BAE-EADS merger would create European defence 'goliath'

A potential deal to reshape Europe's defence and aerospace industries is being discussed at the highest levels by executives of the leading manufacturing firms EADS and BAE Systems. The deal could create a "world-class" firm with combined sales of £60bn and a staff of 220,000 – according to BAE, although the company was unable to confirm that there would be no job losses in the United Kingdom.

Rumours over the deal caused BAE shares to rocket by 11 per cent yesterday while EADS shares fell 6 per cent. But the agreement would actually result in BAE shareholders owning just 40 per cent of the combined group while EADS – which has its headquarters in Paris and Berlin, and owns Airbus - would take a 60 per cent stake. If completed, the agreement would result in a £200m dividend for shareholders.

A spokesman for BAE claimed that the two companies had "a long history of collaboration and are currently partners in a number of important projects, including the Eurofighter" – adding: "The potential combination would create a world-class international aerospace, defence and security group with substantial centres of manufacturing and technology excellence in France, Germany, Spain, the UK and the United States."

However, it is not yet clear how the European Union and national governments will react to what could effectively be a monopoly in the defence and aviation sectors. The European Commission is famed for its appetite to pursue anti-trust cases against large corporations, but pressure is on the two firms to agree a deal before a deadline of October 10 – under city takeover rules. Trade unions were also expected to fight against any merger, due to the potential loss of jobs as costs and workforces faced cuts.

In recent years, BAE has suffered from falling levels of defence spending in Europe, America and the Middle East – with profits falling by 7 per cent to £2bn in 2011. It is thought that EADS was also keen to seek out efficiencies to bring its business model in line with recalibrated defence and civil aviation markets. While BAE specialises in defence – including the UK nuclear submarine fleet and armoured vehicles for the US army - EADS is Europe's largest civil aerospace contractor as the owner of Airbus, the Toulouse-based maker of the A380 superjumbo.

But Guy Anderson, a defence analyst at IHS Jane's, said: "A merger between BAE and EADS is unlikely and wouldn't happen without a lot of trials and tribulations. It would have to navigate onerous regulatory hurdles and sell off many overlapping chunks along the way. If it did go ahead it would create a goliath in terms of scale, putting BAE/EADS ahead of Boeing in revenues, but there is no telling how much of the combined offering would have to be sold off to satisfy regulators. There is a political dimension. The fact that the UK will keep a stake of sorts in the combined group bodes well and the UK-France defence pact shows that pragmatism can prevail."

The largest rival firm, Boeing, claimed to be relaxed about the prospect of a merger with chief executive Jim McNerney stating: "I have a pretty deep and abiding faith in our company's strength, so I don't see this as something that is going to threaten us fundamentally. It does reflect a global consolidation that is beginning to happen."

Meanwhile, ratings agency Fitch also welcomed the merger as a possible boon for investors, although it warned that the deal faced a number of obstacles that could result in a "watering down" of the agreement. A spokesman said: "The potential merger of EADS and BAE Systems, Europe's two largest aerospace and defence companies, is likely to be rating positive. This is because of the expected improvement in the combined entity's business profile and unlikelihood of deviation from the conservative financial strategies of both existing companies.

"But the transaction faces numerous and significant obstacles in the coming months, which may result in watering down of the deal and its desired benefits. The tie-up between the two companies, both rated 'BBB+', has sound industrial logic. A combined EADS/BAE would not only be the largest A&D company worldwide by revenue, but would also have an almost even split between commercial and defence activities."