Hedge fund challenge to EADS puts Paris on the spot

When an activist hedge fund wrote to Tom Enders urging the EADS chief to sell the aerospace group's big stake in Dassault Aviation, it was essentially tossing a well-aimed grenade at France's socialist government.

The 46.3 per cent shareholding in Dassault - maker of the Falcon business jet and more importantly the Rafale fighter - is at the centre of an elaborate set of cross-shareholdings and family interests knitting together France's strategic defence industry.

But, as the TCI hedge fund pointed out, the stake, worth €4bn at today's market values, represents a poor use of EADS capital. TCI's criticism in a letter to Mr Enders comes as EADS has decided to concentrate its future development on commercial planes, changing its name to Airbus accordingly.

"They have a point," says Francois Heisbourg, special adviser at the Foundation for Strategic Studies in Paris. "The stake is a stack of money frozen into a large minority shareholding that is largely sterile."

TCI clearly knew that, as far as Mr Enders was concerned, it was pushing on an open door. He has made much of recent changes in EADS's structure, removing veto rights from its French, German and Spanish state shareholders, that he says now mean the company is under "normal" governance.

EADS insiders have made no secret of the company's eagerness to shed the Dassault stake. "Central to our strategy is efficient capital allocation and creation of shareholder value," a spokesman said on Monday.

Ben Walker, TCI partner, has been at pains to signal friendly intentions to EADS's management. "We want to emphasise that Mr Enders and the CFO, Harald Wilhelm, are doing a fantastic job," he says, in a rare note of praise from TCI, whose usual dealings with corporate management are more bruising.

But the issue really turns on the French government.

For all Mr Enders' insistence that he is free from state interference, he recently concluded a 90-year shareholder pact with Paris giving it a say in any decisions about the Dassault stake, the right of first refusal in a sale of any part of it - and a single Dassault share.

It appeared this was intended to maintain, at least for the time being, a complex status quo prevailing in the French defence sector.

The share in Dassault maintains French state interest in the maker of the Rafale, France's main fighter aircraft. Dassault also holds 26 per cent of Thales, another key defence contractor, and manages the state's 27 per cent stake in the same company.

Any move to consolidate these interests have been resisted to date by the Dassault family, presided over by 88-year-old Serge Dassault, which holds just over 50 per cent of the eponymous company.

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Mr Heisbourg at the Foundation for Strategic Studies says one solution would be to turn the single share that the state holds in Dassault into a "golden share", allowing EADS to cash in while preserving the government's interest. "That could work out quite well for all sides," he says. However this could raise objections from Brussels.

Meanwhile, TCI is agitating for action. Analysts at TCI believe Dassault trades cheaply relative to its real value precisely because of its ownership structure, with only a tiny free float.

The hedge fund's preferred option is for EADS to arrange for a public offering of the holding, which it believes would result in a significant re-rating of the company. "EADS's stake could be worth €5bn," says Mr Walker.

A sale would resolve one longstanding tension: EADS is the largest stakeholder in a consortium making the Eurofighter combat aircraft that competes head-on with Dassault's own fighter aircraft, the Rafale.

Last year, Eurofighter lost out to Rafale when the Indian government named Dassault as the preferred bidder to supply up to 126 combat aircraft in a deal that could be worth $20bn.

"Dassault Aviation would be happy to see EADS sell its stake, because EADS is a direct competitor," says Sash Tusa, analyst at Eschelon.

But TCI's wish that the proceeds of any sale should be returned to EADS shareholders could yet provoke tensions.

One possible course of action for the hedge fund could be tabling a formal motion at EADS's next AGM. Such a move would replicate the strategy used by TCI at ABN Amro in 2007, where the hedge fund secured massive shareholder approval for an "advisory" motion recommending the sale of the bank.

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