* Limited overlap among companies' work in U.S.
* Both companies have special security agreements
* Pentagon will review deal if, when it proposed
By Andrea Shalal-Esa
WASHINGTON, Sept 12 A merger between Europe's EADS and Britain's BAE Systems would likely get the green light from U.S. authorities, and could be the catalyst for further deals in the Western defense industry.
Pentagon and U.S. antitrust officials are unlikely to block the deal, multiple sources close to the matter said on Wednesday, though a deal would require some complex changes of separate security arrangements that both companies have to prevent their foreign-based parent companies from influencing their work on sensitive U.S. government programs.
Merging the two European companies is not expected to raise significant antitrust concerns in the U.S., given the modest amount of U.S. military work done by EADS, said the sources, who were not authorized to speak publicly.
They said the two companies had little overlapping work in the U.S. market, and cited BAE's long-established and trusted role on some of the most sensitive U.S. military and intelligence programs.
The U.S. Defense Department on Wednesday said the companies haven't submitted a detailed plan, though people familiar with the matter said the companies have been holding preliminary conversations with U.S. officials.
"We have not been formally notified about a merger, but we will review such a merger if and when it is proposed," said Pentagon spokeswoman Lieutenant Colonel Elizabeth Robbins.
EADS, the parent of Airbus, and BAE, maker of submarines and fighter jets, on Wednesday said they were in advanced talks to create a combined group worth $48 billion.
The merged group would overtake Boeing Co as the world's biggest aerospace and defense company in sales
The announcement comes at a time when U.S. and European weapons makers are girding for sustained declines in U.S. military orders after a decade of sharp gains linked to the wars in Iraq and Afghanistan. Many executives and U.S. government officials expect a fresh wave of consolidation, mainly among small to medium-sized companies, although the head of BAE's business in the United States earlier this month said top-tier companies could be affected too.
BAE has nearly 40,000 employees in 42 states, including many with security clearances, while EADS has just 3,000 workers in 15 states. BAE generated $14.4 billion in U.S. revenues last year, while EADS' sales generated sales of around $1.4 billion.
EADS builds light utility helicopters for the U.S. Army, but has not achieved any other significant breakthrough orders, especially after losing out to Boeing on a huge order to build 179 refueling planes for the U.S. Air Force last year.
A top Pentagon official told Reuters last week that further big budget cuts could make the U.S. Defense Department rethink its current wariness about additional mergers among top-tier companies in the weapons industry.
Brett Lambert, deputy assistant secretary of defense for manufacturing and industrial base policy, said that current U.S. policy did not forbid mergers among big weapons makers, noting that and any proposals -- even at the top tier -- would be examined on a case-by-case basis.
Linda Hudson, who heads BAE's U.S. business, told Reuters earlier this month that high-level deals could still be on the horizon, despite the Pentagon's reservations, depending on how deep the coming budget cuts turn out to be. "If budgets are cut enough, there will be consolidation at all levels," Hudson said at the time.
BOEING STILL DIGESTING NEWS
Boeing's Chief Executive, Jim McNerney, speaking at the Council on Foreign Relations in Washington on Wednesday, said he was still digesting the news, but did not believe the increased heft of a combined European company would threaten his.
"I don't see this as something that is going to threaten us fundamentally," McNerney said when asked about it after a speech at Council on Foreign Relations in Washington.
"It does reflect a global consolidation that is beginning to happen," he said, adding that an EADS-BAE merger would create an entity with more balanced commercial and military operations, a model that Boeing has followed for some time.
McNerney declined to comment further, saying he had not studied the issue. Executives at Lockheed declined comment.
A BAE spokesman in the U.S. said both companies operated under special security agreements that allowed them to work on sensitive U.S. government contracts.
"BAE Systems Inc views its security agreement as an embodiment of the trust that the U.S. government has in its security and compliance systems to operate highly classified and sensitive programs," said the spokesman. "Under the contemplated transaction, it is our objective that the security framework will not change substantively."
EADS, which has a far smaller footprint, would likely be folded into the well-established BAE Systems agreement, said one source familiar with the companies' thinking.
One U.S. antitrust expert said the deal was unlikely to encounter obstacles as part of a U.S. Justice Department review.
"I can't see anything that's going to be problematic," said Darren Bush, a veteran of the Justice Department who teaches law at the University of Houston Law Center. "All the U.S. based companies will grouse but from an antitrust perspective I'm not sure what they can do about it."
William O'Neil, a former Defense Department acquisition executive who has also worked for Lockheed Martin, said Pentagon officials worried about losing competition for big orders, but could find it difficult to reject the deal.
"It's questionable whether they could find legal basis to block the BAE-EADS union, especially since neither is a major prime contractor and the overlap in their U.S. operations is limited," said O'Neil, who now consults for the Institute for Defense Analyses.
Combined, BAE and EADS would have sales of about 72 billion euros ($93 billion), based on 2011 numbers, and would have 220,000 employees worldwide. In comparison Boeing has sales last year of $68.7 billion, while Lockheed Martin has sales of $46.5 billion, according to Thomson Reuters data.