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Opposition to EADS-BAE merger may prove insurmountable

Visitors look at an A350 aircraft miniature at the EADS booth during the ILA Berlin Air Show Sept. 13, 2012. Shares in EADS and Britains BAE Systems tumbled as investors feared a planned tie-up aimed at creating the world's biggest defence and aerospace group could run up against political and regulatory obstacles.


The blockbuster merger proposal that would create Europe's answer to Boeing Co. was on the verge of collapse after the deal ran into a barrage of British political and shareholder opposition that may prove insurmountable.

The effort to merge EADS NV, the European aerospace giant that owns Airbus and Eurocopter, with BAE Systems PLC, Britain's biggest defence contractor, was designed to create the world's biggest aerospace and defence group.

With a market value of about €35-billion ($44-billion), it would have substantial presences in businesses ranging from nuclear submarines and satellites to passenger jets and fighter aircraft. The prime goal of EADS was to own a company – BAE – that has emerged as one of the biggest defence suppliers to the United States. For BAE, the attraction was diversification; it would join a company with almost €500-billion in commercial aircraft orders.

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The problems in putting the two companies together reflect the political tensions that can wreck cross-border European deals, where national agendas often collide with management strategy and shareholder interests.

The deal began to unravel over the weekend, when a group of 45 British MPs, including Defence Secretary Philip Hammond, put pressure on Prime Minister David Cameron to block the merger unless the French and German governments promised to greatly dilute or eliminate their state shareholding in the enlarged company.

"We want to see this company … prospering as a commercial business, focused on doing things that are right for the business, not beholden to or controlled by any one government," Mr. Hammond said in a BBC radio interview.

Pressure to kill the merger intensified Monday, when Invesco Perpetual, the British investment manager that owns 13.3 per cent of BAE, making it the company's biggest shareholder, used a public statement to argue that the merger would do more harm than good to the company.

Invesco's response was advised by Ondra Partners, the London corporate finance advisory boutique founded by Canadian investment banker Michael Tory, the former head of U.K. investment banking at Lehman Bros. and the son of the late John Tory, who was president of Ken Thomson's Woodbridge Co.

Invesco has owned BAE shares on and off for 20 years and has always been critical of its acquisition strategy. "Other than through diversification – which investors can achieve for themselves more cheaply and simply – Invesco does not understand the logic of the proposed combination," it said.

BAE has been criticized for using expensive acquisitions to "buy" growth at the expense of shareholder value. In the past decade, it has made £18-billion ($28-billion) in acquisitions, which is about 50 per cent more than its current market value.

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Like the British MPs, Invesco, among other concerns, fears that the French and German influence over the new company would result in a corporate strategy driven by state interests instead of shareholder value.

The French state owns 15 per cent of EADS, a holding that would be diluted to about 9 per cent if the merger with BAE were approved. France wants to raise its ownership in the new company to 13.5 per cent by buying the 4.5 per cent in EADS held by French media company Lagardère. Germany, which has no direct take in EADS, would also take 9 per cent of EADS and add 4.5 per cent by buying the stake held by Germany auto maker Daimler.

Together, France and Germany would own 27 per cent of EADS, effectively giving them control of the world's biggest defence company. Invesco fears that the hefty state ownership block could "materially jeopardize BAE's unique and privileged position" in the U.S. defence market.

While EADS argues that merging with BAE would boost the new group's opportunities in the United States, the world's biggest defence market, Invesco worries that the opposite would happen because it is BAE, not EADS, that enjoys a close relationship with the Pentagon. BAE has a rare "SSA" – Special Security Arrangement – that means it is trusted enough to bid on a broad array of U.S. defence contracts even though it is a foreign company. EADS would not automatically inherit that status if it were to buy BAE; EADS has never been able to crack the U.S. market. In 2008, it did win a $35-billion (U.S.) contract to build a fleet of aerial refuelling tankers for the U.S. military, only to see the Pentagon later reject the purchase and hand the deal to Boeing.

By Monday night, BAE's CEO, Ian King, and his EADS counterpart, Tom Enders, were scrambling to save the deal ahead of the British Takeover Panel's Wednesday afternoon deadline to present a formal merger proposal. Some German newspapers were reporting that the deal was all but dead, although they left open the possibility that the two companies would seek an extension to the deadline.

"The odds of this deal happening are becoming more remote," said an investment adviser who is close to the situation. "It was already struggling and today's announcement will embolden other BAE shareholders since they now know that, together with Invesco, their voices will make a real difference."

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