European Aeronautic, Defence & Space Co. and BAE Systems Plc abandoned their planned merger amid government resistance, leaving in tatters their aspiration to create the world's largest aerospace and defense company.

"Discussions with the relevant governments had not reached a point where both companies could fully disclose the benefits and detailed business case for this merger," BAE said in a statement today, as a deadline neared with no accord in sight.

The attempt to build an equal to Boeing Co. exposed the divisions in Europe, with Germany keen to preserve a balance of power with France and the U.K. wary to check political meddling at the hands of the French. The breakdown blocks BAE's path to a civil aviation business in times of shrinking defense budgets, and marks the second failure in a decade for EADS to combine aerospace assets from Europe's three largest economies.

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The companies had until 5 p.m. in London today to file a merger plan, seek an extension, or walk away from the deal. As time ran out, EADS and BAE had intensified their dialog with governments to overcome political resistance.

EADS, based in Toulouse in southern France, and London-based BAE first said on Sept. 12 that they were exploring a merger, after Bloomberg News reported the two sides were in talks. Even if they two companies had won government backing, they still faced investors and a U.S. review.

The proposed merger had unsettled investors from the start, with EADS losing more than 11 percent since the plan became public. The stock rose as much as 1.15 euros, or 4.4 percent, to 27.25 euros today after talks ended. BAE dropped as much as 9.4 pence, or 2.9 percent, to 316 pence in London.

"It's incredibly shortsighted," said Michel Merluzeau, an aviation consultant at G2 Solutions in Kirkland, Washington. "European governments are still thinking about national interests, national programs. How can you have an integrated program for European defense in the future when they can't even agree on something like this?"

Brokering an agreement on state shareholdings ultimately proved impossible. The two companies had offered the governments special shares that gave them some veto rights. France, which owns a 15 percent direct stake in EADS, would have kept a holding of about 9 percent. Germany was granted permission for an equal stake, even as EADS Chief Executive Officer Tom Enders sought to limit state involvement.

 

Six Months

EADS and BAE spent more than six months putting together the merger plan. Initial talks between Enders and his counterpart at BAE, Ian King, focused on how to more effectively structure the Eurofighter joint venture after their Typhoon bid lost a multi-billion dollar competition in India to the Dassault Aviation SA Rafale.

"The merger would have produced a combined business that would have been a greater force for competition and growth across both the commercial aerospace and defence sectors and which would have delivered tangible benefits to all stakeholders," the companies said in a joint release.

By June, those talks evolved into merger discussions and in July the companies agreed the 60-40 ownership split. That distribution quickly came under siege from lawmakers particularly in Germany, who questioned the relationship and demanded that EADS hold closer to 70 percent of the group.

The merger's failure marks the second time that Enders finds himself on the losing end of an effort to combine Germany's defense and aerospace industry with the U.K.'s.

In 1998, Enders was head of strategy for Deutsche Aerospace when the business sought to merge with BAE-forerunner British Aerospace. As talks unfolded, GEC Marconi was put on the market and British Aerospace merged with the U.K. defense electronics business. Jilted Deutsche Aerospace then pursued a merger with French aerospace entities to form EADS in 2000.

Governments' failure to agree to merger terms and again sink a deal puts into question the future of Enders, who has been pushing for years to end German and French government involvement in EADS, which dates back to the firm's creation in 2000. Instead, Enders remains saddled with both governments and an EADS Chairman in Arnaud Lagardere who opposed the deal.

France maintains a 22.5 percent shareholding, 15 percent directly and 7.5 percent through publishing firm Lagardere SCA, with German interests represented through carmaker Daimler's 22.5 percent holding. Both Daimler and Lagardere have said they want to eventually pare their holdings to focus on their main assets, with Daimler promising shareholders a sale this year.

 

Balancing Act

Combining EADS and BAE would have allowed EADS to balance out its Airbus SAS civil aviation business with more defense assets, while BAE would have gained access to the civil business at a time when governments are slashing defense budgets. EADS would have also enlarged its U.S. defense business, which has made few inroads into the Department on Defense, while BAE is the Pentagon's fourth-largest contractor.

Negotiations went down to the wire as the companies tried to win political backing for the merger that would have eclipsed Boeing by revenue. The U.K. and France initially backed the deal, with Germany remaining on the sideline, people with knowledge of the negotiations said.

The U.K. agreed to let France and Germany hold 9 percent, while not demanding a stake of its own. Germany pushed for more, concerned its interest would be marginalized in a company essentially run out of France and the U.K. Germany had sought for years to maintain a balance with France, while lamenting that more and more business was being pooled in France.

In the end, EADS and BAE failed to overcome national political interests. Opposition also came from financial investors, with BAE's largest shareholder, Invesco Ltd., questioning the logic of the deal and voicing concern that more state involvement would jeopardize BAE's standing in the U.S.

EADS had fallen about 11 percent since the merger plan became public. Enders said last month that he didn't want to go on much longer without a firm commitment because he needed to reinforce his message of the merger's merits with investors. In the absence of a broader consent, he pulled the plug today.

"It is, of course, a pity we didn't succeed but I'm glad we tried," Enders said.

 

Bloomberg News

 

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