Why BAE Systems Decided Not To Sell Its Commercial Unit

BAE Systems began the year by making a smart move: it took its U.S. commercial avionics unit off the auction block. That decision undoubtedly came as a big surprise to the three bidders who submitted final offers last week, and many observers concluded that the offers must have been lower than BAE hoped. However, it appears that what really changed was BAE’s assessment of the unit’s future prospects. Apparently the commercial unit, called Platform Solutions, outperformed management’s expectations for 2010, leading it to reflect on the wisdom of selling now.

Platform Solutions is an anomaly in the company’s U.S. portfolio — a commercial business in an enterprise that is doubling down in its commitment to the defense business. Linda Hudson, CEO of the company’s sprawling U.S. subsidiary, remains committed to growing in defense electronics and security services. However, there was growing evidence that now was not the right time to unload Platform Solutions. The commercial avionics market is reviving and other parts of Platform Solutions are generating surprisingly strong results. Thus, waiting a while will likely increase buyer interest in the property.

The key question this raises in the near term is how BAE Systems will finance U.S. acquisitions it might have been planning in military electronics and services. Sale of Platform Solutions had been expected to provide some of the needed funds. In the aftermath of last week’s very modest weapons cuts by defense secretary Robert Gates, BAE has good reason to believe it will be generating more cash than expected from its military businesses. Gates announced upgrades to BAE’s existing amphibious vehicles, created a new amphibious program on which it can bid, and left two other major vehicle programs where the company is a strong competitor on track. In addition, he accelerated an airborne jammer program on which BAE’s defense electronics unit is competing and continued funding of various other programs generating revenues for the electronics unit.

So “Inc.,” as BAE’s American subsidiary is known among insiders, could prove to be something of a money machine for the next few years, generating enough cash to buy deeper into the parent company’s biggest home market without having to sell anything. On the other hand, the good news from the Gates announcements was not confined just to BAE’s products, so the multiples being sought for defense properties may hold up well in the year ahead. With Hudson unwilling to overpay for acquisitions and organic operations performing well, BAE may decide to wait a little longer to grow its already sizable presence in the U.S. defense market.