European Aeronautic, Defence & Space Co. and BAE Systems Plc are reviving a decade-old plan to build an equal to Boeing Co. that would balance civil and defense operations in an era of shrinking military budgets.
EADS stock slumped as much as 10 percent in Paris, while BAE declined as much as 9.2 percent in London on concern that a combined company will struggle to achieve savings and penetrate the U.S. defense market. EADS, the parent of Airbus SAS, would control 60 percent of the new entity, with London-based BAE owning the rest, the companies said yesterday.
"This will be a very complex organization and there is a risk of synergies coming only much later," said Yan Derocles, an analyst at Oddo Securities in Paris. "Airbus is a big growth story and will be heavily diluted in the new company. And there's also the problem of significant constraints on the defense business in the U.S."
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The new company would have a combined market value of about $45 billion, sales nudging $100 billion and 220,000 employees, with assets spanning civil jets, Eurofighter warplanes and nuclear submarines. A merger would revive plans for a single European aerospace business that were abandoned more than a decade ago when the formation of EADS and BAE split the industry in the region along civil and defense lines.
BAE slumped as much as 33.6 pence to 330 pence, reversing an 11 percent surge yesterday after the companies confirmed that they are in talks. Today's drop, which stood at 5 percent as of 8:41 a.m. in London, clipped BAE's market value to about 11.3 billion pounds ($18.2 billion). EADS dropped as much as 2.89 euros to 25.11 euros in Paris, valuing it at 21 billion euros ($27 billion).
The deal would add Toulouse, France-based EADS's revenue of about 49 billion euros last year to BAE's 17.7 billion pounds. That compares with $68.7 billion at Chicago-based Boeing and $46.5 billion at Bethesda, Maryland-based Lockheed Martin Corp., the world's biggest defense company.
"BAE Systems and EADS believe that the potential combination of their two businesses offers the prospect of significant benefits for customers and shareholders," the companies said in a statement after markets closed.
EADS Chief Executive Officer Tom Enders, who took over in June, has been revamping senior management positions and switched the leader of the Cassidian defense business this month. Enders, a German reserve army officer, previously ran the Airbus business, which is EADS's biggest sales contributor and the world's largest maker of civil aircraft ahead of Boeing.
Airbus Dependence
The companies, who cooperate on the Eurofighter warplane, first explored scenarios for a combination in early June, followed by the first outlines of a combination a month later in Munich that included the 60-40 split, a person familiar with the talks said. Besides Enders, EADS chief strategist Marwan Lahoud has been a driving force behind a deal, said the person, who asked to remain anonymous because the information isn't public.
The companies didn't say where the combined group would be based, or who would lead it. EADS is moving its headquarters from Paris and Munich to Toulouse in order to be on the same location as Airbus. Besides Airbus, EADS also has helicopter, space and defense operations.
"EADS has been seeking to reduce its dependence on Airbus and achieve a better balance between commercial aerospace and defense," said Zafar Khan, an analyst at Societe Generale in London. "A combination with BAE would certainly achieve that."
BAE is a supplier to Boeing on military and commercial aircraft, including automatic flight control systems and belly-mounted guns for the V-22 Osprey, a touch-screen attendant control panel on the 737 airliner and engine-control systems on 787 Dreamliner jets, according to Michel Merluzeau, a consultant with G2 Solutions in Kirkland, Washington.
Boeing CEO Jim McNerney told reporters in Washington yesterday that a combination of EADS and BAE wouldn't "threaten us fundamentally."
"I have a pretty deep and abiding faith in our company's strength," he said at the Council on Foreign Relations office. "It does reflect a global consolidation that is beginning to happen."
A combination of EADS and BAE would be larger than Boeing's purchase of McDonnell Douglas in 1997 that was valued at $16.3 billion. That deal brought together two civil aviation manufacturers, two years after Lockheed's defense-focused combination with Martin Marietta Corp.
U.S. Strength
BAE, led by CEO Ian King, was the U.S. government's ninth-largest contractor in fiscal 2011, with $7.3 billion in direct, or prime, contracts, while EADS was its 100th, with $684 million in contracts, according to a Bloomberg Government study ranking the top 200 contractors.
The two companies employ about 45,000 workers in the U.S., 90 percent of them at BAE, and operate under special security agreements with the government. BAE supplies the U.S. military with combat vehicles and artillery such as the Bradley fighting vehicle, the self-propelled Paladin howitzer and naval guns.
EADS makes UH-72 Lakota light-utility helicopters for the U.S. Army. The company in 2011 lost a bid to Boeing to develop a new refueling tanker for the Air Force as part of an estimated $35 billion program.
Given the "highly secure and sensitive" nature of the defense business involved, BAE and EADS plan to ring-fence certain activities, particularly relating to the U.S., the world's biggest defense market, they said.
Weapons makers worldwide have been struggling with shrinking defense budgets as austerity-minded administrations rein in spending. BAE has suffered as Britain seeks to eliminate a 38 billion-pound defense shortfall, while governments across Europe have cut commitments for Eurofighter combat jets and armored-vehicle sales have fallen following the end of the war in Iraq and a wind-down of troop numbers in Afghanistan.
Governments in Germany, France and the U.K. would be issued with special shares in the new business, BAE said. EADS has also agreed to pay shareholders 200 million pounds before completion to help harmonize the companies' dividend payouts.
Among EADS's biggest shareholders is the French government, which owns 15 percent. German carmaker Daimler AG controls 22.5 percent, of which 7.5 percent is owned by German federal states and some banks. The Spanish government owns 5.4 percent. Daimler said it still intends to reduce its stake in EADS this year.
European Schism
The British government's Department of Business, Innovation and Skills said it was aware of the merger proposal and that while any business benefits are "a matter for the companies," it will ensure that the public interest is protected in any deal.
BAE was created in 1999 when British Aerospace Plc, which had been exploring a merger with Daimler's Dasa unit in Germany, opted instead for an all-U.K. combination with the Marconi Electronic Systems unit of GEC in 1999.
That prompted Dasa first to acquire Construcciones Aeronauticas SA of Spain and then to combine with France's Aerospatiale Matra SA to form EADS. The sequence of events gave EADS control of 80 percent of airliner manufacturer Airbus, which BAE exited in 2006, while allowing the U.K. company to dominate the European defense sector.
Morgan Stanley, Goldman Sachs Group Inc. and Gleacher Shacklock LLP are advising BAE, with Freshfields Bruckhaus Deringer LP as legal counsel. UBS AG is serving as BAE's corporate broker on the deal. EADS is being advised by Evercore Partners Inc., Perella Weinberg Partners LP, Lazard Ltd. and BNP Paribas SA, and Clifford Chance LLP is acting as counsel, according to two people familiar with the matter.
Credit Suisse Group AG will probably be asked to compile a fairness opinion, said one of the people, who asked to remain anonymous because the advisers have not been publicly announced.
Bloomberg News
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