BAE shares have underperformed over the past three years, leaving them on a low PE and a high yield. However, despite these low ratios, they could continue to underperform on concerns over defence budget cuts, particularly in the US and the UK as these two countries account for some 70% of group sales. Management has pledged a series of measures, including bolt-on acquisitions, cost reduction, share buybacks and higher dividends, but these do not appear to have had any positive impact on the stock price.
We believe that a radical move is required to reverse the share-price decline and we advocate a complete reversal of the group's long-held strategy in order to unlock the substantial hidden value within the group's business portfolio.
De-merging the US businesses should allow the market to value the two resulting groupings on their individual merits and this could provide an immediate uplift in the valuation of some 36%. Furthermore, an independent BAE Inc could then generate further value for shareholders by merging with or selling itself to one of the US defence companies, releasing a further 10%-20% of value. A similar strategy was successfully pursued by General Dynamics in the last major defence downturn in 1991 and yielded total shareholder returns of over 500% between 1991 and 1994.
So breaking up the profitable bits in the US from the bits in the UK that makes a loss - here comes a sucker punch!
LJ