US Military Access may be Key to BAE-EADS Merger - Analysts

The key hurdle in creating Europe's biggest aerospace and defence firm could lie with a decision to be taken in Washington, analysts say, as investors continue to question the success of the proposed $45bn tie-up between BAE Systems and EADS.

The largest US defence industry lobby group has long resisted giving Airbus, Boeing's chief rival, a seat at the table when it bargains for contracts from the US Department of Defence (DoD) because of the 15 percent ownership of the French government. With Germany set to acquire a similar-sized stake in EADS, the parent company of Airbus, from automaker Daimler AG, some analysts are beginning to speculate that any combined group would need to separate its US operations in order to protect access to lucrative US military and civil aviation contracts.

"Our preliminary assessment, based on the simple assumption of no major changes to the two businesses when combined, results in a "strong" business risk profile," wrote analysts at the credit ratings firm Standard & Poor's.

"[However], downward pressure could arise from integration risks and changes to the business configuration related to a possible carve-out of sensitive defence-related business areas - especially in the US, where BAE Systems has significant operations."

BAE generates around $7.3bn each year from business with the US DoD, more than seven times more than the $684m generated by EADS. Boeing does around $22.1bn each year as the DoD's number two partner after Lockheed Martin. With US government plans to trim as much as $500bn from the DoD's budget over the next 10 years, analysts say competition for contracts will increase significantly and domestic job creation could mean the difference between winning and losing lucrative business.

German automaker Daimler told the Reuters news agency last week that it may consider dumping its 22.5 percent stake in EADS, the parent of Airbus and the world's largest planemaker, if the "planned transaction would also be linked to a possible dissolution of the Shareholder Pact."

Both the Spanish and French governments also own stakes in EADS, as do certain German federal states and some of its banks. France's finance minister, Pierre Moscovici, issued a statement through his office Wednesday saying the government would decide on a course of action in its own time and within the governance rules of the group.

The German government has denied an earlier report that it had given approval for the merger, although it said in a statement Thursday that it had been informed of the merger and was asked for its support. Officials in Britain and the United States have told Reuters they will also examine the deal if asked.

Airbus, which plans to set up an assembly plant for its jumbo A320 in Mobile, Alabama, has tried unsuccessfully to join the main industry lobby group, the Aerospace Industry Association of American (AIA), largely because of concern over its partial state ownership. US units of part-state owned Thales and Safran have what is known was associate membership, but the size and scale of Airbus has kept them out of the group which includes Boeing as well as UK-based firms such as Rolls-Royce and BAE Systems.

"We also believe that the complex ownership structure and partial government ownership could constrain the combined company's ability to expand its US business, as demonstrated by the long, acrimonious competition between Boeing and EADS to produce aerial refuelling tankers for the US Air Force," S&P analysts wrote on 13 September.

Noting the cross-pollination of ownership within EADS that includes both national governments and some if its European commercial rivals, analysts at Moody's Investors Service has suggested that "extra ring-fencing of certain operations beyond existing structures will likely be a requirement if the transaction proceeds to successful completion", senior vice-president Russell Solomon wrote in the company's Weekly Credit Outlook report.

"As such, even higher-level management complexity than exists today would be an important risk factor for the combined entity. These complex interrelationships could complicate, delay, or outright preclude requisite regulatory approvals of an EADS-BAE merger."

Under UK takeover laws, the two groups have until 10 October to declare their formal intentions of their proposed 60-40 merger.