"Serving multiple markets is one of our strengths" - Interview Thales CEO Patrice Caine

September 14, 2021

Investir, a key French medium in financial information and stock market consulting, interviewed our CEO Patrice Caine this weekend. Caine gave a clear update on the Group's trajectory and confirms a solid outlook; you can read the English translation of the French source material below!

1. Thales has practically wiped out the effects of the crisis on its financial results. How did you manage that? What are the lessons learned from an operational point of view?

It has been a chance to take a long, hard look at our organisation and cost models. You should never let a good crisis go to waste, the saying goes, so we've been exploring all our options. We had no choice in the aerospace sector, which was the hardest hit, but we have also accelerated the action plans that were in place across the whole Group before the pandemic began. In the summer of 2020, we were already saying we would have recovered our room for manoeuvre in R&D and rebuilt our full capacity to make acquisitions if an opportunity arose. At the same time, we said we could return to pre-crisis levels of profitability within two years, in other words by 2022. That was a firm intention, not a projection, aimed at showing the market our confidence in the future. Today, we confirm those objectives. That means that certain businesses are outperforming, while aerospace is still hurting, even if the worst is over. In defence, we have reached the same level of profitability as the world's best-performing companies in the sector. We rank second worldwide, just behind an American company, despite the fact that American defence contractors have much more favourable conditions in their contracts. We also expect to grow in other areas of business: in digital security, but also in the space market, after some sluggish years, and in rail transport, which will remain part of the Group until the sale closes at the end of 2022 or the beginning of 2023.

2. Will America's withdrawal from Afghanistan push up defence spending?

It is too early to say whether the events of this summer will have an effect on national defence budgets. These are long-term spending plans, so there is quite a lot of visibility. But recent events would seem to endorse the underlying trend of rising defence budgets in all our countries of operation in the developed world: France, Australia, Canada, the United Kingdom, and to a lesser extent, Germany. Added to that, in some emerging countries, the political will to expand military capabilities clearly existed before American troops left Afghanistan. These countries, along with mature Asian markets, accounted for about 24% of our defence sales last year. So all of this gives us confidence that our defence businesses will achieve their growth target of about 5% a year.

3. What about the rise of China?

There is no direct correlation between China's power politics and specific defence spending plans, such as the Military Programming Law in France. These issues take many other, more global factors into account, including China, Russia, certain Middle Eastern countries, terrorist threats in Europe, and so on. Tensions are regrettably rising around the world, so the major democracies need to be able to protect or defend themselves. And that means re-equipping the military, but also investing in security services like the police, the gendarmerie and the interior ministry in France. Security is a pillar of any democracy.

4. Isn't it a bit of a contradiction to rate defence contractors on their ESG performance?

It's true that some investors find it hard to grasp the societal role of defence: in order to live in peace, protect individual and collective freedoms and uphold democratic values, there is first a need to guarantee everyone's safety and security. It's the very basis of our societies. Defence is also one of the most tightly regulated and supervised industries in the world. The rules are very clear in all the countries we export to — cross-border transfers of defence technologies are prohibited without explicit government authorisation. So this sector is extremely closely scrutinised by exporting nations in terms of both the products being sold and the countries wanting to buy them. At the European level, there is also a kind of paradox between the creation of the European Defence Fund and the questions surrounding the taxonomy regulation. The defence industry is as principled and as respectable as any other industry, and it needs to be given credit for that.

Still on the subject of ESG, we are very active on issues of environmental responsibility and inclusion. For example, there are more than a billion people around the world who have no official identity, which is tantamount to not legally existing. Our digital security and identity business is helping them get an official identity. Also, on a major new project with Eutelsat and Orange, we are helping to bridge the digital divide by providing access to knowledge to all, wherever they are located in France or Europe, via high-quality Internet connections.

5. How are you going to cope with a slump in the civil aerospace sector that could last several years?

Domestic air traffic has rebounded strongly in the United States, and in China too, although the situation there is still a bit volatile because of the successive lockdowns. The recovery has been slower in Europe but it is happening nonetheless. I'm talking about short- and medium-haul flights, because long-haul traffic will probably take longer to pick up. Our services business, particularly avionics maintenance, which is directly proportional to the volume of air traffic, is back on track. As for line-fit equipment for new aircraft, it's Airbus that sets the pace for us. Projections point to a short-term increase in production rates for single-aisle aircraft, with long-haul activity not picking up until around 2025. Serving multiple markets is one of our strengths. It means we can retain our civil aerospace talent (several hundred employees in Châtellerault, Bordeaux, Toulouse and Valence) and transfer staff to our defence businesses, for example, where demand is growing. It's a much better solution than furloughing employees: the cost to the community is lower, and our people have a chance to explore new horizons. It's a win-win scenario.

6. The space market has made a strong comeback. Can it last?

There are two main parts to the space market: institutional customers and telecommunications. In the institutional market, we won five of the six major awards on Copernicus, the European Earth observation programme, which is practically a clear round, and we have been selected to provide half the satellites for the second-generation Galileo constellation, the competitor to America's GPS. So our space business is strong. The market for telecommunications satellites went through a slow patch in 2017-2019, with our customers, the operators, tending to adopt a "wait-and-see" posture as new satellite and constellation technologies emerged. Thales Alenia Space has been part of almost all the constellations that currently exist: Globalstar, O3b (before it was acquired by SES), Iridium Next, etc. So we cover the whole spectrum, and we are seen as one of the leaders in both satellite constellations and geostationary satellites. I am quite sure that both types of satellite solutions —constellations and geostationary satellites — will continue to co-exist, because they meet different types of requirements. Also, a new constellation doesn't appear every year, whereas between 10 and 15 geostationary satellites are ordered annually, which creates quite a lot of momentum. In a word, the need for communications and observation is colossal over the long term.

7. In digital security for civil and defence markets, what are your investment priorities, and why?

We are investing heavily in our digital security and identity business, even in mature markets such as bank cards, where technological innovations (like contactless payments with biometrics, new metal cards and cards made of recycled ocean plastics) are helping to drive growth and maintain prices. The same is true in the SIM-card market, where a shift is underway from physical SIM cards that can be removed from the device to e-SIM technology, which will ultimately be 100% software-defined. These are mature markets, but they offer lucrative opportunities. Our Digital Identity & Security business also serves many other markets, such as cybersecurity, where profitability is truly remarkable and growth rates are high. When we merged with Gemalto, we also combined two of our other businesses in this area — Vormetric, a world leader in data protection, and Safenet — to create a world-class player in encrypted data management. It is no longer sufficient for a company or an administration to set up firewalls or proxies: data needs to be encrypted and protected wherever it is stored, in datacentres, private or public clouds, etc. This is a very promising area we are investing in. We are accelerating our investments in R&D, which is the lifeblood of all our other activities: between 2013 and 2017, research accounted for 5% of revenues; now it accounts for 6%, even as profitability has improved and growth has continued to rise. For the next five years, R&D should represent 6.5% of revenues, and even more than that once the sale of the rail signalling business has been finalised.

8. Why are you selling the rail signalling business?

A portfolio of businesses needs to breathe. In 2015, our rail signalling business recorded a negative margin of 2.4%, and we said it would take us five to six years to return to a level of profitability that could be considered normal for a sector like this. That goal should be achieved this year.

Today, the question is how to move the next level. Players in the rail market are highly integrated, with an involvement in both rolling stock and signalling. There is more and more "intelligence" on board the trains and less and less on the trackside, which shrinks our addressable market. So we opted to merge this business with Hitachi Rail. In 2023, we will only have three business segments —defence and security, aerospace, and digital identity and security — which will bring greater clarity to the Group's operations. And in all three markets, we are in pole position to be world leaders and to continue to improve our performance and become stronger.

9. Are you envisaging any future acquisitions in other sectors?

We have already rebuilt the capacity for external growth that we had before Gemalto. Our analysis is that civil markets are less constricted than defence markets, where assets are scarce and very complicated to buy. A case in point was the sale of Hensoldt by KKR, which interested us. But prices are very high and the degree of control would be limited. In the case of Hensoldt, the German State took a 25% equity stake in the company. There are fewer constraints in civil markets, and things go more quickly, although in certain areas like cybersecurity, market values are also high.