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Tuesday, March 1, 2005

Eurowatch

Giovanni de Briganti

Agusta, the US101 and Westland

By any measure, the selection of the US101 (nee AgustaWestland EH101) as the winner of the U.S. VXX Presidential helicopter competition opens a new era in transatlantic relations. Thirty years on, it finally opens the two-way street in the defense trade between the United States and its European allies. It marks the first instance when Pentagon acquisition officials selected a European competitor against a competitive domestic bid.

Selection of the US101 allows Lockheed-Martin to enter the U.S. helicopter market, while consigning Sikorsky to manufacture additional Black Hawks without having anything much to follow them in the pipeline. Its effect on the future prospects of Sikorsky's S-92--a helicopter that will now be seen to have been spurned by its major domestic customer--will be brutal. And Canadian defense officials must be wondering about their decision to buy the H-92 instead of the EH101, now that even the Pentagon has snubbed Sikorsky's latest offering.

But barely two days after its VXX victory, AgustaWestland announced that it would lay off 640 people at what has now become its U.K. subsidiary, Westland Helicopters Ltd., because of falling orders.

This is widely seen as a warning shot across the bows of Britain's Ministry of Defence, which has still not awarded Westland a long-awaited contract to develop Future Lynx, a successor to the Lynx helicopter, whice was due by Nov. 11, 2004. If the contract is not awarded by May 31, 2008, Agusta will receive 50 million euros ($65 million) being held in escrow. While this leaves some margin, AgustaWestland is clearly eager to get some new work on its books, especially since it recently paid out more than ?1 billion ($1.88 billion) to GKN to seal the Westland deal.

But despite its cost, AgustaWestland's decision to take control of Westland seems to have been especially astute in the light of the VXX decision. In addition to Westland itself, AgustaWestland also bought complete ownership of the EH101 program, so it will not have to share any of the royalty and other payments it will receive from Lockheed Martin for the US101. As Lockheed Martin stands to receive $6.1 billion for the 23 Presidential helicopters it must develop and produce, these are likely to add up to serious revenues for AgustaWestland.

But the real money will come from the additional helicopters the Lockheed Martin "Team US101" stands to sell in the United States, main among them the 200 to 400 aircraft that the Pentagon is looking to buy for its combat Search and Rescue (PRV program) and other requirements. Even if AgustaWestland receives only relatively small royalty payments, they will add up and go a long ways toward offsetting the money the Italian state-owned Finmeccanica group paid to buy out GKN. Best of all, these payments will allow AgustaWestland to amortize its remaining investment in the EH101 even if it doesn't rack up any further export sales; which, of course, it will now that the S-92 has been shot down as a credible competitor.

What does this lead to down the road? Having produced the EH101 for the Royal Air Force and Royal Navy, and the WAH-64 Apache for the British Army, Westland Helicopters can look forward to a decade or two of steady revenue from support and maintenance contracts. Similar support revenue will be generated by the British Army and Royal Navy Lynx fleets, and this will more than suffice to keep Westland comfortably ticking over for a decade or two.

Assuming the Future Lynx contract comes through, Westland will also have more than enough R&D and production work on its books to generate satisfactory profits. But, even if it doesn't, AgustaWestland has all the cards in hand to offer Britain's MoD fall-back solutions which require no new R&D investments. Most British Army Lynx helicopters could be replaced by a mix of Bell/Agusta AB139s and TTH90s, both now in production, while the Royal Navy's Lynx variants could be replaced by the naval variant of the NH90. In both cases, these are off-the-shelf solutions that should appeal to the MoD's spendthrift--value for money--approach to defense acquisitions, while increasing AgustaWestland's profit margins by doing away with the need for risky R&D investments.

In fact, AgustaWestland could hardly be faulted if it shut down the Lynx product line four decades after the program was launched, especially as the British forces would be offered more economic and better-performing alternatives to meet their requirements at lower overall costs.

This scenario explains why Finmeccanica group was willing to pay ?1 billion to take over Westland and why it is already beginning to cut costs at Yeovil even though the deadline for a Future Lynx contract is still three years away and despite having won the VXX competition. The question, though, is whether AgustaWestland CEO Amedeo Caporaletti is Macchiavellian enough to implement such a plan. Whatever happens to Westland, some older heads at Sikorsky must surely be gnashing their teeth at the US101's victory in the VXX competition. Less than 20 years ago, Sikorsky had taken control of the British company and could still be the majority partner today if it hadn't cut and run.

But it did, and the fact that it now runs a very real risk of being pushed out of the helicopter business by the EH101 and other AgustaWestland products must be a matter for unalloyed regret in Connecticut.

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