The Need for Euro-Atlantic Interoperability and Investment

Mr. William O. Schmieder
Vice President, General Dynamics

INTRODUCTORY REMARKS

Transatlantic cooperation is, and will remain, an important focus for each U.S. and European company represented here. The profound restructuring underway on both sides of the Atlantic is creating within the defense industrial base a new level of maturity. The model of a national industry that operates within protected domestic markets and is sustained by government largesse is defunct. We need a new model, based on a defense sector that is efficient, commercially viable, and able to compete for funds in the capital market if we are to achieve greater value for our customers and shareholders.

The Kosovo campaign was a reminder of the negative impact on coalition operations that results from a lack of interoperability. Although the problem was magnified by the decline in defense investment and by structural inefficiencies in Europe's defense sector, regulatory obstacles to the transfer of technology from the U.S. to its Allies were also a factor. The Defense Trade Security Initiative created in 2000 by the U.S. government seeks to create a de facto transatlantic defense community in which technology can be transferred with few impediments. Although implementation is just beginning, the policy appears to be supported by the Bush administration. But two-way transatlantic investment is crucial to complete this initiative.

THE GENERAL DYNAMICS SANTA BARBARA TRANSACTION

I would like to take this opportunity to share with you General Dynamics' experience as a foreign investor in Europe's defense sector. As is the case with virtually every other industrial and service sector in the global economy, the defense sector can no longer afford the luxury of serving only national markets. The transatlantic alliance must ultimately be served by a transatlantic industry. While leading European firms have recognized this fact and successfully invested in the U.S. defense market, the U.S. has not made significant investments in Europe's defense sector.

General Dynamics held its first round of discussions with SEPI, the Spanish privatization agency, in 1997. The timing for this initiative was critical. While General Dynamics was seeking opportunities to access the armored-vehicle markets in Latin America, Europe, and North America, the Spanish armored-vehicle organization, Santa Barbara Industries (Empresa Nacional Santa Barbara de Industrias Militares [ENSB]), was seeking privatization. What followed was a three-year process to develop a business case that satisfied and mutually supported Spanish government and General Dynamics' interests.

In the background, German industry and the German government took sometimes extraordinary measures to slow the process and ultimately stop the sale. The factors that led to the Spanish government's selection of General Dynamics to privatize Santa Barbara serve as a metaphor for the environment surrounding foreign direct investment in Europe's defense sector. And the process by which the issue was finally resolved is a useful case study in transatlantic defense consolidation. The leading German armored-vehicle producer, Krauss-Maffei Wegman (KWM)/Rheinmetall, shared General Dynamics' interest in Santa Barbara. As you may know, Santa Barbara produces the German Leopard 2E main battle tank under license to Krauss-Maffei. Krauss-Maffei was understandably concerned about a major competitor purchasing a plant that produces the Leopard 2E.

The Spanish government evaluated Krauss-Maffei's and General Dynamics' offers based on the two companies' respective proposed investment, retention of the work force, complementary products, market access, and work infusion. In January 2000, SEPI informed General Dynamics that its offer had been selected. Negotiations for the sale were concluded the next month and the contract was signed following the March 2000 Spanish general election. The signing of the sales contract produced the first of four "transition" meetings between Santa Barbara and General Dynamics. It also produced the first clear indications that the transaction had become enmeshed in the politics surrounding the European consolidation process.

The German government, with encouragement from Krauss-Maffei, applied diplomatic and industrial pressures in an attempt to overturn the Spanish government's decision. Increasing German pressure resulted in a "summit" meeting between the German Chancellor and his Spanish counterpart in October 2000. While the German government's activism did not reverse the Spanish decision, it did succeed in delaying further action until after the Nice Summit thru December. Pressure on Spanish authorities to abandon privatization of Santa Barbara reached a peak following the summit. A subsequent meeting between Spain's President Aznar and Chancellor Schroeder in Berlin finally produced a German government agreement to stop resisting the Santa Barbara transaction. Two developments important to the final resolution took place in March 2001. The Spanish government awarded the contract to produce a high-speed train to a German firm, and a Special Technology Protection Agreement was reached between Santa Barbara and Krauss-Maffei. This agreement established procedures for protecting Krauss-Maffei's intellectual property rights in the Leopard 2E when ownership of Santa Barbara passed to General Dynamics. All parties are expected to sign the agreements in June 2001, and General Dynamics' ownership will be official in July 2001.

However, General Dynamics has not waited for the official transfer of ownership, but has begun placing work in Santa Barbara's factories. Today, Santa Barbara is under contract to produce parts for the M-1 Abrams main battle tank-not for Spain, but for the U.S. market and other global opportunities. General Dynamics is also committed to placing additional work in Santa Barbara facilities to address worldwide requirements for a variety of new programs. We believe this is a clear sign to Spain and other European governments that U.S. investment in your industry can lead to greater efficiencies and broader market access.

If I may, let me offer several observations that we have drawn from our Santa Barbara experience:

• Few agree that direct investment in the European defense sector by parties outside Europe should be evaluated on traditional economic and industrial criteria.
• Not all European governments accept consolidation along transatlantic lines; some remain convinced that a Euro-centric approach to consolidation is the only acceptable answer.
• Many European decision makers are conflicted about transatlantic industrial consolidation. Most of Europe's leading defense firms seek to achieve global access to critical enabling technologies by investing in the U.S. market. However, they are reluctant to accept U.S. investors in the European defense sector.
• The politicizing of decision making regarding foreign direct investment has been raised to the head-of-government level. This further complicates a process that should be driven by commercial, industrial, and technical considerations.

CONCLUDING REMARKS

In closing, let me say that we expect that our purchase of Santa Barbara and our investment in European industry will prove successful for both sides and result in access to markets, capital efficiencies, shared technologies, and better returns to our customers and shareholders. To expect anything less suggests returning to a model that no longer reflects the realities of 21st -century market conditions.