Editorial: Inconsistencies in VT Group's defence versus the Babcock International Group bid

February 15th saw a rebuttal of the approach made by Babcock International Group (LSE:BAB) for VT Group (LSE:VTG). The Guardian newspaper (Feb 15, 2010 - VT Group spurns Babcock bid) reported a VT Group spokesman as saying that, "We believe Babcock is strategically challenged because we think they will be heavily exposed to defence [spending] cuts in a new administration,".

However the statement seems a little at odds with the facts;
* The exposure of Babcock to the Ministry of Defence is primarily on the Naval support from as well as work for Defence Estates. In the latter Babcock is the only company to lead two of the five regional prime contracts - splitting the MoD need for infrastructure services across five geographic districts.

* In terms of naval support and new build the UK Government is deeply committed to the Future Aircraft Carrier (CVF) programme and Rosyth, after a long battle, emerged as the site where work performed by BAE Systems (and before that VT prior to divesting its shipbuilding arm) will integrate the sections of the new vessels (Rosyth having the only closed basin and dry docks of sufficient size to handle the project in the United Kingdom. Such large vessels which have a projected service life of some 50 years will need the security of such facilities for major overhauls or emergencies.

With regard to naval support the Acquisition of DML from Halliburton KBR in 2007 put Babcock in the position of being the only player in nuclear submarine support to the Royal Navy. Refit on the four Vanguard Class nuclear deterrent submarines and hunter killer (T-Class) boats has a schedule dictated by the laws of physics rather than the MOD Commercial branch - providing an important and very stable revenue - something which noone would wish to tamper with for safety reasons.

The scope for cutbacks in the naval domain with regard to Babcock is therefore minimal.

Concerning infrastructure services whilst some cuts can no doubt be made one of the major UK political imperatives is to be seen to looking after its servicemen and their families to prevent a) unnecessary reductions in personnel and b) to avoid electoral discomfort. Therefore the Defence Primes will no doubt see price pressure when renegotiation is due but fundamentally the activity has to be done.

Looking beyond defence there are many areas where Babcock has made the strategic shift and has its ducks in a row whereas VT Group is coming late to the game. In the area of nuclear support, babcock acquired Alstec in 2006 and has been building a nuclear support business to which VT Group assets could be added.

Babcock exposure to South Africa has long been beneficial given infrastructure and the raw materials industry. VT Group could add a complimentary US defense venture where Babcock has the knowledge from its years with the UK MOD to be able to build a strong niche position. babcock network services business - supporting the power sector as well as communications could have major synergies with VT Group's Merlin communications business.

In summary there is little doubt a takeover of VT Group would bolster the strong Babcock International Group's support services business and whereas Babcock has been through the pain of reorganisation, VT Group is only just embarking upon the process having sold its ship-building business to BAE Systems - are institutional investors prepared to wait a few years to see the benefits of a solo approach versus Babcock applying their skills to harness VT Group's expertise now in a larger combine ?

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Babcock International Group PLC (London: BAB), VT Group (London: VTG)