Europe’s defence firms are flying. Now for the hard part

An “era of rearmament” is under way in Europe, declared Armin Papperger, the boss of Rheinmetall, earlier this year. Investors in Germany’s defence champion certainly seem to think so. Since the start of the year its market value has rocketed from €27bn ($31bn) to €80bn, equivalent to 90 times its annual net profit and within shooting distance of Lockheed Martin, an American defence colossus. The values of other large European defence contractors, including Britain’s BAE Systems, France’s Thales and Italy’s Leonardo, have also soared (see chart 1).

European leaders were already nervous owing to the war in Ukraine, but the return of President Donald Trump has further convinced them of the need to ratchet up defence spending in order to reduce the continent’s dependence on American security guarantees. This year Europe will spend some $180bn on military kit, more than double its outlays in 2021 and greater even than the amount spent by America (see chart 2). That figure is set to rise further still, after NATO members agreed in June to increase defence spending from a current target of 2% of GDP to 3.5% in a decade’s time, with another 1.5% for adjacent spending on things like infrastructure.

In the process, European leaders envisage revitalising the continent’s arms industry, which has suffered from decades of underinvestment. Europe relies on American military gear; between February 2022 and September 2024 American weapons accounted for a third of European procurement spending, according to the International Institute for Strategic Studies, a British think-tank. The wisdom of that approach has now come into question. In a scenario where Europe needed to replace weapons at the same time that its long-time ally is drawn into conflict in, say, the South China Sea, America’s defence industry would undoubtedly prioritise resupplying the country’s own arsenals.

Can Europe’s defence industry rise to the challenge? “Readiness 2030”, a white paper published by the European Commission in March, concluded that the continent’s companies are “not able to produce defence systems and equipment in the quantities and speed that member states need”, and called for a “massive ramp-up of European defence industrial production”. “Preserving Peace”, a follow-up plan published on October 16th, laid out the bloc’s defence priorities for the next five years. But scaling up to meet these will be a struggle for an industry held back by fragmentation, glacial procurement processes and too few innovative newcomers. If it stumbles, far more than investors’ money will be at risk.

Start with fragmentation. Europe’s defence companies lag far behind their American counterparts in scale owing in part to the propensity of the continent’s governments to favour equipment from their domestic defence champions. Rheinmetall generated revenue of just €10bn last year, a sixth as much as Lockheed Martin.

This lack of scale has made it particularly difficult to match the might of American contractors when it comes to high-end equipment. Investment in military research and development in Europe was a meagre €13bn in 2024, well behind the $148bn spent in America, according to the Kiel Institute, another think-tank. The continent’s local suppliers are close to meeting its demand for artillery shells and howitzers, and have expanded production of tanks and other fighting vehicles, but the development and production of advanced kit such as rocket artillery, long-range missiles and air defences is “limited at best and absent at worst”, according to the Kiel Institute. In February Guillaume Faury, the boss of Airbus, a European aerospace giant with a large defence business, stressed the need for “more co-operation and more consolidation”.

Efforts at consolidation are under way. In September Rheinmetall announced that it would acquire Naval Vessels Lürssen, a maker of warships. The value of European defence deals hit $2.3bn in the first half of this year, up by more than a third from the same period in 2024. But with governments reluctant to cede control of firms deemed vital to national security, mergers among the biggest companies are unlikely.

Greater co-operation on major defence programmes offers another possible solution to fragmentation. Joint programmes, however, have had mixed results. Although the Eurofighter Typhoon jet, a collaboration between Britain, Germany, Italy and Spain, has been a success, the Future Combat Air System, an effort to develop a new European fighter jet that will be supported by a swarm of drones, is threatened by bickering between France and Germany.

Lengthy procurement processes pose a further problem for Europe’s defence industry, which is wary of investing based on loose commitments to future spending. Bureaucratic inertia is endemic in Europe. Without firm orders for large amounts of equipment, defence contractors struggle to insist on increases in capacity further down the supply chain. “No one is building on a promise,” says John Schmidt of Accenture, a consultancy. When it comes to the most advanced military equipment, long development cycles mean American kit may remain cheaper and faster to get hold of for many years to come.

Then there is the question of whether Europe can compete in the development of the technologies transforming warfare. The conflict in Ukraine has shown the importance of drones on the battlefield and satellites in space. If Europe is not to be dependent on outsiders, it must be able to produce such systems at scale.

To do that, Europe needs the types of upstart defence contractors that have been gaining sway in America, including Anduril, a maker of drones, and SpaceX, which is behind the Starlink satellite network. Yet Europe’s capital markets are not as deep and liquid as America’s, making it hard for newcomers to “raise funds, innovate and compete”, according to the Goldman Sachs Global Institute, an arm of the investment bank.

Europe has shown signs of promise, argues Ben Prade of Bullhound Capital, a tech investor. It has spawned three defence unicorns (startups valued at over $1bn)—Germany’s Helsing and Quantum Systems and Portugal’s Tekever, all of which make drones. Mr Prade adds, however, that while early-stage funding is available, capital to help companies scale up is still lacking.

Here investors’ newfound enthusiasm for defence companies may help. Whereas the industry was once seen as a pariah, it is now almost glamorous. Karl Rosander, boss of Nordic Air Defence, a startup developing drone interceptors, says that banks which were previously reluctant to provide finance are “banging on the door”. The company’s business model is similar to that of Anduril: rather than waiting for governments to specify weapons and ask for tenders in a procurement process that can last years, it is anticipating what it thinks will be required in the hope that orders will follow.

Europe will need many more such entrepreneurs willing to take big risks if it is to reinvigorate its defence industry and reduce its reliance on American arms. Without them, it will struggle to protect itself in an increasingly hostile world. ■