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WRAPUP 1-Back to drawing board after Berlin halts BAE, EADS deal

* BAE could be takeover target after merger fails

* EADS shares higher, investors say relieved

* German officials say unconvinced by commercial logic

* British PM Cameron failed to win over Merkel

By Matthias Blamont and Jason Neely

BERLIN/LONDON, Oct 11 (Reuters) - Europe's two biggestaerospace firms will go back to the drawing board to find newstrategies after Germany stymied the world's biggest arms andaviation company merger.

Britain's BAE Systems, which earns nearly half its revenueselling arms to the Pentagon, could end up a takeover targetafter failing to seal its $45 billion deal with theFranco-German maker of Airbus civilian jets, EADS.

Politically, the deal's failure may hurt British PrimeMinister David Cameron, who failed to persuade Germany's AngelaMerkel to allow the merger and now faces uncertainty over thefuture of his country's most important engineering firm.

EADS shareholders mainly expressed relief at the collapse ofthe deal, fearing for their investment in a successful civilianplanemaker as it ventured into a declining defence market. EADSshares rose 5.29 percent on Wednesday, while BAE shares

fell 1.38 percent.

The merger's failure is however a setback for EADS boss TomEnders, who had hoped the merger would dilute the politicalcontrol that Berlin and Paris exert over his firm.

Britain and France both backed the planned merger, butGermany never warmed to it, despite the companies saying theywere prepared to pledge to keep jobs there, allow Berlin to holda big stake and meet other conditions.

"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."

BAE, a private company which enjoys privileged access toPentagon contracts, would have needed Germany and France tolimit their control of the combined firm to avoid alienatingWashington which does not want foreign states exerting influenceover its defence contractors.

"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."

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NEGOTIATIONS

Ultimately, German officials said, the parties were unableto resolve the shareholding issue to everyone's satisfaction.Paris wanted to retain the option of going up to 13.5 percent bybuying a stake held by French firm Lagardere at alater date. German officials insisted they be able to followsuit.

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 merger would have created a group employing nearly aquarter of a million people that could better compete with U.S.rival Boeing .

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".

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.

"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.

The merger never won over either company's shareholders.

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 ($38.70 billion) intonew Airbus plane projects, which are only now beginning to breakeven, it made no sense for EADS to now share this with BAEshareholders.

"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 said.

But without the deal, BAE remains exposed to severe cuts inU.S. defence spending as troops finish their withdrawal fromAfghanistan. Among its many U.S. contracts, the British firm isthe largest supplier of armoured vehicles for the U.S. military.

Chairman Dick Olver said the firm would return to businessas normal, despite what he acknowledged was a tough climate.

"We have an excellent Plan A, which is driving the company,admittedly in a difficult business environment, and theexecutives are doing an excellent job," he told reporters on aconference call alongside CEO King.

($1 = 0.7751 euros)

(Additional reporting by Sophie Sassard, Emmanuel Jarry, ArnoSchuetze, Paul Taylor, Andrea Shalal-Esa, Tim Hepher, MohammedAbbas, Kate Holton, Jason Neely, Philipp Halstrick, Paul Sandleand Sinead Cruise; Writing by Peter Graff; Editing by LouiseIreland)

((peter.graff@thomsonreuters.com)(+44 207 542 7923)(ReutersMessaging:)(peter.graff.reuters.com@reuters.net))

Keywords: EADS BAE/