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The US has already axed big budget projects as Obama seeks to curb military spending and analysts anticipate Britain will soon follow suit These are dog days for BAE Systems, Britain biggest manufacturing company, as it faces swingeing defence spending cuts by the US and British governments in the wake of the global banking crisis. The Americans have already acted – axing big budget projects as the administration seeks to curb military spending that doubled during the Bush years. Among the projects to be scrapped are the costly F-22 fighter plane, a new communications satellite, ship-building programmes and missile development. Further retrenchment is inevitable. As BAE derives half its £20bn of annual revenue from the US, this is unwelcome news. Britain is also gearing up for big cuts, with both the main political parties preparing plans to slash defence spending by up to £10bn with announcements expected after the election in May. Analysts anticipate cuts to the existing BAE Harrier and Tornado fighter jet fleet, an early phasing out of Nimrod MR2 reconnaissance aircraft, and a reduction in orders for the new US fighter aircraft, the F-35. Such ruthless cost-cutting means BAE could lose tens of millions in lost revenue. Peter Felstead of Jane's Defence Weekly says: "BAE faces a challenging period as government seeks to rein in public spending by paring back existing orders and cancelling plans for new weapons systems. Plans for new aircraft carriers, war planes and ships are vulnerable at a time when there is cross-party consensus that military spending is too extravagant." The difficult backdrop hasn't been lost on the City: BAE's share price is down 20% over 18 months and Goldman Sachs has published a note claiming BAE's earnings could stagnateuntil the middle of this decade. According to Goldmans' defence analyst David Perry, profits at BAE's land division look set to halve by 2012 after the US cut funding for several vehicle programmes in its 2011 budget. Perry also said he expected news about the group's F-35 joint strike fighter programme to get worse. Programme leader Lockheed warned recently that it would share the burden among partners, including BAE, after the Pentagon withheld $614m (£410m) in performance fees. Ed Steed, an analyst at Execution Noble, says that "BAE is not so well positioned" to withstand an era of reduced defence spending, as it is heavily exposed to so-called platform products, "big ticket items such as ships, aircraft and submarines, where the spotlight tends to fall during a defence review". He adds: "Projects where BAE is involved such as F-35 and Typhoon are far advanced but governments around the world are likely to reduce planned orders or abandon plans to place new ones at a time of budgetary restraint." Deals fall by the waysideBAE is facing pressure on a second front – competition for new weapons contracts – where it has suffered a number of setbacks. The latest to fall by the wayside is a multi billion pound deal to build the British army's next generation of light tanks and armoured vehicles where BAE has been beaten by General Dynamics of the US putting at risk hundreds of jobs at the company's armaments division, particularly in Newcastle. Last year, BAE failed to win the $281m US government contract for armoured battlefield vehicles, sending its stock tumbling by more than 5%. The loss of the US armoured cars contract to its Wisconsin-based rival Oshkosh Defense was the first major setback since BAE Systems launched the latest phase of its American expansion strategy two years ago. BAE is now the fourth-biggest defence contractor in the US market. To hedge against uncertainty in the US and UK, BAE is expanding in India, Australia and Saudi Arabia, where defence spending is expected to rise; and it aims to boost its presence in niche product areas such as cyber security and unmanned aircraft. When the company's results were announced in February, Ian King, the chief executive, said he expected combat aircraft to take over from land vehicles as the main driver of growth. He said he expected land systems to decline by 30% over the next two years, following contract setbacks, and because of retrenchment as the US and Britain withdraw from Iraq and Afghanistan But Howard Wheeldon, head of strategy at BGC Partners, says he remains positive about BAE, as "it is a past master at being able to adapt to changed circumstances". He adds: "These may be worrying times, but the company is well positioned, as it has a diversified product portfolio and international interests." Analysts at Exane BNP Paribas say they expect "a flat performance over the next couple of years" but point out that about 30% of BAE's income depends on maintenance and support programmes for projects that still have many years to run. BAE rebutted suggestions that it faces a rocky period ahead, saying: "We have a large order book and programmes such as Typhoon continue to deliver a strong performance. During the year £3bn of new support contracts were awarded. "In the US, our high-technology capabilities within our electronics, intelligence and support business continue to be in demand." BAE battles image problem Elsewhere BAE is battling an image problem, after bribery and corruption investigations in the US and UK ended with the firm paying £255 in fines to the US department of justice (DoJ) after admitting to irregularities over the sale of fighter planes to Saudi Arabia and eastern Europe. In a court filing, the DoJ claimed that BAE transferred millions to Swiss bank accounts controlled by an agent, with a high probability that a payment would go to a Saudi Arabian official in a position of influence. In the past, there have been allegations that BAE maintained a £60m slush fund to underpin the Saudi al-Yamamah arms contractthat has been worth £43bn over the past 20 years. BAE has denied the allegations. In Britain, the Serious Fraud Office (SFO) dropped an investigation into BAE's Saudi business after intervention by the Blair government in 2006. But the company must pay £30m after agreeing to plead guilty to a lesser offence of failing to keep accurate accounting records for its activities in Tanzania. Although the UK National Audit Office investigated al-Yamamah, the conclusions are shrouded in secrecy. The Ministry of Defence (MoD) says: "The report remains sensitive. Disclosure would harm both international relations and the UK's commercial interests." Anti-armaments campaigners have accused the government of a cover-up. King has attempted to draw a line under the corruption investigations by stating: "The company regrets and accepts full responsibility for past shortcomings. The firm has systematically enhanced its compliance policies and processes." Francis Tusa of Defence Analysis says: "If you ask people what they think of defence companies, they would be extremely cynical and assume that dodgy stuff is going on all the time. Of course, that doesn't make it right." Rita Clifton, chair of the branding agency Interbrand, said: "No one expects a defence company to be a hearts-and-flowers organisation. Customers are primarily concerned about product quality and service, but reputation can be a factor when potential clients are shopping around in a highly competitive marketplace. And image matters in the wider public and political arena. BAE cannot afford to rest on its laurels."
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