Dee Dee Doke/LONDON

Paul Lewis and Ramon Lopez/WASHINGTON DC

Julian Moxon/PARIS

A rancorous reception from Germany's DaimlerChrysler Aerospace (Dasa) greeted British Aerospace and GEC's announcement last week that a £7.7 billion ($12.3 billion) deal had been struck to create a monolithic defence entity based in the UK. If approved, the link will boost BAe to third place among global aerospace companies in terms of sales, following Boeing and Lockheed Martin of the USA.

Under the deal, billed as a merger, BAe will absorb GEC's Marconi Electronic Systems defence business with GEC shareholders receiving in return 1.17 billion new British Aerospace shares, equivalent to a 36.6% stake. BAe's shareholders will own 63.3% of the new company.

BAe's chairman Sir Richard Evans says the merger will reap annual cost savings of at least £275 million within three years and says a 10% increase in shareholder earnings after three years is "highly conservative".

Job losses are not ruled out, but Evans asserts that jobs will be safeguarded over the long term. The new BAe/Marconi combine will employ just under 100,000 workers across 60 sites in the UK and 39 sites in a further seven countries (Australia, France, Germany, Italy, Saudi Arabia, Sweden and the USA). The combined order book will add up to £33 billion.

The 19 January announcement saw Evans optimistically suggest that the BAe-Marconi marriage still left the door open to future consolidations with continental European aerospace interests and, eventually, across the Atlantic. Evans acknowledges that the "sheer scale" of the BAe-Marconi conglomerate will "-be seen as a threat" to the creation of a European aerospace entity, but he emphasises that BAe would work hard to make cross-border mergers in Europe work. "Europe can only afford one aerospace and defence entity", he says.

Lord Simpson, GEC's chairman, adds that with the strong European links which the deal brings it is "-inconceivable that European partners will turn their backs on this relationship".

The term BAe and GEC executives have used to describe the proposed marriage is "synergy," or the combined effect of joining entities that exceed the sum of its parts. The international reaction to the link-up could also have been described as exceeding the sum of its parts.

Officials at German aerospace giant DaimlerChrysler Aerospace, which BAe left waiting at the altar of a merger in December, huffily characterised the BAe-Marconi link instead as "an obstacle to European integration." If the BAe/ Marconi merger goes ahead, it will make balanced European horizon- tal mergers such as Dasa/ BAe impossible", a statement says. Dasa says the landscape has changed. "What we have in the UK is the creation of a vertically organised powerhouse. Any cross-border partnership would by definition have been horizontally oriented, which makes more sense."

BAe counters this by claiming that with a business mix of 15% electronics and 85% platforms and systems, the new entity does not constitute vertical integration.

The new BAe will encompass a wide range of new activities including warship construction, ground and airborne radars, civil and military avionics, missile seekers, reconnaissance and targeting systems and flight computers. BAe also acquires GEC holdings in the latter's wide ranging joint venture with Alenia Difesa, the stake in Europe's largest space company, Matra Marconi, and the sonar business with France's Thomson-CSF. It also gains a strong foothold in the USA via Marconi's recent purchase of Tracor and its North American business.

GEC intends to expand its businesses in telecommunications and technology and its stake in power engineering group Alstom.

UK Prime Minister Tony Blair criticises the deal for being "too British". A decision is awaited on whether the tie-up will be referred to the UK Monopolies and Mergers Commission (MMC). European Commission scrutiny will be necessary, although it says that the UK Government could exempt the merger from EC inspection by invoking Article 223 of the Treaty of Rome which allows defence industry mergers of national interest to be treated separately.

BAe says the MMC had already made it clear that it would help the merger clear the regulatory process. "We are in their hands. If they do have a European vision for the defence industry, the best way is to allow us to get this through," Simpson says.

France's aerospace industry is divided over the merger plan. Thomson-CSF's board says it considered "the European game- wide open" following the BAe-GEC announcement, but tacitly criticises the UK companies for creating "-a national bloc which is inconsistent with the European dimension of aerospace and defence industry restructuring."

If Thomson-CSF's plans to merge with Marconi had gone ahead, the statement says, the company created would have had "a truly European dimension".

According to Simpson, talks broke down with the French defence electronics group at the last minute because they could not agree an acceptable structure. Nor was Thomson's offer high enough. Marconi's strong US interests were also a factor, however, with the prospect of a large French group dominating the UK company unpalatable. Thomson-CSF released a statement as Flight International closed for press saying the group would pursue an independent global development strategy.

French industry observers opine that the BAe/GEC merger "sows the seeds of confusion" in the European defence industry's integration. One analyst says it is perhaps France itself which is to blame - having twice stifled a merger between Thomson-CSF and GEC in 1995 and 1997, preferring to retain control of the defence electronics giant rather than share it with a strong UK company. Thomson-CSF then was merged with Alcatel, Dassault Electronics and the space division of Aerospatiale to create a huge national entity.

Aerospatiale has no official comment, but clearly considers itself better off than before the merger, having objected strongly to the proposed Dasa/BAe tie-up on the grounds that it would leave the French company with a minority share in Airbus Industrie. A company source says: "We are not marginalised by this. We are preoccupied by our merger with Matra Hautes Technologies, which we hope will form the basis for a wider European grouping." In the medium term, the Aerospatiale/Dassault/Matra group may be better placed to embrace a tie-up with BAe given its links in space and missiles.

One option being pursued by Dasa is to construct a merger with the French industry. This would not be the first such initiative. Talks between the two on separate mergers of their respective satellites and missiles businesses broke off in 1996. Failure to resolve differences over investment in military satellites, leadership problems and Aerospatiale's decision to push first for a merger with Dassault Industries were the prime reasons.

The UK, meanwhile, is expected to try and return to the negotiating table with the German company in an attempt to pull it into the BAe-Marconi line-up. But Dasa, reacting to the BAe snub, says this would be impossible as it would not be a partnership of equals. BAe believes that by adding Marconi, a deal with Dasa would be more financially attractive now to DaimlerChrysler than before.

Yet one analyst at Credit Lyonnais says that Dasa's defence electronics business, worth about $2.6 billion, has "many complementaries" with that of Thomson-CSF in naval systems, communications, ground and airborne radars.

Another possibility is a vertical alliance between Aerospatiale and Thomson-CSF. While such a move would create an entity not unlike that formed between BAe and GEC, analysts say "-there would be very little benefit for shareholders."

Across the Atlantic, industry officials and analysts predict that the move puts added pressure on the US Government to clarify its policy on the transatlantic cross-border consolidations involving US defence contractors. The Defense Science Board Task Force - formed last year to look at this issue and develop policy recommendations for the US Defense Department - is due to present its findings soon.

"The BAe-GEC move will accelerate European consolidation and increase the potential for a transatlantic tie-up. This is putting pressure on the task force to finish its work sooner rather than later," says Morgan Stanley aerospace defence analyst Pierre Chao.

Few actual obstacles exist now to prevent such a cross -border tie-up, but the potential for barrier building lurks ahead. Any combination of a foreign defence contractor and a major US aerospace firm is likely to attract scrutiny on antitrust and national security grounds.

Jacques Gansler, US Undersecretary of Defense (acquisition and technology) says: "This is a top priority issue, and we are looking for a variety of ideas to help us evolve a new posture."

What US industry hopes to see are indications on how a transatlantic tie-up would affect the awarding of government contracts and how government regulators would view the possibilities.

"We want to see what the government has to say, and we should hear something soon," says one US industry source, while Richard Aboulafia, aviation director at the Teal Group, says: "It's a case of sending signals . It's not a question of what they [US government] should do - it's more a case of what they should not do, which is interfere with the market."

As for the direction of any transatlantic tie-up, many in the USA now view the new BAe "too big and too British" to be a candidate for a merger with a US concern. As for Dasa, Aboulafia notes: "Germany has neither the depth nor the breadth of the UK aerospace industry. Merging with the French is too problematic, while the British are too big to be equals".

US Government officials had no comment on BAe's move to acquire the Marconi defence unit. But sources say that European defence industry officials met with senior US defence figures late last year seeking guidance on how Washington would react to foreign acquisition of US defence companies. US defence officials have indicated that they would be receptive to some deals if certain conditions are met. Gansler suggests that acceptable mergers could theoretically involve countries with "common legal and ethical practices and enforcement" and "apply and enforce rigid technology leakage and third-country sales controls".

Many US defence observers expect transatlantic co-operation to take the form of smaller acquisitions rather than large corporate mergers. "It doesn't have to be a major merger," says Chao. "Niche purchases on either side of the Atlantic establish a local presence and insurance policy against a European or US fortress". He adds: "The creation of one huge European company is a pipedream. You're looking to end up with two or three large groupings and it's those groupings that will start to throw links across the Atlantic."

Source: Flight International