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In this file photo dated Monday July 14, 2008 visitors talk and wander around a Mantis unmanned aircraft by BAE Systems PLC during a presentation at the opening day of the Farnborough aerospace show, in Farnborough, England.LEFTERIS PITARAKIS/The Associated Press

The quick death of a proposed merger between European aerospace and defence giants BAE Systems PLC and EADS NV Wednesday has dashed faint hopes of increased liberalization of the continent's highly fragmented defence market.

"This highlights the real challenges for Europeans in their attempt to create an integrated defence industry and market," said Clara Marina O'Donnell, a research fellow with the Centre for European Reform think tank. "We had three countries with three different approaches to defence that were impossible to reconcile."

BAE, Britain's biggest defence company, and EADS, the European aerospace giant that owns Airbus, announced the collapse of the deal that would have created the world's biggest aerospace and defence group, shortly before their deadline to launch a formal merger proposal. They blamed their inability to overcome government opposition. "We are obviously disappointed that we were unable to reach an acceptable agreement with our various government stakeholders," Ian King, chief executive officer of BAE, said in a statement.

The merger was designed to create a European defence and aerospace giant that could compete with Boeing Co. in everything from commercial aircraft to nuclear submarines. EADS would also have been joining a company that had much better luck winning U.S. defence orders.

The deal was fraught with political difficulties from the start. The French and German governments wanted to exert effective control over the enlarged company (Together, they would have owned 27 per cent of the combined firm). Britain objected to formation of a company where Franco-German interests might override its interests and wanted France and Germany to have no stakes. There were disputes about board representation and where to put the head office, while Germany was keen to ensure jobs stayed in country, said George Thilenius, owner of Dr. Thilenius Management, an investment firm in Stuttgart. Sources close to BAE and EADS said the Pentagon was concerned about a BAE change of ownership, since EADS, unlike BAE, did not have the special U.S. security clearance to bid on big defence contracts. Even EADS chairman, Arnaud Lagardère, voiced concerns about the deal.

"It's somewhat surprising the managements of these two companies didn't have a better sense of the irreconcilable differences," said Philip Finnegan, director of corporate analysis with Teal Group, an aerospace and defence market research firm based in Fairfax, Va. "There was a tremendous amount of miscalculation."

European nations have widely varying approaches to their defence firms, ranging from relatively liberalized England and Sweden to France, where the government holds key stakes in its largest contractors. European nations have generally favoured local champions and created bureaucratic barriers to exporting equipment. As a result, the continent has too many armoured vehicle and ship manufacturers, for example, and had 90 separate weapons programs in 2009, more than three times as many as in the much larger U.S. defence market. European defence spending has also been hit by austerity-minded governments.

European nations had recently passed two directives that would ease exports between counties and increase competition for European defence contracts, raising hopes of integration and consolidation across the continent. Instead, RBC analyst Robert Stallard said in a note, the abandoned deal marked "a dark day for European defence" that leaves BAE in particular vulnerable for potentially damaging its U.S. market position.

BAE shareholder Invesco Perpetual also criticized the merger for lacking strategic logic and said BAE for its poor history of creating shareholder value through acquisitions.

BAE shares closed down 1.38 per cent at 320.9 pence in London, while EADS shares were up 5.29 per cent at 27.480 euros in Paris.

With files from Reuters