PARIS Efforts to create a new European defense giant enter a perilous political phase this week, with national concerns growing over security and jobs while BAE Systems and EADS look ready to scrap their $45 billion merger if governments make too many demands.
After the companies laid out basic proposals to create the world's biggest arms company twinned with jetmaker Airbus, it is the turn of British, French, German and Spanish governments to put forward demands in exchange for giving their backing.
Each is likely to have a shopping list of concerns ranging from German fears over jobs to French soul-searching over the loss of state influence or Britain's need to ensure the creation of a European supergroup does not dent BAE's strong U.S. sales.
While careful to avoid putting public pressure on nations that own the keys to any deal -- and that will also be its major customers -- defense industry sources have ruled out opening the door to protracted negotiations or a cascade of concessions.
A source familiar with the talks said the companies were ready to listen to European governments, but stressed that their responses could "make or break" the deal.
EADS EAD.PA and BAE (BAES.L) declined to comment on the political factors involved in completing the merger.
However, EADS said the companies would reserve the last word on the deal for themselves after hearing governments' views.
"We are in good, advanced discussions with the governments concerned," a senior spokesman said.
"When we have their concerns and requests on the table, we and BAE will jointly look at them and determine whether they can be reasonably accommodated within the governance structure we have in mind."
ARMS SPENDING CUTS
German Chancellor Angela Merkel said on Monday that her government was studying the merger.
"We are discussing and evaluating the EADS-BAE merger plans and we are in discussions with others on this. We will give an answer within the deadlines," Merkel told a news conference.
The project to build a company 60-percent owned by Franco-German-Spanish EADS and 40-percent by BAE would make the world's largest arms firm ahead of Lockheed Martin (LMT.N) and grant Europe an all-round aerospace player rivaling Boeing (BA.N).
The aim is to cushion the company against cuts in defense spending and prepare for future global competition from Asia.
Under British stock market rules, the two companies have until October 10 to announce whether they plan to go ahead.
The task of securing political backing is delicate after details of the plan leaked last week and a certain amount of bluff is expected on all sides, but a source close to BAE said "discussions are progressive and ongoing".
In particular, negotiators must juggle BAE's red lines over French government involvement with France's determination to maintain a significant stake in a flagship industrial group.
EADS is tightly controlled by a shareholder pact linking the French state, which owns 15 percent, with Germany's Daimler (DAIGn.DE) and French media firm Lagardere (LAGA.PA).
"BAE has told EADS it will walk away if it cannot remove the voting block rights and have a normalized governance structure and normal shareholder rights," a source close to BAE said.
Weekend reports highlighted the risks to BAE's U.S. defense sales if France's role encroaches on the commercial dividends of Britain's "special relationship" with the United States, where EADS recently clashed with a defense lobby.
Britain's former First Sea Lord, Admiral Lord West, warned that the BAE-EADS deal would cost jobs and threaten Britain's security if it went ahead, according to The Times newspaper.
In France, the key question is whether French President Francois Hollande is ready to accept the full privatization of EADS after a previous Socialist government started the process by marrying state Aerospatiale to Lagardere in the late 1990s.
The prospect has triggered debate within the new Socialist government which has so far displayed a hands-on approach to industry by intervening to halt factory closures and save jobs.
French Finance Minister Pierre Moscovici said in London that the government was looking closely at the deal.
"We are asking a lot of questions, concerning as well the strategic interest of such a merger, the industrial effect, possible synergies between the two companies, the governance of the entity, the future of our defense industry and employment in France," he said.
"We will examine these proposals in the light of the answers to these questions, it will take time," he added. "We will do that alongside our German colleagues."
If the plan is accepted, the French government and Daimler are expected to maintain a diluted stake of 9 percent in the new group with broadly the same rights as other shareholders.
EADS has clashed with Germany in the past over defense priorities but Berlin's most immediate priority is likely to be securing guarantees over Airbus jobs following a recent row.
Financial Times Deutschland reported that EADS had offered unspecified guarantees to win German backing, but some analysts say German officials are playing for more time over the deal.
Doubts have been raised over whether a "special" anti-takeover share to be issued to Britain, France and Germany would be legal given the large civil content in the group.
EU rules only allow national security assets to be governed by golden shares, but EADS appears confident it has found a watertight system after doing the groundwork during previous inconclusive efforts to shake off its rigid shareholder pact.
Besides the special share, no investor will be allowed to control over 15 percent, a majority of the board must be European residents and key sovereign technology such as the British and French nuclear deterrents will be ring fenced.
"It is a binary discussion: either it goes along these lines, or the deal fails," said a source close to the deal.
Other prickly questions yet to be resolved include precise board composition and the location of company headquarters.
EADS Chief Executive Tom Enders has upset Germany by moving central operations from Paris and Munich to Toulouse, next to Airbus. But even supporters of the move acknowledge it is doubtful that France's aerospace capital would fit a global defense company with strong reliance on U.S. defense markets.
Enders and BAE counterpart Ian King, meanwhile, are talking to investors to try to shore up confidence in the plan.
EADS shares recovered more than 2 percent on Monday after a 15-percent three-day drop when the proposal surfaced last week, but many investors question the logic of the deal.
"Given the obstacles to real consolidation of the European industrial base, considerable synergies are unlikely," said RBC Capital markets analyst Rob Stallard.
Monday's share prices continued to value the groups in line with the proposed 60-40 split, suggesting at least some investors have priced in the probability of the deal going ahead.