Wanted: top gun to take on the toughest job in British industry

Tackling cost overruns and building bridges with the MoD are just two tasks awaiting the new BAE chairman. Clayton Hirst reports

Sir Richard Evans will conduct a ritual on Thursday that has become something of an institution at BAE Systems. While other companies prefer to get their financial results presentations over as quickly as possible - a few slides, Q&As with the executives and a cup of coffee if you're lucky - Britain's largest arms manufacturer believes things should be done a bit differently.

The BAE chairman is due to step down in less than three months. Over lunch in the 18th-century King George III room at the Brewery, the City's oldest conference venue, he will present for the last time the company results and outline its strategy for the coming year.

It will, however, be an inglorious end to Sir Richard's long career at BAE. While the results will be solid - with an estimated full-year pre-tax profit of around £750m - City analysts and journalists will want answers to tough questions. What has happened to BAE's US ambitions after it was jilted by its favoured merger partner, Boeing (and a couple of other US defence groups, to boot)? How does it propose to build bridges with the Ministry of Defence after a series of rows and blunders? When will BAE see an end to the long line of tortuous projects dogged by cost overruns and delays?

Flanked by his chief executive, Mike Turner, Sir Richard will be unable to offer any real food for thought as the assembled guests tuck into their slap-up lunch. And there is even dark talk in the City that unless the fortunes of what is supposed to be the pride of British engineering change pretty quickly, it could also be one of Mr Turner's last appearances at the Brewery.

"Turner has got a bit of reputation in the City for being confrontational. He is too closely associated with BAE's obsession with finding a US company to merge with," said one analyst, who asked not to be identified. "The only solution at BAE may be to start afresh and bring in new management."

A senior adviser to the Ministry of Defence goes further: "BAE is like an immune system. It treats change like an invading body, smothering it and spitting it out. The new chairman will need to overwhelm this."

With Sir Richard due to retire at BAE's annual general meeting on 5 May, the company is running out of time to find someone to take on what is probably the toughest corporate job in Britain. Some shareholders, feeling that BAE has for too long behaved as if it had a monopoly, have already made it clear they are not prepared to see the company "do a Sainsbury's" by imposing a chairman they consider inappropriate. Investor pressure has already forced Sir John Parker, the chairman of the energy network group National Grid Transco, to rule himself out of the running. He had been touted as a leading candidate, but BAE shareholders objected to the idea of his chairing two companies at the same time, in the light of the new government recommendations on corporate governance.

BAE insists the appointment of its new chairman is causing no panic and that it has a solid shortlist. It won't reveal who it is courting, but contenders are thought to include Sir David Lees, the outgoing chairman of GKN, John Gardiner, who retires from Tesco in the spring, and Vanni Treves, the chairman of Equitable Life.

Whoever is sitting at the chairman's desk in May will have a clean slate in front of him. A US merger is still not entirely out of the question, but the number of potential partners is limited, and it would require a lot of back-peddling by BAE's chief executive. A more popular move in the City would be to concentrate on improving BAE's fortunes as an independent British defence company.

While its rivals, General Dynamics, Northrop and Raytheon, trade on share price-to-earnings ratios of 16.4, 20.5 and 20.8 per cent respectively, BAE has a lowly 9.6 rating. One reason for this is its legacy in shipbuilding. Despite its attempts to shift into fatter-margin, hi-tech, defence engineering, it still has huge shipbuilding interests focused on the Clyde. This produces puny margins, a problem exacerbated by the UK's glut of shipyards. One source close to the MoD says: "Shipbuilding is essentially a disguised welfare programme. It's not sustainable. There is probably only demand for one or two shipyards in the UK."

One potential solution lies in the formation of a major shipbuilding company in Britain. This could be created by merging the shipbuilding interests of BAE Systems with those of VT Group, Swan Hunter and Devonport dockyard, which is owned by Kellogg Brown & Root, a subsidiary of the US construction giant Halliburton. Bringing together these businesses would be a logistical nightmare and would inevitably lead to thousands of job losses, but defence analysts believe it offers the best hope for the future of shipbuilding in Britain.

Such a move would require support from the Government. Therefore, before any plans can be even contemplated by ministers, BAE must mend its strained relationship with the MoD and the Treasury.

The National Audit Office's damning report last month into the country's biggest defence projects (£3bn over budget) revealed just what poor bedfellows the MoD and BAE are. The MoD privately accuses BAE of "arrogance" for believing it has a right to the lion's share of government contracts. BAE, meanwhile, privately accuses the MoD of being an unreliable customer, chopping and changing the specification of projects at the last minute.

One example of this strained relationship is a project to build two aircraft carriers. Working with French defence contractor Thales, BAE is in the last stages of negotiations with the MoD. However, it is understood that the Navy has recently upgraded the specification of the ships, and BAE and the MoD cannot agree on the new price. The project was originally slated to cost £2.8bn, but an MoD spokesman now says: "We envisage the two carriers will cost around £3bn." Meanwhile a project insider says: "Even in their relative basic form the carriers will cost £3.5bn. With all the kit the Navy wants, you're looking at £4bn." The final project details are to be agreed this spring, and could represent the first problem facing the incoming BAE chairman.

The carriers deal could have a bearing on what is likely to be one of the largest defence projects ever, a giant £12bn contract to provide military training facilities for the RAF. Bidding with Bombardier, EADS and Serco, BAE has already secured an early victory by controversially persuading the Government that the RAF should use its Hawk jets. BAE's competitors for the contract are Boeing and Thales; Lockheed Martin, VT Group and Rolls-Royce; and Brown & Root and Lear Siegler. The MoD team formed to assess the bids has committed to deliver the project on time and on budget and avoid a repeat of past project failures, such as the ill-fated Nimrod surveillance aircraft.

The project to build Nimrod is six years behind schedule. BAE stunned the City last February by revealing a £750m charge against this and its Astute submarine project just days before it published its financial results. The news almost cost Mike Turner his job, and there has since been speculation that the Government may cancel the project altogether. But according to a Whitehall source, a £2bn-plus contact will be signed within a fortnight.

Unfortunately for Sir Richard, the contract is unlikely to arrive before he presents BAE's latest set of results on Thursday. That would have given him at least one piece of positive news to help his lunch with the City go down more easily.