1. ITV Report

Analysis: What would BAE merger mean for the aerospace industry?

BAE has confirmed talks over a potential merger with Airbus aircraft manufacturer EADS to create the biggest aerospace company. Photo: PA Images

A mega-merger between British arms giant BAE Systems and Airbus parent EADS would create a European defence and aerospace titan that would put rivals firmly in the shade.

With around 220,000 staff worldwide - including 48,000 in the UK - combined sales of #60 billion and a market value of more than #30 billion, the merger would usher in a new era in the defence industry.

While news of the talks caught the City by surprise, the rationale behind a tie-up makes commercial sense for both groups.

BAE said there would be little overlap between the two, with BAE an expert in defence with lucrative contracts in the US and UK in particular, and Franco-German group EADS a leader in the commercial aircraft and aerospace sector.

Jonathan Jackson, head of equities at Killik & Co, said the deal would "provide BAE with commercial aerospace exposure and increase EADS' access to US defence contracts as well as the Saudi and Australian markets, in addition to cost synergies".

In particular, BAE has lucrative contracts with the US and it is the largest supplier of land vehicles to the US army.

Roger Johnston, analyst at Edison Investment Research, said the deal had "good industrial logic", with BAE said to be over-exposed to defence and EADS looking to gain a foothold in the crucial US market.

He added that the deal, whereby EADS would hold a 60% lion's share of stock in the merged group, "looks like EADS wants that high level access to the US market where it has notoriously struggled in the past".

"The combined group would provide capabilities in air, land, sea, space, cyber and civil aerospace, creating a more balanced portfolio with greater access to global markets to take on the big US boys - Boeing in particular - in both home and export markets," he said.

London-headquartered BAE is the UK's main defence supplier, making Astute nuclear-powered submarines, aircraft carriers and fighter jets.

It is one of a handful of firms in which the Government has a "golden share", meaning it can veto deals that are seen to put the public interest at risk.

BAE has 35,000 staff across 50 sites in the UK, with main bases including its submarine building yards in Barrow, Cumbria; military aircraft sites in Lancashire, and shipyards in Glasgow and Portsmouth, although the latter is said to be under review.

Its prospective merger partner EADS - European Aeronautic, Defence & Space - was formed in the 1990s by a consortium of aerospace and defence manufacturers from France, Germany and Spain.

Part-owned by the French and German governments, the jewel in its crown is the Airbus passenger jet maker, which accounts for most of its sales and profits.

With recently appointed chief executive Tom Enders keen to make his mark on the group, EADS is looking for added scale and might - and a counterweight to its Airbus arm.

It employs nearly 15,000 people in the UK, including at its Airbus sites at Filton, near Bristol, and Broughton, North Wales.

Other subsidiaries include Astrium, the UK's largest space company, and Paradigm, which is the world's first commercial provider of military satellite communications services.

For BAE, the deal would allow it to reclaim Airbus - a major cash earner - after it sold its 20% stake in the aircraft maker to EADS in 2006.

This would provide valuable protection from government spending cuts, which have already taken their toll.

BAE reported a 14% fall in sales last year as military spending in the US and UK was cut, which left 2011 profits 7% lower at #2 billion.

The group said defence spending had reduced in its largest markets - the UK and the US - while it was also hit last year by a delay in an order for Eurofighters to Saudi Arabia.

The case for the merger to go ahead seems clear, but there are numerous hurdles, not least the requirement for approval from numerous governments.

The UK government would no doubt want to retain its golden share ownership, while it is possible EADS shareholders France and Germany will want to keep their stakes.

More worrying is the possible backlash from the US, according to experts.

It is thought that America would have concerns over sensitive military assets transferring from British ownership to a European business and one that would be bigger than US-owned Boeing.

BAE said in its statement that certain defence activities would be "ringfenced with governance arrangements appropriate to their strategic and national security importance, particularly in the USA", suggesting special arrangements to ease US fears.

Andrew Gollan, analyst at brokers Investec, said while competition and approval issues were not "insurmountable", BAE investors should sell their shares following news of the announcement.

He said: "We do not believe competition and approval issues are insurmountable.

"Practically, however, combination will be complex.

"Approvals will be required from multiple global governments.

"Perhaps of more significance, agreement by UK, French and German governments on ownership structures and protection of national interests, for example nuclear deterrent, will prove politically sensitive issues."

Aside from the political implications, the deal could also spark a seismic shift in the defence sector as other rivals jostle to gain scale in the industry.

Mr Johnston at Edison said: "The key question is whether this deal could kick off a wave of consolidation in Europe."

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