Completed joint venture: BAE Systems plc/European Aeronautic Defence and Space Company NV/Finmeccanica SPA

No. ME/1066/02

A report under section 125(4) of the Fair Trading Act 1973 on the advice of the Director of the Legal Division of the Office of Fair Trading, given on 26 March 2002 to the Secretary of State for Trade and Industry under section 76 of the Act

Please note that the full text of the advice can be downloaded from the bottom of this page. What follows are extracts from the advice regarding the parties, the transaction and the conclusion.

The parties

BAE Systems plc (BAe Systems) is a public company incorporated in England and Wales, active in several defence and aerospace sectors, including guided missiles through two joint ventures: AMS with Finmeccanica and MBD with EADS. It is not controlled by any other undertaking. BAe Systems was created through the merger of British Aerospace and the defence electronics business Marconi Electronic Systems (MES) on 30 November 1999. In the financial year ended 2000, reported pre-tax profits were £183m, on a turnover of £9,516m and gross assets of £10,253m.

European Aeronautic Defence & Space Company NV (EADS) is a jointly-held vehicle which combines the former group activities of Aerospatiale Matra SA, Daimler-Chrysler Aerospace and Construcciones Aeronauticas SA. EADS itself is jointly controlled by DaimlerChrysler, Lagardère and the French State. EADS consists of five business units (Airbus, Military Transport Aircraft, Aeronautics, Space Systems and Defence and Civil Systems). EADS is active in guided missiles through AM Missiles (a 100% subsidiary) and the MBD joint venture with BAe Systems. EADS is also a joint owner of LFK-Lenkflugkorpersysteme GmbH (LFK) and has a 20% non-controlling stake in BGT, both of which are active in missiles. (Diehl -  another European missile system manufacturer, owns the remaining 80% of BGT.) In the financial year ended 2000, EADS reported pre-tax profits of 1,115m euros (about £638.6m at today's rate of conversion), on a turnover of 24,208m euros (about £13,864.8m) and gross assets of (an estimated) 41,444m euros (about £23,736.54m).

Finmeccanica SPA (FNM) is the holding company of a group active inter alia in the defence and aerospace sectors. The Italian government is the largest (minority) shareholder in FNM. As a result of the formation of the AMS joint venture (GEC Marconi/Alenia), FNM's activities in the fields of radar systems, missiles systems, naval systems, command and control systems, traffic control systems and the relevant customer support services were contributed to the AMS joint venture. BAe Systems subsequently acquired MES from GEC on 30 November 1999, thereby acquiring joint control of AMS with FNM. In the financial year-ended 2000, reported pre-tax profits of 890.434m ItL (about £285m at today's rate of conversion), on a turnover of 12.036.182m ItL (about £3,853m) and gross assets of 38.952.789 ItL (about £12,470m).

The transaction

This transaction results from an internal reorganisation and rationalisation of the missiles businesses of BAe Systems, EADS and FNM into a new entity called MBDA. In summary, the transaction involves three distinct 'mergers'.

(a) EADS is acquiring a material interest in AMS' guided weapons business. (AMS is the joint venture between BAe Systems and Finmeccanica.)

(b) Finmeccanica is acquiring a material interest in the MBD business. (MBD is the joint venture between BAe Systems and EADS.)

(c) Both Finmeccanica and BAe Systems are acquiring a material interest in AM Missiles (which was previously 100% owned by EADS).

CONCLUSIONS

Competition

As you know, when considering the BAE/MES merger in 1999, my predecessor recommended that a reference should be made to the Competition Commission for investigation. Your predecessor decided that concerns about the merger could be met by undertakings. The BAE/MES merger, which affected a number of products, is part of the background to this advice.

In the case of this transaction, which effectively eliminates competition between AMS and AM Missiles, I have concluded that, on balance, the merger would not be likely to substantially reduce competition. In reaching this conclusion, I have considered whether, subsequent to the merger, there will remain a sufficiently competitive environment in which the sole UK customer – the MoD – can procure cost-effective GW/GWS for the UK armed forces. A negative conclusion would lead me to recommend reference to the Competition Commission.

At the horizontal level, the merger would appear to result in loss of an actual or potential supplier through the elimination of AMS as a potential independent competitor to AM Missiles. Moreover, the present transaction reduces from two to one the number of EU companies with products across the range of GW/GWS categories.

However, competition takes place globally and I have concluded that the merger does not significantly reduce competition or create horizontal problems. AM Missiles, AMS and MBD were prior to the creation of the joint venture effectively under much the same ownership and control. The transaction is a rationalisation of that arrangement. AMS and MBD have not effectively been competing against each other since the BAE/MES merger, competing against each other only twice since 1995 on small international contracts. Moreover, MoD has not been a customer of AM Missiles in the past (see note). There is therefore no reason to expect that, in the absence of the transaction, AM Missiles and AMS would be effective rivals for UK GW/GWS contracts.

I have considered how the MoD has used its buyer power in the past when making procurement choices and whether the merger reduces the MoD's ability to obtain the effective GW/GWS that it requires at a competitive price. The MoD's buyer power is considerable. Historically, it has sought tenders and placed contracts world-wide. At the prime level, the MoD is able to turn to Raytheon which has won previous MoD GW/GWS contracts. MoD does not make teaming with an EU partner a contract condition. I have also taken into account MoD's argument that the transaction may increase competition for UK GW/GWS contracts by creating a company with the scale and scope to compete world-wide.

Regarding possible vertical concerns, the transaction appears unlikely to increase significantly any incentive for MBDA to foreclose sub-system suppliers (in favour of its own upstream sub-system suppliers) or raise prime contracting rivals' costs (by denying them access to sub-systems or by raising prices). MoD tenders are open to international bidders, including non-EU companies. Through the exercise of its buyer power, MoD is able to influence the selection of systems and sub-systems suppliers and to structure contracts to eliminate vertical concerns where these might arise from concern about the behaviour of the prime contractor. Again I have no reason to doubt that the MoD will be able to ensure that suppliers of sub-systems will continue to compete in a sufficiently competitive environment and that MoD's choices will not be impaired.

It appears likely that the MoD, through procurement contracts, will be able to continue to use its buyer power to deal with any potential anti-competitive effects. It is able to specify its preferred suppliers at all levels of the value chain to source the best product. It can use visibility of price contractor data and price comparisons to obtain cost effective defence solutions. Through its procurement policy, which is subject to scrutiny and internal audit, it will continue to exercise choice. MoD is committed to ensuring that the tendering process is open to international bidders and its procurement policies, which are subject to rigorous audit are designed to ensure that purchases represent value for money.

In sum, I do not believe that there are sufficient competition concerns to justify reference of this merger to the Competition Commission.

National security

However, the merger also raises national security concerns and it remains open to you to make a reference to the Competition Commission on wider public interest grounds, or to accept undertakings in lieu of such a reference. (As you know, it is proposed that national security will come under the Exceptional Public Interest provisions of the Enterprise Bill). The MoD believes that FTA undertakings are the most effective means of remedying its national security concerns, that they would both provide a legal mechanism for imposing undertakings, and that they would facilitate direct UK government influence over MBDA for the purposes of monitoring compliance.

The OFT is not expert in national security matters and must, therefore, rely heavily on the representations made by the MoD. I have no reason to doubt the views of the MoD in relation to the public interest concerns it has identified or that the draft FTA undertakings are an appropriate measure to address these adverse effects. I consider the MoD to be a body having a substantial interest in the above transaction within the meaning of section 76 of the FTA.

Following discussions with OFT officials, MBDA has confirmed in writing that it is prepared to sign the draft FTA undertakings attached to this advice. However, this will in no way bind your decision whether to accept the proposed undertakings in their current form, nor in a modified version, if found appropriate following public consultation.

I therefore recommend that you accept the attached draft undertakings in lieu of a reference, but that before doing so, you should publish them for consultation.

NOTE 
Parties contend for some 30 years.

Download full text of advice (pdf file 80 kb)    

Download undertakings (pdf file 35 kb)

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Merger of the guided weapon businesses - Undertakings given to the Secretary of State (pdf 34 kb)

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