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13 Dec 02. The problems associated with the BAE SYSTEMS Astute and Nimrod contracts highlighted in BATTLESPACE UPDATE 48 AND 49 were clarified by BAE SYSTEMS in a short statement on Wednesday. The company announced that, ‘additional issues have arisen in relation to its Astute attack submarines and the Nimrod MR4A aircraft. BAE SYTEMS has been reviewing with the UK MoD the outlook for these contracts and it has now become apparent that there are substantial schedule and cost implications. The company and the MoD are continuing to discuss the extent to which these two contracts can be modified to the mutual benefit of the MoD and BAE SYSTEMS. Discussions with the Mod arte likely to take some months and no assurances as to the outcome can be given. However, the company anticipates agreeing with the MoD the principles to be applied in the envisaged contract modifications in order to be able to assess any cost implications by the time of the company’s 2002 Preliminary results announcement in February 2003.

The company is believed to have sent a top level delegation to Number 10 on Monday November 18th to discuss these two problem contracts and has used the excuse that they could not inform the City until negotiations had been finalised. BAE SYSTEMS’ Mike Turner has played the hard man with its biggest customer the MoD, always a dangerous game, and come out second.

However, BAE walked away empty handed having hoped for some contract renegotiations and an increase in the Astute order. It has been mooted that the company was firm favourite for the CVF programme before this meeting and the revelations during discussions have put Thales back in the frame. The MoD said on Wednesday it could not protect BAE Systems Plc from cost over-runs on aircraft and submarine contracts worth more than £4bn(US$6bn).

“We have made it clear to the company that the MoD cannot protect it from cost-overruns which have arisen from its failure to perform,” the ministry said in a statement. “We are however prepared to explore areas where the scope of the contracts could be varied on a value-for-money basis for the taxpayer and where these are in the nation’s defence interests,” it said. “However, we are clear that the company must face up to its responsibility for the cost-overruns arising on these contracts.”

The City reacted with amazement and the shares were marked down by over 40% ending the day below £1.00, on Friday the shares have rallied slightly to 104p.

The FT reported that investors already had their suspicions and the shares had fallen sharply on Monday and Tuesday after a number of analysts predicted there would be a profits warning (despite denials from BAE). The Financial Services Authority is now investigating the heavy selling amid speculation that prior warnings about the row leaked out from sources close to the government. Yet the early selling was nothing compared with the panic when BAE changed its mind and released a statement on Wednesday afternoon, warning about unquantified losses from the two projects.

As soon as they learned the government was taking such a hard position, analysts began to pencil in estimates suggesting the overruns on both projects would cost between £500m and £1bn.

Irritation among analysts at the lack of disclosure was matched by anger among investors that the accident-prone company should be back in this position so soon after earlier profit warnings. Leading shareholders, including one normally conservative fund manager among BAE’s top 10 investors, have called for the immediate retirement of Sir Richard Evans, executive chairman.

Apart from the bungled communication, a bigger worry among investors is the longer term implications of such a bitter dispute with the government, which remains BAE’s biggest customer. As negotiations over the aircraft carrier contract enter their most delicate stage, the row could not have come at a worse time for the company.

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