Analysts disappointed by BAE contract loss to Dassault

Fitch Ratings has spoken out about the Indian government's decision to select Dassault Aviation over UK defence contractor BAE Systems for a major contract, saying the competition underlines the increasing importance of emerging markets in this space.

By MoneyWeek

published 1 February 2012

in Features

"The deal demonstrates the growing importance of emerging markets to the defence industry in developed markets at a time when their domestic revenue base is under pressure as a result of widespread fiscal constraints," the agency said.

The comments come one day after the Indian Ministry of Defence announced that it is set to enter into exclusive negotiations with Dassault to purchase 126 of its Rafale jet-fighter as its next generation combat aircraft, in a deal rumoured to be worth as much as $20bn over the lifetime of the contract.

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The government's selection prevented the Eurofighter consortium's Typhoon, of which BAE Systems is a member, from scooping the deal.

The decision has proved controversial, with UK Prime Minister David Cameron promising to "encourage" the Indian government to rethink its choice, which he described as disappointing. Speaking in Parliament, he said: "I will do everything I can, as I have already, to encourage the Indians to look at Typhoon, because I think it is such a good aircraft."

BAE itself has said it will continue to support the Indian customer, and will work with others to understand the reasons for the decision.

Tom Chruszcz, Director in Fitch's Industrials team commented that the competition is one of the biggest defence deals in recent years, but noted that, "it is likely to be only one of many as far as defence procurement by emerging market countries in the coming two years or so is concerned."

"In the fighter jet segment alone, up to a further 340 fighters could be ordered by emerging markets before the end of 2014 in what may prove to be boon for western defence companies suffering from weaker local demand."

Indeed, Fitch said the fighter jet segment demonstrates most acutely the recent shift in demand from traditional western markets to emerging countries, adding that in the medium term, the reliance on emerging markets for the defence sector will continue to grow.

Trade union Unite also expressed serious concern over the decision saying that it could mean bad news for BAE's workers in the UK and made a plea for urgent discussions with group.

Credit Suisse mirrored Cameron's sentiment, saying that, "(it is a) serious blow to Eurofighter. We, along with many in the industry, had been cautiously optimistic that Eurofighter would get the deal, and while we do not believe the market was pricing in a win, it will nonetheless be a serious disappointment to the consortium (led for this bid by EADS's Cassidian).

Likewise, analysts at Goldman Sachs insisted the deal and others like it are needed to offset "growing headwinds in the US and UK defence markets".

As an aside, nonetheless, Credit Suisse says that it sees little 'read-across' from that decision to other related names which it covers (Meggitt, MTU Aero Engines, Chemring, Cobham), in terms of immediate stock price movement, as it believes that the market was not pricing in either Eurofighter or Dassault winning.

Writing in the weeks before the announcement some analysts had highlighted that the contract was only worth up to £6.4bn, so that in reality it would only increase BAE's earnings per share by 1% to 2%. Nonetheless, it was believed that at the very least it would have boosted sentiment in shares of the firm.

As of 16:11pm shares of BAE Systems are up 1.6% to 312.6p.