PARIS Shares in EADS EAD.PA tumbled as much as 11 percent on Thursday, adding to the previous day's fall and erasing more than half of the gains made this year, as investors questioned the rationale of a tie-up with BAE Systems Plc (BAES.L).
The two aerospace and defense groups said they are in advanced talks over a merger deal that would give BAE shareholders 40 percent and EADS investors 60 percent of a combined group with a dual stock listing.
EADS stock, which earlier this week was up nearly 30 percent since the beginning of the year, has plummeted as much as 16 percent since the merger talks were unveiled on Wednesday, wiping about 3.8 billion euros ($4.9 billion) off the market value, or roughly the price of 12 Airbus A380 superjumbos.
"We don't like the deal. EADS's strong EPS (earnings per share) momentum will be completely diluted in the new company," a Paris-based trader said.
"The positive sentiment on EADS was fully based on the strong improvement of Airbus's profitability over the next five years due to improvements in the A380 and A350 (longhaul aircraft)programs, pricing power on the A320 Neo (shorthaul aircraft), and reduction in R&D costs. This great story will be completely diluted. On top of that, synergies in the new company will be very limited and execution risks will be massive," he said.
Shares in BAE were down 6.4 percent at 340 pence on Thursday, surrendering more than half of the gains made since the merger talks were revealed on Wednesday afternoon.
WORRIES OVER DEFENCE BUDGETS
"The deal's rationale lies in the reduction of defense budgets, increasing competition from emerging players and more recurrent free cashflow generation, but clearly nothing to do with shareholder's interest. It's time to take profit," the trader said.
Meanwhile Citigroup analysts downgraded their rating on EADS shares to "neutral" from "buy" and also removed the stock from their 'Europe Focus List'.
"We believe that the proposal of merging EADS and BAE changes EADS's investment case materially," the analysts said in a note.
"A merger would allow EADS to achieve its aim of balancing civil aerospace ... with non-Airbus activities and a 'European Champion' would effectively be created. However, we believe that achieving merger synergies for the combined entity could be difficult, particularly given the need to ring-fence certain strategically sensitive activities. We believe that the merger also reflects a challenging outlook for U.S. defense budgets."
A merger arbitrage trader suggested setting up a pairs trade on the shares of EADS and BAE.
But instead of "buying the prey, selling the predator" as arbitrage traders and hedge funds usually do to profit from takeover deals, he recommended buying shares in EADS and selling shares in BAE, betting that the terms of the merger will be revised in favor of EADS, or that the deal will ultimately fail, an arbitrage strategy called a "Chinese position".
"The process is going to be long, many risks will materialize, like politics, etcetera. Considering that EADS is paying a premium for BAE of around 20 percent, the risk-reward looks attractive as a 'Chinese position'," he said.
(Additional reporting by Leila Abboud; Editing by Greg Mahlich)
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