By Li-mei Hoang
LONDON, July 31 (Reuters) - British infrastructure company Balfour Beatty has terminated talks with Carillion over a possible 3 billion pound ($5 billion) merger, only days after the deal was revealed.
Balfour said it backed away after Carillion insisted Balfour cancel the planned sale of its U.S. engineering and design business Parsons Brinckerhoff and keep it within the merged company.
Carillion said it was surprised by Balfour's decision to quit merger talks and said it still believed in the strategic rationale of the deal.
The company said in a statement it would think further about the talks after the initial work on the deal showed the potential to realise significant value for both companies' shareholders.
The approach by Carillion followed a difficult 18 months for Balfour Beatty, which has made a series of profit warnings and lost its chief executive in May.
Balfour announced it would sell Parsons Brinckerhoff in May. It acquired the business in 2009 for 636 million pounds ($1.1 billion) but Balfour said it failed to deliver significant benefits.
Carillion and Balfour had said in a joint statement last week that the Parsons Brinckerhoff sale would be unaffected by their tie-up talks. Engineering firm WS Atkins was understood to be one of the interested parties in the business.
Whitman Howard analyst Stephen Rawlinson who has a "sell" rating on Balfour, said the company's decision to walk away from a possible deal would not help its weak position.
"We suspect that Carillion may have had a change of heart about the potential contribution of Parsons both financially, in the short term and strategically in some markets," said Rawlinson.
"Balfour appear to have taken the view that the sale of Parsons is more important than working with Carillion to create synergies that will deliver we believe around 200 million pounds of annual improvement, permanently and create a more robust and profitable business," he added.
Balfour, which has a stock market capitalisation of about 1.75 billion pounds, said in July it would take another 35 million pound hit to its profit after trading in its mechanical and electrical engineering division deteriorated.
It is expected to report a 17 percent fall in pretax profits for the full year, according to a Thomson Reuters poll of 11 analysts.
The company said it would proceed with its own business plan and was still searching for a new chief executive.
Carillion, with a market capitalisation of some 1.5 billion pounds, operates in Britain and Ireland, Middle East and North Africa and Canada.
A deal with Balfour, which provides construction, engineering and facilities management services in more than 80 countries, would have helped significantly expand its international business and add heft to its construction division.
Balfour's shares have fallen 12 percent since the start of the year and were down 3.6 percent by 1132 GMT. Carillion shares were down 3.1 percent.
The decision to terminate talks with Carillion has left Balfour open to external bids, said Rawlinson.
"In our view, there is substantial value to be unlocked. Combining with Carillion on a nil premium basis at least provided some method of unlocking value that has eluded the current management," said Rawlinson.
"It will take at least two years if not longer and possibly more cash than the sale of Parsons will raise to get Balfour to a robust position. In the meantime its contract win rate is likely to fall, its bonding capacity and costs will be adverse and its negotiating position on account settlements with customers is weaker," he added. ($1 = 0.5916 British Pounds) (Editing by Kate Holton and David Holmes)