EADS-BAE Merger Hinges on Germany as France, U.K. Unite

EADS CEO Tom Enders
Tom Enders, chief executive officer of European Aeronautic, Defence & Space Co. Photographer: Simon Dawson/Bloomberg

European Aeronautic, Defence & Space Co. and BAE Systems Plc are struggling to convince Germany and skeptical investors to back their merger plan, with less than three days to go before a regulatory deadline.

Even as the French and British governments have agreed with EADS and BAE on the terms of a combination, Germany is holding out for more, people familiar with weekend talks said. Invesco Ltd., BAE’s largest shareholder with 13.3 percent, said it opposes the combination as it lacks “strategic logic.”

“The merger would materially jeopardize BAE’s unique and privileged position in the U.S. defense market, and has been unable to identify any corresponding benefits to offset this,” Invesco said in a statement today.

The two companies have been hamstrung in what they can tell investors until a merger plan is delivered. Germany, which currently doesn’t own a direct holding in EADS, is concerned about being marginalized. The business would be headquartered in France, with defense operations run out of London, leaving Germany without a center of command. Chief Executive Officer Tom Enders, who is German, scaled back a Munich administrative hub this year.

Germany has to join France and the U.K. in signing off the agreement to try and form the world’s largest aerospace and defense company by sales.

EADS shares fell as much as 0.9 percent in Paris and were little changed at 26.45 cents at 9:05 a.m. BAE shares were down 0.1 percent to 327.7 pence in London.

German Recalcitrance

German recalcitrance may force the companies to seek an extension to an Oct. 10 U.K. regulatory deadline to file a merger plan. Enders said last week he wants a deal by the deadline or soon after to ease investor and employee concerns. The companies will likely decide by Tuesday whether to extend, one person said. The deadline is set for 5 p.m. in London.

“It would be awkward for the Germans to go on resisting something that the other EADS member countries want, especially since the primary driver behind this is a German,” said Richard Aboulafia, vice president of Teal Group, a Fairfax, Virginia-based aviation consulting company. “They would have to say that despite a commitment to a unified Europe they’re getting back into provincial politics of old Europe.”

CEO Enders sought to convince Angela Merkel’s government in a phone conversation with one of her most senior advisers on the weekend, one of the people said. All sides backed Germany’s demand for a direct stake, they said.

Government Shareholding

Enders spoke with Merkel adviser Lars-Hendrik Roeller over the weekend to address German demands, one of the people said. Roeller had participated in a phone conversation with senior advisers from the U.K. and France at the end of last week and aborted the talks when he failed to win backing for a divisional headquarters, another person said.

Martin Aguera, a spokesman for EADS, said he had no comment on the negotiations.

Even if some parts of the 200-page merger document can still be changed, the paperwork would not be submitted without a nod from all governments, one person familiar with the matter said. France and the U.K. have drafted a document that spells out the main points of the combination, leaving only Germany outside of an agreement, two of the people said.

The U.K. government said it would not oppose Germany and France each holding 9 percent stakes in the new company, even as it settles for a so-called golden share to protect its strategic interests. U.K. Defense Secretary Philip Hammond said yesterday that he will have “crucial” three-way talks with his French and German counterparts at a NATO defense ministers’ meeting in Brussels tomorrow, in which he will set out the U.K.’s resistance to any government stake more than 9 percent.

Impaired Prospects

Invesco said it “is very concerned that the level of state shareholding in the combined group will heavily impair its commercial prospects - especially in the U.S. - and result in governance arrangements driven more by political considerations than shareholder value creation.”

As Enders seeks to pull governments across the finishing line, he risks increasing the regulatory challenge in the U.S., which also has to sign off on elements of the deal. The Pentagon is BAE’s largest customer and the firm’s access to secret technologies will come under review once a merger document is ready.

The U.S. government is examining whether the combined company would be categorized as under foreign ownership or control, said Sash Tusa, a partner at Echelon Research & Advisory in London.

A main determinant is likely to be the level of French and German government shareholdings and influence, he said, adding that this may force EADS and BAE to keep their U.S. operations at arms length via a proxy board.

Political Involvement

Enders has sought to limit political involvement in the enlarged company, offering the main companies special shares that grants some veto powers. The U.K. owns a golden share in BAE, letting it block a change of ownership. Prime Minister David Cameron’s government isn’t seeking a direct stake in the merged company, while the 15 percent owned by France would shrink to about 9 percent. Germany’s interests are represented by Daimler AG, which controls about 22.5 percent of EADS.

Among German demands is that one of EADS’s more significant divisions be based in Germany, two people said. German Defense Minister Thomas de Maiziere broached the topic with French Defense Minister Jean-Yves Le Drian, saying Germany would like to see EADS’s Eurocopter helicopter business based in Germany rather than in Marignane, France, the people said.

Cash Generation

Enders is not inclined to move Eurocopter simply to appease political demands, because the French contributions to the business have outweighed those of Germany, two people said. The business’s chief executive, Lutz Bertling, is a German. Eurocopter has a major production facility in Donauwoerth in southern Germany now.

EADS would control 60 percent of the combined business, the world’s largest aerospace and defense company by sales. “The merger ratio does not reflect BAE’s superior cash generation, or the quality of its earnings stream, derived from the length and nature of its customer contracts,” Invesco said.

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