BAE Systems-EADS: The rationale

Eurofighter Typhoon outside a BAE Systems hangar A deal would have combined BAE's defence industry prowess with EADS-subsidiary Airbus' passenger jets

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The planned tie-up between BAE Systems and EADS, designed to create a defence and aerospace giant to rival Boeing of the US, has been called off.

The deal was supposed to marry BAE's expertise in military and defence with EADS' aerospace juggernaut, Airbus, and was not simply aimed at cutting costs and employee numbers, according to the two companies' bosses.

It would also have marked the final consummation of a union of the French, German and British defence industries that was originally mooted way back in the 1990s.

But ever since being leaked to the press on 12 September, various obstacles have been thrown in the planned merger's path.

The French and German governments have weighed in, the UK parliament has announced a review, an EADS shareholder has called foul, and Downing Street has threatened to veto.

Germany has been widely blamed for the deal's death. However, the decision to call off talks does not preclude resurrecting them in a few months' time.

Here is a guide to the two companies, what they do, and why they are beholden to so much politics:

BAE Systems EADS

Proposed share of merged entity

40%

60%

Background

British Aerospace was created by the UK government in 1977. Between 1981 and 1985 it was fully privatised, although the government retained a golden share giving it veto rights over the firm. The company was renamed BAE Systems after its takeover of another UK firm, Marconi, in 1999 - a deal it pursued at the expense of a planned merger with the founders of EADS. BAE was the joint founder of Airbus with EADS in 2001, but sold its 20% share to the majority owner in 2006.

EADS was created in 1999 from the merger of Germany's DASA (the aerospace wing of the Daimler industrial group), France's Aerospatiale and Spain's Construcciones Aeronauticas. British Aerospace was also intending to participate in the merger, but belatedly dropped out. The four firms were already co-operating on various projects, the biggest being the Airbus line of planes. Airbus was incorporated into a separate subsidiary in 2001, initially owned 80% by EADS, and then 100% from 2006.

BAE worker

Employees

89,000 worldwide. BAE claims to be Britain's biggest manufacturing employer, with 18,000 engineers on its UK payroll. Its main sites are the shipyards in Barrow-in-Furness and Portsmouth, and its aircraft production line in Lancashire's Ribble Valley. BAE employs 3,600 people around Scotland - most of them on the Clyde.

136,000 worldwide. EADS employs 17,000 in the UK, notably in wing design and production at its facilities in Filton, near Bristol, and Broughton, North Wales. The firm also employs 50,000 people in each of France and Germany, and 25,000 people work for its suppliers across the two countries.

Turnover*

£16.9bn ($27.3bn)

52bn euros (£42bn; $67bn)

Profit*

£1.24bn ($2bn)

1.52bn euros (£1.21bn; $1.96bn)

Shareholders

BAE is listed on the London Stock Exchange. Its largest shareholder is currently the US asset manager Invesco, with 13%. The UK government retains a "golden share" in BAE, giving it certain veto powers, including the power to block a change of control of the company, and blocking any non-UK nationals from the top jobs at the company, or any foreign investor owning more than 15% of the company.

Just under half of EADS is floated on the stock exchange.

However, the company is jointly controlled by three national groups under the terms of a shareholders agreement, the details of which are not fully public:

  • German investors, led by industrial group Daimler: 22%
  • the French state and Lagardere together: 22%
  • the Spanish state: 5.5%.

Lagardere started out as an aerospace business, but under the leadership of its founder's son, Arnaud Lagardere, it has shifted its focus to the media industry. The company directly owns 7.5% of EADS (which it has reduced over time), but it has an agreement to manage the French state's 15% stake.

Spain exercises minimal influence through its stake.

Airbus A320

Main business lines

A major defence contractor, delivering and servicing military aircraft, ships, armaments and equipment, BAE ranks second in the global defence industry, some way behind Lockheed Martin of the US. BAE is also active in electronic warfare and cyber-intelligence.

EADS' biggest earner by far is Airbus, accounting for 62% of revenues in 2011. Airbus effectively operates within a global duopoly of the manufacture of civil aircraft along with Boeing of the US, and (like Boeing) also builds military aircraft. Other subsidiaries include a small defence business (Cassidian), helicopters (Eurocopter) and satellites (Astrium).

Geographical focus

The US is its main client. Some 45% of revenues came from the US market in 2011, including 27% from its platform business with the US military. The UK is also a staple market. However, the US and UK markets are shrinking due to defence spending cuts. In contrast, sales to Saudi Arabia (BAE's number three customer) are still growing.

About half of EADS' sales come from Europe, while a large (29%) and growing share also comes from Asia Pacific, due to the rapid development of civilian air transport in that region. The Middle East, although accounting for only 10% of sales, has also been growing very fast.

F35 strike fighter

Political considerations

US: BAE is a privileged contractor of the US Pentagon, working on classified projects such as the new F-35 Joint Strike Fighter. The US was likely to be concerned about any deal that gave political control over BAE to the French and German governments. The business with the US is already carried out by an independent subsidiary to protect US national security interests from any possible UK influence. As part of the deal, the US business had been expected to be further "ring-fenced" by limiting the number of non-US nationals on its supervisory board to just one Briton - in other words, to the exclusion of any French or Germans. BAE and EADS also wanted to block any representatives of any government from sitting on the merged parent company's board, and to limit the shareholdings of the French and Germans to 9% each.

France: The French government was concerned about potential job losses in France, as well as protecting a European "champion" firm from any possible future takeover by non-Europeans. The government also wanted the merged group headquarters to remain in EADS' home of Toulouse.

Meanwhile, Lagardere complained that the merger did not represent a good deal for EADS shareholders, and had called for a review.

UK: BAE is closely intertwined with UK defence policy. For example, it will build the UK's new generation of Vanguard submarines. It is also a major UK employer. Employment and national security concerns prompted the parliamentary defence committee to launch a review of the merger. The UK government retains a veto over the merger by virtue of its "golden share" in BAE, and had reportedly threatened to use it if the merger was not deemed to be a good deal for the UK. It is unclear whether and how the UK would have surrendered its golden share as part of the deal.

Germany: The German government exercises considerable influence through the shareholding of the privately-owned Daimler. The company owns 15% of EADS directly, but controls a 22% stake under an agreement with other German shareholders. The German government has confirmed that it is continuing to negotiate a buy-out of Daimler's shares by the state-owned development agency KfW

The German government had similar concerns to the French. The two governments had suggested that their respective "stakes" in the merged firm be at least 9%, with the German government taking over some or all of Daimler's stake. Daimler's chief executive Dieter Zetsche would rather focus on Daimler's automotive business. Moreover, a memo from the German economy ministry obtained by Reuters complained (like Lagardere) that the merger did not represent a good deal, and did not contain safeguards against a possible future foreign takeover of the merged firm.

*12 months to June 2012, US GAAP pre-tax

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