Will the marriage of BAE and EADS be derailed by politics?

BAE systems is looking a little more perky today, rising over 3% to 347p after the volatility of the last two days which accompanied the announcement that it was in talks to combine with European focused aerospace company EADS. After an initial surge on Wednesday, scepticism about the deal set in yesterday and both companies saw their shares drop back heavily.

The marriage would see BAE’s shareholders hold a 40% interest in the combination, while EADS’s shareholders would own 60% in the new company, with around a €40bn market capitalisation and combined revenues of over €80bn. EADS would pay £200m to its shareholders prior to completion to align payout ratios in terms of dividends. A new dual-listed company structure would be created, meaning that both companies would operate as one group but would be separately listed on London FTSE 100 and Paris CAC 40 indices.

From BAE’s perspective, the deal reduces its reliance on the US defence market which currently accounts for 45% of sales and enhances its prospects in Europe. For EADS, it allows cost savings through back office cut backs and beefs up its North American presence particularly giving opportunities for Airbus.

Given that the deal gives EADS overall control of the combination, if the necessary approvals are received it will essentially see the demise of BAE systems as a major UK entity with control being effectively moved to Paris. Whether the UK, German and French governments actually allow the deal to happen is a big question mark and the reason behind the steep sell off yesterday – much still remains to be agreed. Given the fact that BAE is the USA’s largest foreign supplier of defence equipment, the Pentagon is sure to be unhappy with the new relationship given the political sensitivities of a larger European group vying with North American stalwarts like Lockheed Martin.

The deal was announced prematurely on Wednesday after press and City speculation and it is clear much still needs to be done to consummate the tie-up. Whether it turns out to be a good deal for income hungry BAE investors given the solid historical dividend payments is less clear but with the US due to cut $500 billion from its defence budget over the next few years, the international pull out from Afghanistan and general cut backs by governments in this area, it seems a logical move for the British company in the face of a wave of uncertainty.

Contrarian Investor UK