UPDATE 4-UK, France closer on EADS-BAE merger as deadline nears

* Sources say UK, France propose broad state voting cap

* Idea would allow states to raise stakes if ceiling intact

* Germany said to maintain demand for parity with France

* EADS, BAE boards meet to decide whether to seek more time

* UK deadline for deal expires on Wednesday

(Adds French minister) By Tim Hepher and Chris Vellacott

PARIS/LONDON, Oct 9 (Reuters) - An Anglo-French breakthroughover state shares in a $45 billion arms merger between EADS andBAE Systems made an extension of a negotiating deadline morelikely, but put the two nations on a potential collision coursewith Germany.

With a 1600 GMT deadline on Wednesday fast approaching,both companies' boards met to decide whether to keep theirmerger hopes alive by seeking a roughly two-week extension tocomplete their dramatic obstacle course towards a deal.

British Defence Minister Philip Hammond said the groups nowhad a clear idea of government "red lines" for the complex andsensitive deal. He expected them to say whether they would seekan extension before the London stock market opens on Wednesday.

The decision is a critical one for Tom Enders, the head ofEADS and BAE counterpart Ian King, who havestaked their companies' reputations on realising a decade-oldplan for a global aerospace and defence giant based in Europe.

"Ian King and Tom Enders will discuss the situation latertoday and then decide, jointly with the respective companyboards, the way forward," EADS said in an emailed statement.

In an important change of tone after days of tense talks,sources familiar with the matter said France and Britain hadsignificantly narrowed differences over the wording ofguarantees on state shareholdings in the merger to create theworld's biggest arms and aerospace group.

French Defence Minister Jean-Yves le Drian said on thesidelines of a meeting of NATO defence ministers in Brusselsthat negotiations on the merger had moved forward.

"We had made a lot of progress, I think, but have weprogressed enough? That is up to those who initiated the projectto say," the minister said.

Yet doubts emerged almost immediately over whether Germany -the other half of the Airbus parent group forged together withFrance in 2000 - would back the proposal.

The companies have insisted they will only request anextension to the Oct. 10 deadline set by UK regulators if thereis meaningful progress at government level.

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The idea hammered out in three days of talks is to allowFrance to increase its stake but only if an overall ceiling onstate shareholdings in the new aerospace group, which willemploy 220,000 people, was respected.

U.S. CONCERNS

Sources said this should not be much more than 18 percent inorder to win backing from BAE, which wants to protect its largeU.S. defence business from any disruptive new regulationstemming from U.S. concerns about foreign government control.

But this would mark a departure from a system ofpower-sharing between France and Germany or their industrialallies in EADS and risks rekindling years of cross-bordermistrust.

"For this to work, it would mean breaking the link betweenthe potential future size of the French shareholding and theGerman one," a diplomatic source following the talks said.

France has so far insisted on the right to acquire more than10 percent of the new group, compared with the 9 percent itwould automatically end up with under proposed merger terms.

Germany wants parity with France, and a senior negotiatingsource said the German position was unchanged and that Berlinremained far from impressed with progress.

"The situation looks dark for the merger since there isstill no consensus between the governments," the source said,adding the companies could decide to call the merger off.

EADS denied a German news agency report that talks hadcollapsed and confirmed progress in the UK-French negotiations.

"We are surprised to see the reports from Berlin. Only thismorning, we have received the information that France and the UKhave made significant progress on the issue that was blockingthe negotiations for the last few days," an EADS spokesman said.

"The two companies will discuss the situation and possiblesteps forward this afternoon."

"NOTICEABLY CLOSER"

The approaches of the French, British and German governmentsat the start of the talks were different, the French ministersaid. "They have moved noticeably closer together but have theymoved closed enough for the companies to think it is worth(asking for) an extension? That is up to them to say," he said.

EADS has put its unions on stand-by for briefings on apossible deal in either one week or two weeks, union officialssaid, suggesting the companies would seek a far shorterextension than the maximum allowed 28 days. A scheduled Europeanworks council went ahead on Tuesday with no managers present.

The mention of "significant progress", the most upbeatcomments by EADS since merger talks emerged last month, appearedto meet the criteria for an extension in the UK deadline.

A French government source said the nation had not changedits official opposition to a 10 percent cap on its futureshareholding in the group that would team Airbus airliners withBAE's weapons factories.

Underscoring doubts among investors, shares in EADS rosesharply on the reported failure, then fell back to mark timeawaiting the decision from top management assembled in Toulouse.

The companies say they cannot spell out the full benefits ofthe merger before completing negotiations over the shape of thecompany's capital and possible guarantees on investment.

"The first thing they will have to do is get an extensionand then the communication from the company has to improve,"said one of the top BAE shareholders, asking not to be named.

"They have to get on the road and convince investors whythis is a good thing. I don't think just placating thegovernments is going to work any more now."

Britain and France have the power to veto the deal, whichmust also be approved by the United States and overcomepolitical objections in Germany. France owns 15 percent of EADSwhich would be diluted to 9 percent of the new group. Germany isnot a direct shareholder.

Core EADS shareholders Lagardere , the French mediafirm, and German car firm Daimler also have the rightto veto a deal. Both have expressed unease about the terms butare not participating in board discussions to prevent a conflictof interest, according to a person familiar with the talks.

(Additional reporting by Gernot Heller, Matthias Blamont,Sophie Sassard, Paul Sandle, Chris Vellacott, Arno Schuetze,Elizabeth Pineau, Andreas Rinke, Adrian Croft, SebastianMoffett, Mohammed Abbas, Julien Ponthus, Jason Neely, BlaiseRobinson, Simon Jessop, James Regan, editing by PeterMillership)

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Keywords: EADS BAE/