Edition: U.S. / Global

Military Contractor Gets Deal To Limit Its Losses in Britain

Published: February 20, 2003

BAE Systems, Europe's largest military contractor, said today that it had reached an agreement with the British government to limit its losses on two major contracts that have been plagued with cost overruns. The deal lifted a cloud from the company's financial prospects and inspired investors to bid up its shares by more than 10 percent.

News of the problems with the two weapons programs -- Astute-class submarines and Nimrod MRA4 surveillance aircraft -- had depressed the value of BAE's shares by about 40 percent over three days in December, and had undermined confidence in the company's leadership.

Doubts were growing about BAE's ability to deliver profits from a huge new contract it has just won, a $4.6 billion order to build two aircraft carriers for the British Navy. BAE will subcontract much of the work on the carriers to its main rival for the order, Thales of France.

''They've received a get-out-of-jail card this time, but one wonders how many times they will keep getting them,'' Gareth Evans, a consultant at A. T. Kearney who follows the military procurement industry, said of BAE's agreement today.

Analysts said Britain had little choice but to agree to absorb most of the cost overruns on the Astute and Nimrod programs. Western European countries generally spend proportionally much less on weapons than the United States. Big weapons contracts are few, and production runs are short, making economies of scale hard to achieve.

To maintain a viable European weapons industry, governments will have to live with the need to insulate suppliers from catastrophic losses when a program runs into problems.

The new agreement provides for BAE and the British Ministry of Defense to share future cost overruns (or savings if there are any) on the two programs.

For the cost overruns already incurred, BAE will take a charge of £750 million ($1.2 billion) against 2002 earnings, which are scheduled to be reported Thursday. The British government will also provide some new money for each weapon system.

Both programs are years behind schedule. The Nimrod aircraft, originally planned for delivery this year, is now expected in 2009; the first Astute submarine, once meant to see service in 2001, will probably not be completed until 2008.

''Addressing these issues has been important but it should be recognized that the balance and majority of the company's business has continued to perform well,'' said Mike Turner, the company's chief executive.