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Regulatory Turbulence Lies Ahead

When Tom Enders, a former paratrooper in the German armed forces, took the helm of EADS in June, he let it be known inside the company that he wanted to do something bold to put his stamp on the European aerospace manufacturer.

Wednesday’s announcement of a possible combination with Britain’s BAE Systems certainly delivers on that promise.

But people close to both companies warned that the deal, which would create a single European defence and aerospace heavyweight to rival Boeing of the US, still faces considerable hurdles.

“We clearly believe it has a lot of merit or it wouldn’t have got this far,” said one person involved in the talks. “But even though we are optimistic, this still has a long way to go. It has to be cleared by the French, Germans and Brits as well as the Americans and Saudis.”

Guy Anderson, senior defence industry analyst at IHS Jane’s, went further, saying a successful merger was still “unlikely and wouldn’t happen without a lot of trials and tribulations. It would have to navigate onerous regulatory hurdles and sell off many overlapping chunks along the way.”

If Mr Enders is successful, his deal would at one stroke bring about a large part of the European defence industry consolidation that its political leaders have been looking for, while satisfying EADS’s longstanding desire to find a counterweight to Airbus, the passenger jet maker that accounts for most of its sales and profits.

Mr Enders has tried once before to drive through a merger with BAE, back in 1998 while he was still at Dasa, the then aerospace business of Germany’s Daimler. The failure of that deal led to the Franco-German agreement to form EADS just a few years later, while BAE eventually moved out of civil aerospace to concentrate on the defence business.

As well as Airbus, a combined BAE/EADS would own assets ranging from the Eurofighter to nuclear submarines, US battlefield electronics and cyber security systems used by the British intelligence services. The companies employ 220,000 people combined.

A deal would also remove a particular bugbear for Mr Enders – the distorting grip on the EADS shareholder register held by the German and French governments, which each control through direct and indirect holdings a 22.5 per cent stake in the company.

The heavy hand of Paris and Berlin has in particular stymied the development of EADS’s defence business in the US, and was believed to have played a large part in its loss to Boeing of a huge contract for air-refuelling aircraft.

In a detailed disclosure on the possible deal structure, BAE said the French, German and British governments would each holding on to a so-called “golden share”, allowing them to intervene if any of the merged company’s decisions went against their national interests.

People close to the talks said the existing Franco-German shareholder agreement would be “dissolved” by the deal.

The German government issued a short statement on Wednesday night, saying that the proposal was “a complex transaction with far-reaching security and industrial policy implications”.

Pierre Moscovici, the French finance minister, was even more terse, saying that his government would “give its opinion at the appropriate time”.

France’s success in blocking efforts to reduce its influence has been blamed in the past for EADS’s failure to become a “normal company”.

Another big potential stumbling block for a deal would be concerns in the US about sensitive military assets changing ownership from a British company to a large European business, particularly one that would be a significant rival to Boeing.

“It’s going to be a tough sell to the US government,” said Nick Cunningham, an analyst at Agency Partners. “[To persuade them] that they should allow one of their top five prime contractors [BAE] to be part of a European group when one of their major concerns over the years has been about transfer of intellectual property.”

However, people involved in the talks said that the US assets of BAE would be “ringfenced” to placate the Pentagon. They said this was why it was crucial that the deal was put together as a merger, with dual listings maintained for both companies to preserve the distinction where needed.

A Pentagon spokesman said that it had not been notified about the merger plan of the two companies but would review the proposal when it is received.

People briefed on the deal said one factor driving the talks was the precipitous decline in European defence spending as one government after another launched austerity cuts.

It is this need to find savings in defence budgets that has strengthened the view of Mr Enders, and his number two at EADS, the Frenchman Marwan Lahoud, that he could overcome the political objections to a deal.

Advisers said that both groups had consulted closely with governments in the UK, Germany, France and Spain, since serious talks began early in the summer. The US government had also been informed.

For BAE the fact that is essentially the subject of a takeover offer by EADS shows its relative decline over the past few years because of the squeeze on military budgets. In the past five years, EADS shares have risen 40 per cent because of strong sales of its Airbus passenger jets, while those of BAE have fallen by about 30 percent, shifting the balance of power between the two rivals.

Jim McNerney, Boeing’s chief executive, said on Wednesday that he did not believe the merger would “threaten us fundamentally”, adding that it was part of a “global consolidation of the industry that is beginning to happen”.

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