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BAE Systems: Tough To Find Another Partner After EADS Fiasco

 October 11, 2012 02:18 PM

(By Mani) BAE Systems Plc (LSE:BA) and Airbus maker European Aeronautic Defense and Space Co., or EADS, have formally scrapped their merger plan, stating that their respective government interests could not be "adequately reconciled."

The breakdown in discussions arguably leaves BAE's shares in a weak position as the prospective merger led investors to question the company's long-term prospects in the export market and U.S. On Sept. 14, former BAE CEO Mike Turner called the deal the "last chance saloon."

The $45 billion merger would have created an industry giant that might have surpassed rival Boeing Co. (NYSE: BA) in terms of sales. Now, the deal has been terminated, it would be difficult for BAE to find another suitor.

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"We maintain our view that U.S. defense primes are not interested in buying BAE subsequent to the merger collapse," RBC Capital Markets Robert Stallard said in a client note.

BAE would be a mixed bag for a buyer with some prize growth assets in the form of Cyber and electronic warfare, as well as some under-performers in land systems. All the primes would also face some carve out in the U.S. business on DoD competition concerns. Perhaps more nebulous for U.S. primes is the political risk of taking over BAE and becoming the defacto main supplier to the U.K. MoD.

[Related -The Boeing Company (BA): Why You Should Look At Boeing's Defense Business?]

"Finally, we think that Saudi Arabia, probably BAE's most lucrative major market, wants to keep separate arrangements with its main British and American defense suppliers," Stallard said.

Now, here comes the hangover following the collapse of the deal. BAE's shares had traded close to the FTSE100 until July and since then have outperformed the index by 7 percent in large part on the prospects of the multiple-enhancing tie up with EADS. Over the same period, BAE's forward P/E increased a full turn to about 8 times from 7 times.

"With talks now off, and plenty of U.S. news flow about the sequester, we expect BAE to re-rate by ~1x. Over the last year, BAE's shares have stayed in a range of ~270p-310p," the analyst noted.

However, the fundamentals of BAE look good with a solid export franchise, and strong cash deployment amid challenged end markets.

"What has changed is the shares pricing in a takeout premium that we no longer see as credible," Stallard added.

BAE Systems is one of the world's larger defense contractors. Formed in 1999 by the merger of British Aerospace and Marconi Electronic Systems, BAE Systems now generates in excess of £20 billion in recurring business turnover through defense platforms and services, and is the prime contractor on marquee programs like MRAP, Eurofighter Typhoon, Hawker trainer, and the UK's new destroyers, subs, and aircraft carriers.

EADS was formed in 2000 by the merger of Aérospatiale-Matra, DaimlerChrysler Aerospace AG of Germany, or DASA, and Construcciones Aeronáuticas SA of Spain.

The failed merger had envisaged a 60 percent ownership for EADS in the combined entity, with the remaining stake being held by BAE Systems. The French and German governments have a 22.5 percent shareholding in EADS each, while a merger with BAE could reduce that stake to 9 percent each. French media group Lagardere SCA (LGDDF) and German automotive major Daimler AG (DDAIF) also hold stakes in EADS.



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