UPDATE 8-EADS, BAE call off world's biggest arms merger

(Adds German officials)

* 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 complex cross-border deal in asector where commercial considerations are typically trumped bypolitical, economic and national security concerns was alwaysgoing 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 aircraft. In the end, it wasBerlin, 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 said. "If that was going to impinge on ourability to commercially run this new merged organisation, andsupport and develop our existing business, then we wouldn't goto that point, and that is where we are today."

Asked if he had encountered more problems with Berlin thanParis, he said: "That would be an accurate representation."

EADS chief executive Tom Enders, himself a German, said: "Itis, of course, a pity we didn't succeed, but I'm glad we tried.I'm sure there will be other challenges we'll tackle together inthe future."

A source close to the talks said the companies had met allof Berlin's requests and were baffled as to why ChancellorAngela Merkel's government blocked the deal.

"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 economic adviser.

But German officials said they were ultimately unconvincedby the commercial logic of combining the Airbus maker with aBritish firm whose biggest customer is the Pentagon on behalf ofthe U.S. military.

"We started asking ourselves, 'Does this deal really makesense?'" one senior German official said. "The market went down,investors were against it, the synergies were unclear, as wasU.S. market access with the big state shareholdings."

Many EADS shareholders had also opposed the deal, and thefirm's share price rose more than 5 percent on Wednesday.


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 theAmerican armed forces account for nearly half of its revenue.Because Washington is reluctant to give contracts to firmsinfluenced by foreign governments, BAE considers minimisingstate control as crucial to its business.

EADS has a more complicated share structure that gives biginfluence to German and French industrial groups and the Frenchstate. To keep its influence at the combined firm, Germany wouldhave had to buy out a holding by engineering firm Daimler.

Many Germans see EADS as primarily a civilian planemaker.Making a large investment in a trans-Atlantic arms firm could bepolitically uncomfortable in Germany, which has a post-World WarTwo history of pacifism.

"This would have created the biggest defence company in theworld," said a second source close to Merkel. "But defence is anespecially sensitive subject in Germany."

Ultimately, German officials said the parties were unable toresolve the shareholding issue to everyone's satisfaction. Pariswanted to retain the option of going up to 13.5 percent bybuying a stake held by French firm Lagardere at a later date.German officials insisted they be able to follow suit.

The British wanted a cap of 10 percent each, concerned thatthe Germans and French could approach a blocking minority ifthey went above that level.

Still, the companies believed they could have bridged thedifferences if Germany was more willing to negotiate.

"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.


The companies had until Wednesday afternoon to declare theirintentions and either scrap the merger, ask British regulatorsfor more time or finalise their plans. The merger would havecreated a group employing nearly a quarter of a million peoplethat could better compete with U.S. rival Boeing .

Analysts called the breakdown a severe blow especially forBAE boss King, 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".

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 backed the deal and has largely supported BAE's casethat French and German influence would have to be limited tomake the deal work, especially given BAE's vast U.S. business.

The deal's failure is arguably a setback for Prime MinisterDavid Cameron. A source familiar with the negotiations saidCameron spoke to Merkel about the deal on Tuesday but failed topersuade her to lift objections.

"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."


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," he added.

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.

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 and aims to reduce its stake. Franceholds an identical stake, split between the state and Frenchpublisher Lagardere .

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/