UPDATE 2-Costs, delays scupper Airbus A400M sale to S.Africa

* Cancels $5.2 bln deal to buy 8 planes

* Government says unaffordable burden on taxpayer

* Still seeking military air transport alternatives

* Shares in Airbus parent EADS (EAD.PA) flat

(Adds Airbus, defence minister, analyst quotes)

By Wendell Roelf

CAPE TOWN, Nov 5 (Reuters) - South Africa cancelled a $5.2 billion contract to buy eight Airbus A400M military transport aircraft due to rising costs and delivery delays, cabinet spokesman Themba Maseko said on Thursday.

The move is a setback for the European planemaker, which appeared caught off guard by the decision, and could hand business to U.S. rivals eager to pounce on delays and uncertainty surrounding Europe's largest defence project.

"We have terminated the contract with Airbus but we've not terminated our quest to ensure we have the necessary capabilities. That is very clear," South African Defence Minister Lindiwe Sisulu said.

"We have as one of our priorities the acquisition of strategic military air transport capability."

Shares in Airbus parent EADS initially fell 1 percent but recovered ground to trade almost flat on the day at 13.23 euros.

"We cannot comment at this point of time. We have just learned this from the media," Airbus spokesman Stefan Schaffrath said.

The cancellation comes at a time when EADS is in the final stages of negotiating a rescue package for the rest of the 20 billion euro A400M project with a core group of European buyers, some of whom have also threatened to trim or cancel orders.

Lockheed Martin (LMT.N), producer of the veteran C-130 airlifter, has predicted extra sales due to A400M delays, which have mainly been blamed on engine software problems.

Launched after almost two decades of debate over European requirements in 2003, the A400M is designed to drop troops and heavy equipment in combat zones or disaster areas.

Britain, France, Germany, Belgium, Luxembourg and Turkey ordered 180 planes in Europe's largest single arms procurement deal. Export sales to South Africa and Malaysia brought the total order tally to 192 but Chile cancelled an order.

South Africa's decision does not affect the main 20 billion euro European contract which looms large over EADS finances, but the company is already relying on exports to make the airplane break even after taking 2.3 billion euros in provisions.

"The termination of the contract is due to extensive cost escalation and the supplier's failure to deliver the aircraft within the stipulated timeframe," Maseko said.

BUDGET DEFICIT

South Africa has vowed to slash borrowing for three years to bring down a record deficit of 7.6 percent of GDP this year.

"They are clearly worried about the need for extra borrowing and so a few big ticket items are easy wins," said Peter Attard Montalto, emerging markets economist at Nomura International.

South Africa's arms procurement agency Armscor told parliament last month the cost had jumped to 47 billion rand ($6.1 billion) from 6.4 billion, or 837 million euros at the time the order was placed.

The value of the deal had already risen to 17 billion rand by the time the transaction was signed.

"The escalation would have placed an unaffordable burden to the taxpayer at a time when the national fiscus is under pressure due to the economic downturn," Maseko said.

South Africa's main opposition party, the Democratic Alliance, has called for a parliamentary investigation into the deal, which took place under former President Thabo Mbeki, who was forced from office last year.

Maseko said the cost of the South African order would have been $5.22 billion. He said no penalty fee was expected as the contract made provision for cancellation.

Airbus plans to carry out the maiden flight of the A400M by year end, two years behind schedule. (Additional reporting by Matthias Blamont and Tim Hepher in Paris; Writing by Marius Bosch; Editing by Will Waterman and David Holmes) ($1=7.761 Rand)