In 2006, BAE Systems, formerly and better known as British Aerospace, sold its stake in Airbus for a disappointing price. Airbus, a civil aviation consortium established by several European governments, is now Boeing’s only competitor in the market for large commercial jets. BAE told the world it had decided to leave this market, with a view to focusing on its core defence business. In 2012, the company proposed a merger with EADS, owner of Airbus, emphasising the complementarity of defence with civil aviation.
There may be advantages to a company from concentrating its activities, and there may also be advantages in diversifying into related businesses. It is even possible the balance of these advantages has shifted markedly between 2006 and 2012, though it is difficult to see why.
Several other advantages were claimed for the projected merger. But the claim that diversification promotes earnings stability seems to confuse the role of a company director with that of a portfolio manager. Some corporate executives do indeed perceive their role in this way, trading a collection of businesses as a fund manager might trade a portfolio of stocks. But history suggests that few of them are very good at it – recall ICI or GEC, for example. And the transaction costs involved in dealing in businesses are higher than those for stocks.
Another confusion of perspective is found in the claim – made for almost all acquisitions – that the merged business will create a stronger competitor. Usually, as in this case, stronger is just another word for bigger. The normal meaning of “stronger competitor”, however, is a business with better products and keener prices, a goal generally accomplished through operational improvements rather than transformational deals.
I once thought that however thin the public arguments for large corporate transactions, there was probably some serious analysis going on behind the scenes. Just as I once thought that whatever nonsense politicians might talk on public platforms, more substantive discussion took place when they retired to their offices.
But closer acquaintance with business and politics dispelled both illusions. What you see and hear is more or less what there is. When I was sometimes employed to explain the economic rationale for a corporate transaction, I discovered that it was rarely useful to ask the principals why they were doing it. Usually you just heard those familiar clichés. Sometimes you got closer to the truth, sniffed the testosterone, glimpsed the inflated egos.
And, of course, observed the fees earned by the cheerleaders. Dick Rumelt provides a hilarious account in Good Strategy/Bad Strategy of an investment banker explaining the shaky logic of a planned merger between Telecom Italia and Cable and Wireless. The tone of the banker’s account – at once patronising and ignorant of fundamentals of business economics – rings all too true.
These commercial decisions often reflect policy-based evidence, not evidence-based policy. Doing the deal is what matters: business autobiographies frequently congratulate their authors on the speed and decisiveness with which their big deals were consummated. Justification comes afterwards; the PR advisers prepare their fluff and analysis is undertaken by planners and consultants who understand the answers expected by the people who pay their salaries and their fees.
The merger of BAE and EADS fell apart in what has become Europe’s field of broken dreams – the Berlin office of Chancellor Angela Merkel. The traditional stance of the British government has been that it did not care where corporate control rested. The French, German and US governments, however, do care and their requirements were irreconcilable. And perhaps people in London are learning to care about these things too.
The other threat to the deal came from the English market town of Henley, where BAE’s largest shareholder, Neil Woodford of Invesco Perpetual, is based.
Mr Woodford epitomises the style of fund management favoured in the review of equity markets and long-term decision making I completed this summer – concentrated portfolios and material and committed shareholdings. (And, incidentally, returns which have made him a favourite of small investors.) Mr Woodford criticised the deal, having presumably failed to obtain in private the explanation of its underlying rationale that he then sought in public. There needs to be more such interrogation, to help distinguish sound bites from sound strategy.