EADS and BAE in Talks of a Merger

on Sep 14, 2012
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EADS (EPA:EAD), the parent corporation of Airbus, and BAE Systems (LON:BAE), the British multinational security and aerospace company, have began discussing a €38 billion (£30.5 billion) merger to battle shrinking defence budgets. If the deal goes through, the global defence industry will be reshaped and a formidable new rival to Boeing will emerge, threatening to become a global leader in sales.

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“The deal would be the single most significant European response to US defence and aerospace consolidation and the huge defence economic power it created,” said Sash Tusa, analyst at Echelon.
When Boeing acquired McDonnell Douglas in 1997 it was able to secure a more reliable income stream and offset the boom-and-bust cycles in passenger travel. Only because of its rapidly growing military business was Boeing able to thrive after 9/11, which led to a collapse in the demand for passenger jets. In the last several years, there has been a reversal and Boeing’s commercial business has soared, while its military operations have been sluggish due to budget cuts in many countries.

Exactly this type of flexibility is what EADS and BAE Systems are looking for as the primary benefit of their potential tie-up. Currently, 63 percent of EADS’ revenue comes from Airbus; after the deal, commercial aerospace would account for 53 percent of revenue, while the rest will come from military and security. With a total of $96 billion (£60 billion) annual sales in 2011, the two companies combined will overshadow Boeing and its $70 billion (£43 billion) revenue of last year.

!m[](/uploads/story/367/thumbs/pic1_inline.png)”In a difficult spending environment it makes sense,” opined Neal Dihora, an analyst at Morningstar in Chicago. “EADS has been saying they would like to have a better balance between commercial and defence.”
The merger would give EADS shareholders 60 percent and BAE investors 40 percent stakes in the combined group, which would remain dual listed. The combination of EADS and BAE, who intend to keep their separate listing status in the Netherlands and the UK respectively, would have a joint market capitalisation value of €38 billion (£30.5 billion), based on Tuesday’s closing prices. The two companies even complement themselves geographically – BAE’s strength lies in the United States, Britain and Saudi Arabia, while EADS’ operations are mainly in Europe.

EADS and BAE have a long history of collaboration. The two companies worked together on the Eurofighter jet project and were partners in the European MBDA missile joint venture. BAE also held a share in Airbus for many years before selling it back to EADS in 2006. In a statement made to the London Stock Exchange on 13 September 2012, BAE said a potential merger “would create a world class international aerospace, defence and security group with substantial centres of manufacturing and technology excellence in France, Germany, Spain, the U.K. and the U.S.A.”

Having said that, the deal faces a number of security, regulatory and cultural hurdles and is far from being certain. According to a British defence source “No one is counting their chickens just yet as it is a very complex transaction with lots of possible pitfalls, especially government related ones,” The German government holds a 22.5 percent stake in EADS, while the French government holds 15 percent. BAE has issued a golden share to the UK government that gives it veto power over important strategic decisions. Both companies hope that the tie-up will reduce Paris, Berlin and London’s day-to-day influence over them, which has politicised many of their business decisions.
The news of the possible merger excited BAE shareholders and pushed stocks up by 10.6 percent to 353 pence on 13 September. On the same day, EADS’ stocks fell 5.6 percent in Paris, leaving it with a market capitalisation of $29.8 billion (£23.9 billion).

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