Defense cuts cast shadow over big arms show

PARIS (Reuters) - Behind the wheeling and dealing at one of the world's biggest arms shows this week, weapons makers are feeling the strain from shrinking Western defense budgets and could be forced into mergers or joint projects to survive.

A fearsome array of weapons and military equipment, ranging from assault rifles to tanks and sophisticated drones, was on display at Eurosatory, a week-long fair near Paris that defense firms from around the world use to showcase their wares.

Thousands of visitors, including defense ministry officials and senior army officers in uniforms dripping with medal ribbons and gold braid, toured the vast exhibition halls, taking aim with rifles, examining high-tech missiles and holding hushed conversations with salesmen.

Some armored vehicles carried signs saying they were "combat proven" with the NATO-led force in Afghanistan.

Outside, small all-terrain vehicles and bridge-building trucks were put through their paces on a churned-up muddy demonstration ground featuring a mock Afghan village while tiny drones buzzed overhead filming the action.

Organizers said there were 1,400 exhibitors at the show this year, up 8 percent from the last show two years ago, suggesting a sector in rude health.

In reality, European and U.S. defense firms are being hit by sharp defense cuts their governments are driving through as they wrestle with economic crisis and budget deficits.

"Particularly in the West and in Europe, defense budgets are falling and therefore that means it is more competitive ... so defense companies are definitely feeling the pressure," said Gordon Lane, managing director, defense, of the British defense industry trade group ADS.

Consolidation in the worldwide defense industry was "inevitable" in the next few years, he told Reuters at the show.

COOPERATION

Christian-Peter Prinz zu Waldeck, director of the German defense industry federation BDSV, said budget cuts and the need to share capabilities would force European firms to cooperate more on defense projects and lead to more mergers.

"Otherwise, Europe will have no chance in comparison to the United States," he said.

Analysts believe consolidation between the major defense contractors is unlikely to take place any time soon but predict the major players could look to pick off the second tier of defense groups.

"What you could see is mid-market deals taking place - they would be substantial multi-billion-dollar deals. The likes of Britain's Cobham and Ultra Electronics have attracted admiring glances from some of the bigger players for some time," said a defense fund manager who declined to be named.

The United States and Britain jealously guard their national defense capabilities, making cross-border deals harder than ever to push through. Transatlantic deals are also unlikely to happen in a year when the U.S. presidential election will slow defense-related decision-making.

Declining business in their home markets is driving Western defense firms to look to still buoyant export markets in the Middle East, Asia and Latin America for their salvation.

The pressure to export is intensifying already fierce competition in a worldwide market that some estimates say is worth $1 trillion a year.

"If you read the annual accounts of every major aerospace company, if you can find a chairman's statement that doesn't say we are chasing international business strongly, that would be a very rare company," said Alan Garwood, group business development director at Britain's BAE Systems, Europe's biggest defense company.

Competition was intense, "but it has always been like that", he told Reuters during the show.

With foreign forces due to bow out of combat in Afghanistan by the end of 2014, a stream of lucrative contracts for Western defense firms is set to dry up, dealing another setback to the companies, although one they insist they have planned for.

BAE Systems said last month it would consult unions over 620 potential job losses and the closure of an armored vehicle factory in Britain.

EURO ZONE CRISIS

The financial crisis that has lashed Europe since 2007 is having a severe impact on defense spending there and some industry players fear more cuts could be on the way.

The International Institute for Strategic Studies, a British think-tank, said in its Military Balance review this year that defense spending in European NATO states fell by an average of 7.4 percent per country in real terms between 2008 and 2010, with double-digit drops in countries such as France, Italy and Spain.

Britain is cutting 8 percent in real terms over four years from its 34 billion pound ($52.7 billion) defense budget.

In the United States, the Pentagon is under orders to cut spending by $487 billion over the next decade as the government tries to rein in its trillion-dollar deficit.

By contrast, emerging powers such as China and India - both of which had companies exhibiting at the Paris show - are increasing spending on arms.

Waldeck, of the German defense industry group, said European countries' insistence on different designs for new military equipment caused wasteful duplication.

"We can't have two tanks because one country would like to have the driver's seat on the left side and the other country would like to have the driver's seat in the middle ... These are really sometimes ridiculous requirements and we have to overcome this national egotism," he said.

NATO and the European Union's European Defence Agency (EDA) are trying to increase efficiency by encouraging pooling and sharing of military capabilities among their members.

NATO approved a package of 20 multinational projects at its Chicago summit in May while the EDA has commissioned a study on precision-guided or "smart" munitions that could lead to greater cooperation in the European industry.

Another example of the trend is a Franco-British plan to jointly develop a new surveillance drone. A contract with France's Dassault Aviation and BAE Systems is expected to be signed in July, industry sources said this week.

Industry experts say defense companies with innovative technology or a strong position in a niche market continue to do well. Other companies respond by diversifying into other areas, such as the broader security market.

AeroGlow, a small British firm exhibiting at Eurosatory for the first time, is keen to pursue export opportunities for its products, which include a lighting system that helps soldiers escape when their armored vehicle has been hit by a bomb.

"Whilst maybe some of the big markets are contracting, if you walk around here, there's an awful lot of armored fighting vehicle manufacturers ... and as a small company, I still think we've got a lot of potential to grow over the next couple of years," AeroGlow business development manager Keith White said.

(Additional reporting by Rhys Jones; Editing by Pravin Char)

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