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The breaking of the story on Wednesday 12 September that BAE Systems and EADS were in advanced talks about merging their respective businesses caught many observers by surprise. The two Boards sought a commercial solution whereby BAE Systems' shareholders would hold 40 per cent of the merged entity, whilst EADS's owners would control the balance of 60 per cent. The plan was for the new business to retain separate listings for civil aerospace and defence, the former in the Netherlands and the latter in London, mirroring the current arrangements for both companies. Moreover, the market capitation of the new company would be £28 billion, easily rivalling the US aerospace and defence giant, Boeing. It would be one of Europe's largest employers, manufacturers and exporters with a combined balance sheet able to cover, potentially, yet further acquisitions.
The scale of the new entity and the perception of different business cycles for civil aerospace and defence - allowing one to effectively cross-subsidise the other - represented a bold and strategic response to reduced defence budgets in Europe and the United States. Indeed, before the merger announcement, EADS shares had grown in value by forty per cent over the past five years whilst BAE Systems had shrunk by a similar value.
Why did the deal collapse?
Given the ambition and the perceived benefits, why has the deal collapsed? First, both Boards were clear that the merger could only go ahead if governments' direct and indirect stakes in the new business were at a level to avoid political interference in corporate strategy and decision-making. The magic figure in the minds of negotiators was for the French and German governments to convert their holdings in EADS into about nine percent each of the new, enlarged group. Whilst the French state was beginning to move to this position, encouraged by the UK government, the Germans were clear that they wanted a bigger return on their investment in EADS and sought to continue to hold significant influence in the new business. The negotiating teams, rightly, recognised that this would not be acceptable to the US government who, as a major customer of BAE Systems, needed to sign-off on the deal if future contracts and the status of BAE Systems' businesses in the US were not to be compromised.
Second, there were significant shareholder misgivings, especially in relation to BAE Systems. The company had generated strong dividend returns in recent years, and some shareholders questioned whether a tie-up with EADS actually represented sound shareholder value. Some EADS shareholders were equally perplexed, believing that the core financial fundamentals of the two businesses should yield a '70-30 split' in favour of EADS rather than the 60-40 merger advocated by the two Boards.
So political intransigence and traditional notions of shareholder returns on investment have, in essence, prevented the deal going ahead. In a globalised economy where finances and financiers leap borders, the power of investors in shaping the market should not be underestimated. But the sense that the future of Britain's principal defence business has been in part decided by German politicians in pursuit, it would appear, of narrow, factional interests must cause some disquiet and reflection.
So what next for BAE Systems? It seems that it is to return to a zero or low growth strategy based on, primarily, its existing markets. In the short to mid-term the order book is strong and the company should be able to continue to generate good cash returns.
But it is hard to envisage this strategy holding for the long term. The collapse of the merger may have generated more uncertainty than clarity and it remains difficult to see that all parties will be able to resume the positions they occupied prior to 12 September. The paucity of strategic options available to BAE Systems has been laid bare; with the company at the heart of Britain's defence and national security capabilities, this should be a real concern to decision-makers and other stakeholders.
As a consequence of the collapse of this merger, one final thought is that Europe as a defence idea seems profoundly diminished. NATO is attempting to reform itself through a narrative of a strong European capability block, complementing North American competencies and reach. For some analysts, NATO's smart defence initiative is the very evocation of this ambition.
The lack of political will in Europe to bring-together the region's main defence and civil aerospace conglomerates into a 'European Boeing' will not have gone unnoticed in Washington (even if some American politicians are pleased that Boeing will not have a direct rival). In just a few short years we may be discussing the collapse of this merger as more than just an interesting corporate issue. It may prove to be a significant moment in NATO's history and the tradition of Western collective security and burden-sharing.