Armor Holdings/BAE Systems Merger Complex on Multiple Levels

So far, the Armor Holdings Inc. (AH) - BAE Systems (BAESY.PK) merger is one of the more difficult deals to assess from a timing perspective for two reasons: 1) market share data is virtually non-existent for the relevant markets (as discovered in the Stewart & Stevenson/Armor last year); and 2) where defense mergers are concerned, a non-U.S. entity acquiring a U.S. entity -- and a significant one at that -- can be a very tricky matter, presumably even more so during a period of war.

The overlaps are fairly clear: Land Combat Systems (LCS) provided to the Department of Defense. Via the SVC merger, AH increased its line of medium and large land vehicles, which includes the iconic HMMWV. BAE is a well-established supplying of similar vehicles, both the the DoD and European Union military organizations. Obviously, this is not a direct conflict of interest, in a combat sense, but it certainly is enough to raise a few eyebrows in D.C.

This 2006 Land Combat Systems industry report provides extremely comprehensive and recent overview of the industry in question. Some interesting passages are as follows:

Similar to the BAE and UDLP merger last year, the tactical wheeled vehicle market is now working through a period of consolidations. Armor Holdings recently announced plans to acquire Stewart Stevenson. Armor Holdings, headquartered in Jacksonville, Florida, is acquiring Stewart Stevenson in order to obtain the FMTV and increase their market share in the LCS industry. This $755 million deal, while not yet final, will make Armor Holdings the US Army's number one defense contractor for armored tactical wheeled vehicles (Hannaford, 2006). Stewart Stevenson’s closest competitive rival is Oshkosh Truck Corporation, which makes the heavier HET, HEMTT and PLS line of trucks. AM General produces the HMMWV. All three TWV competitors are on solid footing as current suppliers of tactical wheeled vehicles for the DoD. Oshkosh may be in the best long-term position because they have a healthy commercial truck line, which helps immunize them against defense budget slow downs.

[B]oth the combat vehicle segment and the tactical wheeled vehicle segment have seen the continuing effects of mergers and acquisitions. If this trend continues, we should expect competitive forces to contract, perhaps to an undesirable state. Some in the industry speculate there may be one more major round of mergers in the overall defense industry, although it is difficult to ascertain how given there are already very few players.

Contractors within Europe compete heavily, usually across national boundaries, within the wheeled combat vehicle segment. A quick market survey uncovers multiple capable vehicles, to include Patria's Armored Modular Vehicle [AMV], Steyr's Pandur I/II, Mowag's Piranha, KMW's Boxer, the Iveco/Oto Melara consortium's Centauro and Puma, and GIAT's VBCI. Further, these vehicles are not highly differentiated, leaving the contractors to compete on price, offsets, or some other non-performance factor. It is likely that market forces will drive some of these competitors into mergers and partnerships, and perhaps others into exiting the market.

The highlighted areas are both enlightening and a potential cause for concern with respect to this merger. This is not all to suggest that there is a high chance of DOJ and/or CFIUS rejection. However, there is clearly enough initial evidence to speculate that one or both of the regulators may want to step back and fully evaluate the implications of the combination. The concept of the top "armored tactical wheeled vehicles" supplier being controlled by a European company can not be something the Department of Defense will simply ignore.

For the time being, the general assessment for the deal is positive with respect to a successful completion. BAE has already given indication that divestitures may be made in certain AH segments for strategic purposes, which may be a pro-active means of lessening any potential forced divestitures from federal regulators.

The bottom line is that this is a fairly complex deal on multiple levels and as such the companies should not expect apathy from U.S. regulators. There may not exist any legitimate antitrust concerns, yet it is entirely possible that some concerns will surface nonetheless. It would be surprising if BAE successfully completed the transaction in less than three months. It currently seems more likely that this will go four months, perhaps five, if the CFIUS has any interest whatsoever in the deal.

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