighter jets or combat tanks. However, they haven't even begun to explore cross-border transactions that could be advantageous. Take, for instance, the merger of 29 billion euro Thales and 9.5 billion euro Leonardo, which has already resulted in the formation of a strategic joint venture focused on space technology.
Large defense companies run the risk of continuing to repurchase shares using their robust balance sheets, as Thales, BAE, and Dassault said they would do for about 3 billion euros in 2022–2023, if the governments of Europe fail to give the right signal.
Giving money back to investors while a conflict rages throughout Europe seems like an odd way to confront Vladimir Putin.