History Says Europe's Big 3-Way Space Merger Will Fail

Defense industry consolidation -- it's not just for America anymore.

Since the end of the Cold War, the U.S. defense industrial base, which encompasses Army, Navy, Air Force, and even Space Force contractors has famously shrunk from more than four dozen smaller, diversified companies to just the big five: Boeing (NYSE: BA), General Dynamics, Lockheed Martin (NYSE: LMT), RTX, and Northrop Grumman (NYSE: NOC), plus a handful of second-tier contractors such as Leidos, L3Harris, and Huntington Ingalls.

Consolidation within the space industry has been even more dramatic, culminating in the merger of America's two primary rocket launch companies, the space businesses of the aforementioned Boeing and Lockheed Martin, into United Launch Alliance in 2006. Europe saw something similar in 2016, when Airbus (OTC: EADSY) subsidiary Airbus Safran Launchers (ASL) bought out the Centre National d'Etudes Spatiales' stake in Arianespace to give it 74% supermajority control over Europe's premier rocket launch company.

And now, the European launch business looks like it's going to get even less competitive.

Image source: Getty Images.

Airbus + Thales + Leonardo = what?

Already in control of Arianespace and its launch operations, last month Airbus announced it has signed a memorandum of understanding with Europe's other two leading manufacturers of space equipment, French aerospace giant Thales and Italian defense company Leonardo. Under this agreement, the three industrial giants intend to merge their separate space businesses into a unified whole.

This "new European space player," says Airbus, "could be operational in 2027, subject to regulatory approvals and satisfaction of other closing conditions." It "aims to unite and enhance capabilities by combining the three respective activities in satellite and space systems manufacturing and space services."

Airbus will contribute its Space Systems and Space Digital businesses, which build communications, navigation, and Earth observation satellites, and collect and parse data from the same.

Leonardo will contribute its Space Division, which builds satellites, as well as its shares of Telespazio and Thales Alenia Space.

Thales will contribute "mainly" just shares of Telespazio (satellite services) and Thales Alenia Space (satellite manufacturing), and also shares of Thales SESO (specializing in optical systems for defense satellites).

Importantly, the new company (which has yet to be named) will not include Airbus' ArianeGroup rocket manufacturing business, nor the rocket launching business Arianespace, both of which Airbus apparently intends to keep separate for itself.

Airbus will own a 35% interest in the new company, with Leonardo and Thales taking 32.5% stakes each. No one parent company will have control of the new joint venture.

Airbus + Thales + Leonardo: Better together?

Airbus predicts combining the three businesses into one will "generate mid triple digit million euro of total annual synergies on operating income five years after closing." So in other words, the three companies combined might save $550 million or so in annual operating costs.

At the same time, Airbus hopes the market heft of the bigger combined company will "unlock incremental revenues" by winning new contracts, because it will have "greater global commercial reach."

In total, the three merging space divisions will employ around 25,000 people across Europe, generate annual revenue of about $7 billion, and have a backlog of approximately $21 billion.

It's not clear how profitable (if at all) the combined company will be. According to the latest data from S&P Global Market Intelligence, Airbus' defense and space division, which houses its space assets, lost nearly $680 million last year. Leonardo's space business earned only $32 million on $938 million in revenue, an operating profit margin of only 3.4%. Thales doesn't break out numbers for its space operations.

Taken as a whole, and assuming everything goes as planned, the new company could save every penny of the $550 million Airbus projects... and still be unprofitable.

Can Europe compete with SpaceX?

Airbus and friends intend this merged European space company to take on America's SpaceX, and to a lesser extent the space businesses of U.S. companies such as Northrop Grumman, and Lockheed Martin, both of which generate revenue twice what the new European space company generate -- and are profitable.

Suffice it to say, it'll be a tough row to hoe.

Speaking of Lockheed, I'm furthermore reminded of that company's decision to partner with Boeing to form United Launch Alliance back in 2006. On the one hand, the ULA partnership temporarily boosted both companies' fortunes because they were not required to compete with each other for space launch contracts anymore. On the other hand, though, not being required to compete arguably dulled ULA's competitive spirit, to the extent that when SpaceX finally came along and started offering launch services significantly below what ULA had been charging, ULA found itself unable to compete effectively... and it's suffered a long, sad slide toward irrelevance ever since.

Suffice it to say I suspect Airbus', Leonardo's, and Thales' new space alliance will suffer a similar fate. In forming an alliance, they won't have to compete with each other anymore. But they will still have to compete with SpaceX.

And that's easier said than done.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Lockheed Martin. The Motley Fool has a disclosure policy.