FRENCH NAVAL COURTSHIP CREATES DEFENSE INDUSTRIAL

UNCLAS SECTION 01 OF 02 PARIS 008548 SIPDIS SENSITIVE STATE FOR PM, EB, EUR/ERA AND EUR/WE E.O. 12958: N/A TAGS: EIND MARR MASS PARM ECON FR SUBJECT: FRENCH NAVAL COURTSHIP CREATES DEFENSE INDUSTRIAL CHAMPION ¶1. (SBU) Summary: The GOF, Thales, and state-owned shipbuilder DCN, have confirmed that the French defense electronics group has agreed to buy a 25% stake in DCN. Their messages echoed the widespread expectation that the Thales-DCN tie-in would be applauded by its architects as a first step toward wider European defense consolidation. The GOF emphasized (wishfully) that next steps could bring Spanish and (later) German shipbuilders into the fold. However, practical business concerns -- not grandiose ideas of building a "naval Airbus" -- more likely convinced Thales to agree to the deal. Thales' decision to take a stake in DCN appears to have been motivated primarily by DCN's cost- cutting and management reforms as well as a steady near-term workload in the company's shipyards. End summary. ¶2. (U) On December 15, Defense Minister Michele Alliot-Marie and Finance Minister Thierry Breton took the lead in announcing the deal to tie-in French naval construction company DCN with combat systems company Thales, as had been first reported on December 9 (see Paris Points). The announcement included details of the modalities of the deal, which Alliot-Marie and Breton spelled out alongside Thales President Denis Ranque and DCN President Jean-Marie Poimboeuf. The key elements of the deal are that Thales will initially acquire 25 percent of DCN as well as two of the six shareholders' committee seats. Thales will also get the right to veto strategic decisions, such as acquisitions or key partnerships. The deal values DCN at 2.8 billion Euros, based on 1.5 billion Euros in cash and 1.3 billion Euros of company value. The Armaris 50/50 joint venture as well as the MOA2 partnership for aircraft carrier construction (the French Navy has yet to sign a contract) will both be fully ceded to DCN, but Thales will continue to play an important role as a DCN shareholder. ¶3. (U) The tie-in of these two French defense industry leaders was designed to address the fragmentation of Europe's naval shipbuilding sector. Defense Minister Alliot- Marie had reportedly been particularly active, playing a central role in brokering the deal by acting as matchmaker for the two companies over the past three years. Alliot- Marie summed up her motivation in saying that linking the two companies would secure the French military shipbuilding sector for the long-term and put an end to "Franco-French competition that could only weaken us." Alliot-Marie's comments implied that she and others will focus their post- announcement energies on drawing other (non-French) European companies into the fold. The parties to the deal emphasized expected synergies from pooling of research and development efforts. Thales hopes to bring financial and industrial modernization to DCN by among other things improving efficiencies by reducing the number of suppliers, reducing costs paid to suppliers, creation of logistical platforms with just in time delivery, and increasing emphasis on periodically renegotiable maintenance contracts with the French Navy. Thales said that it would encourage an "acceleration of (DCN's) managerial evolution toward a company which is increasingly open and increasingly entrepreneurial." ¶4. (U) To formally seal the deal, Ranque, Poimboeuf, Alliot- Marie, and Breton signed a declaration of intent midday on December 15 with industry-watchers predicting that it would take up to six months to fully gel. Thales will handover assets, including its French naval subsidiary, and 100 to 150 million Euros in cash after a period of due diligence. Thales also gets the option of increasing its stake to 35 percent after two years. Breton took a familiar tone emphasizing that "The State will remain very much the majority shareholder" -- a statement that echoed similar assurances with respect to Gaz de France and Electricite de France as well as assurances given by his predecessors in the early stages of privatization of France Telecom. Thales President Ranque characterized the deal as a "marriage ... of a modern couple .... If their engagement was long, they nonetheless managed to have a few children (presumably Armaris and MOPA2) in the interim." ¶5. (SBU) Several reports compared the still fragmented European naval construction sector with its U.S. counterpart. As with other defense industry sub-sectors, U.S. naval shipbuilders are strong and well-consolidated, with just four main players and a combined annual turnover of 11.6 billion Euros. By contrast, Europe has 11 companies and only 9.1 billion Euros in combined turnover. This fragmentation and significant overcapacity of European naval construction is in marked contrast with the European military aerospace sector, which is concentrated around the UK's BAE Systems and Airbus parent EADS. Hence, this drive for consolidation has led many to nickname the strategy "naval Airbus." ¶6. (SBU) Where is the French hunt for a non-French European partner leading? Industry analysts say that talks with Spanish company Navantia have progressed the furthest, but still have a long way to go. Similarly, many pointed to German shipbuilders TKMS (ThyssenKrupp Marine Systems) or the Atlas Group as the most likely partners. TKMS is 25% owned by U.S. firm OEP, a subsidiary of JP Morgan. There have been many reports that Thales has been trying to buy into the Atlas Group, but that their efforts have been resisted by German officials. The TKMS steel and engineering group recently added German submarine maker Howaldtswerke-Deutsche Werft AG to its marine division, along with Swedish Kockums AB and Greek Hellenic Shipyards SA. A major Franco-German deal is seen as a logical move toward the creation of a European naval equivalent of EADS. Alliot-Marie summed it up by saying that "We will have to get consolidation in Europe. I don't think it will start with the Germans. There are more advanced conditions for it with the Spanish and the Portuguese." Comment: This is mainly wishful rhetoric, since nationalism or, in French terms, "economic patriotism" would keep these potential partners from being consolidated into a French-led European champion. Last resort consolidation remains possible if and when any of these European companies run out of shipbuilding contracts and face an economic abyss as their only clear alternative. End comment. ¶7. (U) As with any major industrial deal in France, concerns of unions play a role, which cannot be overlooked. Indeed, workers resisted efforts to pacify their concerns by calling for strikes on the day of the announcement to protest what they see as creeping privatization. The call for strikes turned out to be little-heeded, with only three of eight sites affected. Only 250 employees out of 2,800 in Brest joined the protest. Thales CGT union leader Bernard Carlier commented: "What doesn't reassure us is that our main shareholder, the French state, does not explain how it will include Thales in reshaping the European defense industry. (The GOF) is acting more as a customer than a shareholder." The GOF maintains a 31.3% stake in Thales. Alliot-Marie took her turn trying to reassure the unions by saying that "DCN is not privatized, the (civil service) status of the employees is confirmed and no side is threatened." DCN has some 12,000 employees and Thales is much larger with broader interests across the defense sector. ¶8. (SBU) Comment: Years in the making, the deal is the result of GOF marketing of "private" company DCN. Although the GOF remained the only shareholder until this deal was announced, it had transformed the state entity into a company structure several years ago, diminishing the state's direct role in DCN. In the interim and motivated by the need to attract other shareholders, DCN cut its expenses and its workforce. Payroll and pension costs were reportedly constrained by not giving civil service status or pensions to new hires. At Euronaval in November 2004, when rumors of a Thales buy-in were rife, the GOF announced that DCN would be opened to other investors. More than a year later, they finally snagged one. We believe that DCN's persistent efforts to constrain costs and modernize management were determining factors. What tipped the balance for Thales might have been the fact that DCN shipyards have enough actual and potential orders (two Malaysian submarines, potential for a second French aircraft carrier, up to 17 French frigates under the Franco-Italian FREMM program, and potential Barricuda orders to build next generation attack submarines for the French Navy) to keep them busy for the next ten to twelve years. End comment. Please visit Paris' Classified Website at: http://www.state.sgov.gov/p/eur/paris/index.c fm Stapleton