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Invesco Voices Concern Over BAE Tie-Up

BAE Systems’ largest shareholder will on Monday signal its “significant reservations” about the U.K. defense group’s proposed tie-up with EADS.

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Invesco Perpetual , which owns more than 13 per cent of BAE , will outline in a statement its concerns about the structure of the 35 billion euro ($45.4 billion) transaction and its likely impact on shareholder value. The fund manager has hired an M&A boutique, Ondra Partners, to advise it.

Invesco has long been a critic of BAE’s acquisition strategy, and has urged the group’s management to return more capital to investors. In correspondence seen by the Financial Times, Neil Woodford, its head of U.K. equities, last year warned Dick Olver, BAE’s chairman, that the company’s “unacceptable” focus on dealmaking was responsible for the low rating of its shares.

The fund manager decided to go public after expressing its concerns about the proposed deal to BAE’s chief executive, Ian King, at a meeting last month. Its intervention comes at a critical moment for the transaction, with the British, French and German governments still wrangling over the political safeguards they require before giving it their approval.

Philip Hammond, the British defense secretary, said on Sunday the U.K. government would not back the deal unless there was a marked reduction of the German and French stakes in the business.

It was a “red line” issue for Britain that both the other governments abandoned their ability to control the combined company, he said — adding that the U.K. government was prepared to use its golden share in BAE to veto a deal.

While Invesco does not have sufficient votes to block the deal, its opposition adds another obstacle for BAE. However, another top 10 shareholder said yesterday: “We have been skeptical from the outset about this deal, both from a strategic and commercial viewpoint. Neil has similar views to us. We have ... felt that it has too many political hurdles. Our view is that this deal may be close to collapsing.”

In its statement, Invesco says it does “not understand the strategic logic for the proposed combination”. While acknowledging that the deal may offer diversification benefits by giving BAE’s investors access to EADS’s growing civil aviation business, it argues that shareholders could achieve these without a merger.

Pushing the two companies together will, meanwhile, “materially jeopardize BAE’s unique and privileged position” in the US defense market.

Although BAE’s shares trade on a lower multiple than many of its US and European peers, Invesco warns that the big state shareholdings the combined group may inherit, and its proposed dual-listed structure, could widen the discount further.

The statement is dismissive of the value case for the merger, arguing that BAE’s low rating offers “significant standalone upside value for its existing shareholders”.

It also questions whether the likely terms adequately reward the UK group’s strong cash flow characteristics and warns that the deal threatens the dividend. At 5.9 percent, BAE’s yield is more than twice that of EADS. Although BAE has indicated that the payout would be maintained in the short term, investors expect this to be cut over time if the deal goes ahead.

Mr. Woodford argues that BAE should hand back more cash through a buyback program, a stance he believes is shared by other investors. Invesco believes this would both increase current returns and drive up the share price.

In a letter sent last May to Mr. Olver, Mr. Woodford expressed frustration that the company was continuing with its dealmaking.

“It is a reversal of this strategy that will help drive a re-rating over time, not, as your non-execs believe, buying high-growth businesses at inflated prices,” Mr. Woodford wrote. He warned that unless there was a “substantial change” in BAE’s strategy, Invesco would have to consider “all options open to us”.

At the time, Mr. Olver responded that many of the fund manager’s views “align[ed] with those of the board”.

Additional reporting by Jim Pickard and David Oakley

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