BAE and EADS in merger talks to create aerospace giant By Paul Sandle and Rhys Jones LONDON (Reuters) - Britain's BAE Systems (BAES.L) and Airbus-owner EADS (EAD.PA) are in advanced merger talks to create a combined group worth $48 billion, overtaking Boeing (BA.N) as the world's biggest aerospace and defense company in terms of sales. Under the detailed plans announced by the two firms on Wednesday BAE shareholders would own 40 percent of the combined group and EADS shareholders the remaining 60 pct with the firm structured as a dual-listed company. The news sent shares in BAE up 10.6 percent to 353 pence, giving it a market value of $19 billion, while EADS closed 5.6 percent lower in Paris to give it a market value of $29 billion. However analysts said they saw plenty of pitfalls in a deal that would face regulatory, security and cultural hurdles. "On the face of it this will create one of the largest aerospace and defense organizations on the planet, depending on how much they have to spin out to get this past regulators," said Guy Anderson, Senior Principal Analyst, IHS Jane's Defence Industry. It could change the European defense market beyond recognition. Paris-based Oddo Securities analyst Yan Derocles said he was surprised by the scope and timing of the deal, given the fact that defense budgets were shrinking while increasing emerging-market competition has added to uncertainties on BAE's outlook. In a sign of the pressures on the industry, the news brought a breath of life to what has otherwise been a quiet Berlin air show, with no new airline orders being announced for either Airbus or arch rival Boeing. A source close to EADS told Reuters that the two companies had been talking on and off for almost a year. The source said the talks were the brainchild of Marwan Lahoud who is in charge of strategy and marketing at EADS. The merged company would supply a range of products from the Airbus commercial jets such as the A380 superjumbo and its A400M military transporters to the BAE-made Tornado fighter jets and its Astute-class nuclear-powered submarines. The two companies have a long history of collaboration and are partners in a number of projects, including the Eurofighter and the European MBDA missile joint venture. A deal would also bring BAE back into having a direct interest in Airbus and the France-based plane maker's British plants, having sold its 20 percent stake in 2006. It would also give defense-focused BAE more access to commercial aerospace markets, which are booming with EADS's main unit Airbus currently swamped with a backlog of order for passenger jets, while EADS will gain more defense expertise. The merger would also mark a turning point for BAE 13 years after it was accused of turning its back on Europe in choosing to concentrate on building its U.S. defense business with the takeover of GEC Marconi in preference to merging with Germany's main aerospace and defense group, Daimler Aerospace (DASA). Spurned by BAE, DASA decided in the same year, 1999, to instead go ahead and create EADS through a merger with French group Aerospatiale and Spain's Construcciones Aeronautica (CASA). A tie-up could also allow EADS to break free from the shackles of its shareholder agreement which dictates a Franco-German balance of power at the group. Tensions between the two sides have been simmering this year, notably over plans to refocus more of the group's activities near the Airbus headquarters in Toulouse. And a move by the German carmaker Daimler (DAIGn.DE) to sell its stake in EADS has exacerbated the issue. Plans by the German government to buy the stake, for a lack of other investors, have reportedly drawn ire from the French side and from EADS management, which wanted less state involvement. If the tie-up goes ahead, the shareholder pact as it stands would likely become obsolete. Combined, BAE and EADS would have sales of about 72 billion euros ($93 billion), based on 2011 numbers, and would have 220,000 employees worldwide. In comparison Boeing has sales last year of $68.7 billion, while Lockheed Martin (LMT.N) has sales of $46.5 billion, according to Thomson Reuters data. EADS and BAE said that due to the sensitive nature of the companies' defense business in countries stretching from the United States to Saudi Arabia and Australia, they were talking to governments around the world about the proposed deal. They said certain defense activities would be ring-fenced with governance arrangements appropriate to their strategic and national security importance, particularly in the United States, given the importance of that market to the enlarged group. A merger of the two European companies are not expected to raise antitrust concerns in the United States given the modest amount of U.S. military revenues generated by EADS, according to two sources close to the deal. U.S.-based defense consultant Loren Thompson said a merger of the two would create a larger enterprise that was equally strong in commercial and military products, similar to the strategy already pursued for many years by Boeing. A Pentagon spokesman had no immediate comment on a possible merger. The French government declined to comment while the British government said it was working with the two companies to ensure any deal would serve the public interest. A top Pentagon official told Reuters last week that further big budget cuts could make the U.S. Defense Department rethink its current wariness about additional mergers among top-tier companies in the weapons industry. Lazard, Evercore and Perella are advising EADS while Morgan Stanley and Goldman Sachs are with BAE. Among BAE's biggest shareholders is UK-based Invesco Asset Management, which owns 13.02 percent and which increased its stake last month. Its head of UK equities, Neil Woodford, is widely regarded as one of the UK's most powerful and best-performing fund managers. $1=0.7759 euros Additional reporting Andrea Shalal-Esa in Washington, Laurence Frost in Paris and Victoria Bryan and Maria Sheehan in Berlin.; Writing by Kate Holton; Editing by Guy Faulconbridge and Greg Mahlich paul.sandle@thomsonreuters.com; +44 20 7542 6843; Reuters Messaging: paul.sandle.thomsonreuters.com@reuters.net