Road to riches

Road to riches

.... ambitions are not constrained to the airliner market: EADS made a key
move late last year with its sale of four Airbus Military A400M transports
to Malaysia. ...



The rapid expansion of Asian economies ? particularly in China ? is acting
as a magnet for European investors. But will US sabre-rattling hold them
back?

In the tradition of Marco Polo, Europe?s aerospace adventurers are plying a
trade route to the Far East that promises riches and rewards, but also
comes with risks. The commercial trail blazed by Airbus and Eurocopter
looks to be lucrative, but the burning question is whether Europe?s defence
industry will follow their lead, and at what cost?


© AIRBUS


Airbus sees huge potential in Chinese market and already has 325 aircraft
in service

For the past two decades, Europe?s aerospace industry has been focused on
breaching the walls of fortress America, and while Airbus and Eurocopter ?
now EADS companies ? have broken through, the continent?s defence
manufacturers have been less successful. With the rapid growth of the
economies in China, India and Asia, attention has switched to the East, and
again the commercial market has led the charge. But with the European Union
talking about lifting its arms embargo on China, the potential for defence
sales ? however long term ? cannot be ignored. And neither can the
inevitable negative US reaction. As Europe looks to the East, it is having
to balance the rewards against the risks.

Made in China?

Airbus made its first inroads into China in 1985, when it sold its first
three aircraft to the country. Since then, the company has gained
substantial ground, obtaining an unprecedented commitment for 150
A320-family aircraft last year. Part of the deal was a pledge to consider
the possibility of setting up a final-assembly line for the narrowbody
aircraft in China. Also last year, and after a similarly long engagement in
the country, Eurocopter agreed to invest ?300 million ($360 million) in
co-developing the new helicopter, the EC175, with China?s AVIC II.

EADS co-chief executive Noel Forgeard is clear on the significance of the
$10 billion Airbus deal, and stresses the company?s long-term commitment to
the Chinese market. ?There is a huge market potential,? he says. ?We think
China is the right partner with which to tackle the next 20 to 30 years.?
Eurocopter chief executive Fabrice Bregier agrees, describing Asia as ?the
biggest growth market for the company?.

It is no surprise that China is considered the holy grail by many European
manufacturers, with three consecutive years of 10% economic growth under
its belt. Boeing forecasts 7.8% annual growth in Chinese air traffic, and
predicts the market will need 2,612 new aircraft over the next 20 years.
Airbus is even more bullish, predicting that traffic growth of between 8%
and 10% a year will create a market for 1,790 aircraft with more than 100
seats alone by 2022 in China alone, making it the second-largest aviation
market after the USA. As of September last year, 325 Airbus aircraft were
in service in mainland China, Hong Kong and Macao ? a 34% market share even
before the recent orders are taken into account. But EADS?s plans for China
involve expansion on a wider scale, to encompass everything from
engineering design and development to product support and maintenance.

EADS forecasts that by 2015, 30% of its sales will come from the
Asia-Pacific region, compared with 16% in 2004. The company?s focus is not
just on China. Late last year, Eurocopter was selected to work with South
Korea on development of a new military utility helicopter. EADS is also
expected to announce the establishment of a new research and development
centre in Singapore at next week?s Asian Aerospace show.

Aviation?s other favoured destination is India, and as low-cost carriers
spring up to take advantage of the huge potential for growth in air
traffic, Airbus forecasts Indian carriers will buy 600 aircraft worth over
$60 billion by 2023: its goal is to win at least half of these orders.

Expanding India

And it is not just the potential for sales that attracts Western
manufacturers to India: as the country?s middle class expands, foreign
investors can take advantage of the growing numbers of English-speaking
graduates available in a low-cost environment.


© AIRBUS


Airline services providers are positioning themselves to take advantage of
the huge growth in air transport in the region



High-profile aerospace companies are keen to stress they are not interested
simply in the low-tech, low-cost labour for making simple components that
Asian countries can provide. They are investing in skills, they point out.
Engine manufacturer Rolls-Royce announced late last year it was setting up
an engineering centre in Bangalore, citing the ?capability that exists in
India to develop, reliably and to consistently high-quality standards,
affordable aero-engineering solutions ? including engineering analysis and
design capability?.

Although the European primes and tier-one players may downplay the
significance of the low-cost manufacturing provided by Asian markets,
smaller companies with tighter margins further down the supply chain can
clearly benefit from the lower labour costs the region offers. For
Europeans hit by dollar exposure in recent years, Eastern outsourcing can
provide a valuable way to save on costs.

Toulouse-based supplier Latecoère is ensuring it has an industrial
footprint with China through risk-sharing agreements with industry on the
A350. The company is also guaranteeing continued business with Airbus by
investing in a partnership in a key market for the aircraft manufacturer.

UK-based Doncasters is cautiously considering the region, studying the
feasibility of setting up facilities in low-cost countries such as China.
?It?s partly about having a low-cost source for our products,? says
managing director aerospace Mike Askew, ?but the strategic issue is market
access ? China is a very large and growing market and we have to ask
ourselves if a presence there is necessary.? The company would need to
identify products that would be repeatable in high volumes, with high
value-added content, he says, adding: ?This is where you optimise payback.?
Doncasters is looking at China and India, among others, as markets that
could give medium- to long-term reciprocal trading.

Electronics specialist Thales already generates on average ?100-150 million
in sales from China each year, and this figure looks set to grow. In
aerospace, its main Chinese activities include an Airbus avionics
subassembly repair shop for Chinese airlines as well as equipment for air
traffic control centres in Beijing, Shanghai and Guangzhou.

The group is considering expansion in the training and simulation sector.
?A number of simulation projects are being studied to manage the rapid
growth of air traffic in China and the expansion of aircraft fleets that
airlines will need to satisfy growing demands,? Thales says.

UK-based Smiths has long considered China a key market. The company has a
production site at Suzhou, and is looking at doubling its size and adding
manufacturing of actuation equipment and electronic components to its
portfolio of engine components for General Electric and composite and
structural materials for Airbus and Boeing. Smiths? regional marketing
director for the Far East Jon White also hints at further advances. ?China
is strategically important for us, and the support of our equipment
in-country is also a priority for us. We are looking at options for
increasing service provision.?

The move to place service and support close to key growing markets is part
of a wider industry trend: as the primes recognise the need to head East to
find new airline customers, service providers follow. UK-based Umeco is
setting up a component logistics and distribution joint venture in Xian to
support Western aerospace manufacturers including Airbus, Boeing, Goodrich
and Rolls-Royce as they step up their production in China. Umeco also plans
to support local players including Xian Aircraft and Xian Aero Engine.

Service ambitions

With the huge growth in air transport in the region, service providers to
the new and expanding airlines are also positioning themselves to win Asian
business. SR Technics chairman Frank Turner has cited Asia-Pacific as an
important growth region that he wants to target. Shanghai SR Aircraft
Technics, the company?s MRO joint venture with Shanghai Foreign Aviation
Service Corp (FASCO) will begin operations in April.




Snecma Services is aiming to take advantage of the booming Indian market,
as the growth of low-cost carriers serving the expanding middle-class
market presents business opportunities. ?The Indian market is going to be
huge, and we think there will be a need for a CFM56 [engine] shop there,?
says chief executive Jean-Lin Fournereaux. The company already has a
20-year agreement for CFM56 maintenance in place with Beijing-based Air
China and is hoping to boost its business with other Chinese airlines as
the CFM56-powered A320 and Boeing 737 fleet continues to grow.

European manufacturers? ambitions are not constrained to the airliner
market: EADS made a key move late last year with its sale of four Airbus
Military A400M transports to Malaysia. The deal included initial
high-technology work packages for Malaysian industry worth around ?200
million. EADS is also making inroads into the Asian general aviation market
with the EC175 helicopter project. Eurocopter says the Chinese helicopter
market is growing by up to 15% a year and that the country will need 300
helicopters by 2015, as the 2008 Olympic Games in Beijing and the 2010
Universal Exhibition in Shanghai boost demand for civil applications from
TV broadcasting to medical evacuation, and security to VIP transport.

R-R expects growth in the business jet market of $61 billion over the next
20 years in China, India and Russia. The forecast for these countries ?
based on the key drivers of economic activity, infrastructure growth and
market liberalisation ? is that 500-700 business jets will be delivered
over the next decade, an increase of 600%.

Italy?s Finmeccanica, which earns more than 80% of its aerospace and
defence turnover from the defence sector, has seen significant successes in
Asia in both civil and defence aerospace, with joint ventures in Malaysia
through radar division Selex Sistemi Integrati, as well as in space through
Telespazio. In India, the group has won radar contracts for India?s
military airports, while its success in China has so far been limited to a
joint venture for the marketing, production and local support of
AgustaWestland?s A109 helicopter.

While European companies have recognised the need to establish a presence
in Asia, that does not mean it is all plain sailing. While low-cost
manufacturing countries like China and India may seem an irresistible
opportunity for European players keen to improve margins and offset the
ongoing weakness of the dollar, the outsourcing of jobs to low-cost
economies is a sensitive issue back home.

Reciprocal trading

However, Doncasters? Askew points out that the possibilities for reciprocal
trading offered by a presence in a low-cost economy could help to develop
business and therefore safeguard jobs back home. ?We?re looking to see
where we may need to have a low-cost manufacturing facility to grow the
company as a whole,? he says. A European manufacturer installing itself in
the Far East must be prepared to commit to the project from close range in
the short- to medium-term, he says: ?It?s not possible to run an operation
at arm?s length.? And, says one analyst, there is always a risk that
companies will jeopardise their manufacturing operations back home through
outsourcing too many of their key skills.

ADS?s high-profile helicopter project highlights another potential
stumbling block for European investors in sensitive markets like China.
Some observers have questioned the strategy behind developing a helicopter
that, while its primary use is for civil purposes, could be modified for
military use. Issues over technology transfer and security in China could
damage EADS?s business prospects in the USA, one analyst warns. Washington
has already issued dire warnings about the prospects for European defence
sales to the USA if the arms embargo on China is lifted.

But with the importance of China on the world stage and the huge economic
and air traffic growth that is forecast, the analyst believes EADS would be
more likely to choose success in China at the expense of the US market than
the other way round. Despite sensitive issues for companies to navigate,
bullish growth forecasts for civil aerospace and the possibility of more
military business ensure Asian markets are set to continue to form a key
part of European aerospace manufacturers? portfolio.

HELEN MASSY-BERESFORD / LONDON


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