Cablegate: French Naval Courtship Creates Defense Industrial

This record is a partial extract of the original cable. The full text of the original cable is not available.

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

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