UPDATE 7-EADS, BAE call off world's biggest arms merger

(Adds analyst quotes, updates share prices)

* Companies say they have ended talks

* Sources said Germany opposed the $45 billion aerospacemerger

* BAE shares down 1.38 per cent, EADS up 5.29 per cent By Matthias Blamont, Andreas Rinke, Sophie Sassard

PARIS/BERLIN/LONDON, Oct 10 (Reuters) - EADS and BAE Systemscalled off the world's largest defence and aviation merger onWednesday, and pinned the blame on Germany for wrecking the $45billion deal.

The acrimonious collapse followed weeks of tensenegotiations and triggered recriminations between capitals.

Securing such an enormous and complicated cross-border dealin a sector where commercial considerations are typicallytrumped by political, economic and national security concernswas always going to be desperately difficult.

The merger hinged on France and Germany accepting a morelimited role in the combined firm than they have wielded in thepast at EADS, maker of Airbus jets. In the end, it was Berlin,rather than Paris, that proved the problem.

"We had clear red lines that we were not willing to gobeyond, relative to engagement and involvement of governments,"BAE's CEO Ian King told reporters in London.

"If that was going to impinge on our ability to commerciallyrun this new merged organisation, and support and develop ourexisting business, then we wouldn't go to that point, and thatis where we are today."

When asked if he had encountered more problems with theGerman than the French government he said: "That would be anaccurate representation."

EADS chief executive Tom Enders said: "It is, of course, apity we didn't succeed, but I'm glad we tried. I'm sure therewill be other challenges we'll tackle together in the future."

A source close to the talks said the companies hadaccommodated all of Berlin's requests and were baffled as to whyChancellor Angela Merkel's government blocked the deal anyway.

"Germany blocked the deal, although all demands from theGerman side were met," the source said. "Top German negotiatorLars-Hendrik Roeller was the one who formulated all demands andsaid no in the end."

Roeller is Merkel's senior economic adviser.


Graphic on EADS/BAE market cap and share prices:

Factbox on the two companies:

Text of BAE/EADS statement


Europe's two largest aerospace groups have very differentownership structures. BAE is a private British company, and itsbiggest customer is the U.S. military, accounting for nearlyhalf its revenue. Because Washington is reluctant to givecontracts to firms influenced by foreign governments, BAEconsiders minimising state control as crucial to its business.

EADS, the Franco-German maker of Airbus planes, has a morecomplicated share structure that gives large influence to Germanand French industrial groups and the French state.

To keep its influence at the combined firm, Germany wouldhave had to buy out a holding by engineering firm Daimler.

German officials did not immediately comment on the failureof the merger, but making a large investment in a trans-Atlanticarms firm could be politically uncomfortable in Germany, whichhas a post-World War Two history of pacifism.

EADS said it was still not clear why Germany had objected.

"No firm reason has been given for the German opposition,"an EADS spokesman said. "I suggest you speak to them."


The companies had until Wednesday afternoon to declare theirintentions and either scrap the merger, ask British regulatorsfor more time or finalise their plans to create a groupemploying nearly a quarter of a million people that could bettercompete with U.S. rival Boeing .

Analysts called the breakdown a severe blow especially forKing who had faced a revolt from his company's largestshareholder, Invesco. BAE could now become a takeover target,perhaps from U.S. defence rivals.

Asked whether BAE management felt under pressure as a resultof the stormy investor reaction followed by the collapse of theplans, King said: "Certainly not. No more than usual".

Before the talks collapsed, several sources close to thedeal said Merkel opposed the proposal but they did not know why.

Sources said Germany had wanted parity with France in theshareholding of the new group, plus the basing of some companyheadquarters in the German city of Munich.

"France and the UK agreed that Germany have the samestakeholding as France in the merged group. Separately, vastguarantees were given regarding safeguarding national securityinterests, sites, jobs. The topic of headquarters was beingdiscussed very emotionally, but not an issue big enough to letthe deal fail," a source close to the transaction said.

French President Francois Hollande said the decision to endmerger talks lay with the companies, and his government'sintervention was limited to stating its conditions.

Britain has largely supported BAE's case that French andGerman influence would have to be limited to make the deal work,especially given BAE's vast U.S. business.

"Our view is that for this company as a merged entity tohave been successful, it would have needed to be able to operateas a commercial company free of undue control or influence byany single government and that's something that the companyevidently has decided it is not able to achieve," BritishDefence Secretary Philip Hammond said.

A British source familiar with the deal also suggestedBerlin, rather than Paris, was the holdout.

"It was absolutely heading in the right direction," thesource said of the talks. "There was very significant (British)progress with France. There wasn't the same progress elsewhere."

A source familiar with the negotiations said British PrimeMinister David Cameron had spoken to Merkel on Tuesday night butfailed to persuade her to lift objections to the deal.


With global defence spending declining and the civilaviation sector robust, BAE probably needed the deal more thanthe Airbus maker. Ultimately, investors saw the collapse of thedeal as bad news for BAE and good news for EADS. BAE sharesclosed down 1.38 percent at 320.9 pence in London, while EADSshares were up 5.29 percent at 27.480 euros in Paris.

Barry Norris, founding partner at Argonaut Capital Partners,an EADS shareholder, said: "Today's decision to terminate themerger talks is a triumph for common sense and shareholdervalue. Having sunk almost 30 billion euros into new Airbus planeprojects, which are only now beginning to break even, it made nosense for EADS to now share this with BAE shareholders."

"Continuing merger negotiations would have resulted in along battle with shareholders and sustained tension over weakcorporate governance. That the problems in executing the dealproved too complex should be a source of celebration rather thanregret."

It is still conceivable that a deal could be resurrected,although there were no indications that this was beingdiscussed. Brinkmanship is common in European negotiations. EADS- whose full title is the European Aeronautic Defence and SpaceCompany - was itself only created after talks about itsstructure collapsed and were resurrected weeks later.

Sean O'Keefe, chief executive of EADS North America,underscored that EADS remains committed to its goal of expandingits presence in the U.S. defence markets.

"The fact that this did not work its way to completion ...does not mean there will be any slowdown of any effort to lookmore broadly at other opportunities that may come along."

The merger had faced growing unease from investors in bothcompanies who complained they were lacking information. Manypeople had bought shares in EADS on the strength of its growingAirbus civil unit, rather than its defence ambitions, while BAEinvestors were attracted by its dividend yield.

"While BAE's long-term prospects could still be quiteexcellent, the failed merger will leave the firm much moreexposed to uncertain factors beyond its control, such as majordeclines in the U.S. defence budget and potential losses in anincreasingly competitive international defence market," saidDavid Reeths, consultant at defence analyst IHS Jane's.

BAE CEO King and Chairman Dick Olver said after the mergertalks ended that the company's dividend policy would continueand that it was not looking for a tie-up with another company.They also said management would be staying in place.

The British government holds a golden share in BAE thatallows it to block foreign takeovers.

Germany does not currently have a direct stake in EADS, butis represented by industrial ally Daimler AG , whichholds just over 22 percent. France holds an identical stake,split between the state and French publisher Lagardere. Daimler said it still aims to reduce its EADS stakethis year despite the failed merger talks.

Adding to the hurdles facing the deal, BAE's largestshareholder, fund manager Invesco Perpetual, with 13.3 percent,had said it was not convinced of the rationale for the deal.

A source with the Spanish government, which holds a 5.5percent share in EADS, said: "In the short term this guaranteesSpain's stake in EADS from being diluted, but of course a biglong-term opportunity has been lost."

(Additional reporting by Emmanuel Jarry, Arno Schuetze, PaulTaylor, Andrea Shalal-Esa, Tim Hepher, Mohammed Abbas, KateHolton, Jason Neely, Philipp Halstrick, Paul Sandle and SineadCruise; Writing by Will Waterman and Peter Graff; Editing byPeter Millership)

((tim.hepher@thomsonreuters.com)(+33 1 49 49 54 52)(ReutersMessaging: tim.hepher.thomsonreuters@reuters.net))

Keywords: EADS BAE/