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Over the past few weeks the business world has been contemplating a potential merger between British defence firm BAE Systems (BAE) and the European Aeronautic Defence and Space Company (EADS), a pan-European aerospace contractor.

At first glance, the deal appears to make good commercial sense for both parties. They have strengths in complementary markets – BAE is strong in the UK, the US and the Middle East, while EADS gets most of its revenue from Europe and the Asia-Pacific region. Their product lines are also compatible. Both produce civil and military vessels and equipment, but while BAE is dominated by its defence arm, EADS derives nearly two-thirds of its profits from its subsidiary Airbus, one of world’s leading manufacturers of commercial airliners.

Both parties will be interested in the deal by the prospect of creating a European conglomerate that could mount a serious challenge to Boeing, the US market leader equally mighty in the production of military and civil hardware. The merger would also provide a welcome financial boost to BAE, whose revenues have been significantly affected by UK and US military spending cuts. BAE has also tried to secure a merger with carmaker Rolls-Royce for similar reasons in recent years, but without success. For EADS, the tie-up would offer a welcome opportunity to escape the control of the French and German governments, who currently control nearly half of the company between them, and become part of a purely commercial entity.

However, gaining governmental approval is probably the major impediment to the merger. The French, German, UK and US governments all get a say given the sensitive nature of the business involved, and Berlin and Paris are pressing hard for a 9 per cent stake each in the new organisation. Their request might well scupper the deal because the US government, BAE’s biggest customer, is unlikely to want to share sensitive military secrets with an entity controlled by foreign powers, however friendly relations between America and Europe remain.

As The Gateway goes to print, crunch time is approaching fast – the UK’s Takeover Panel has set BAE and EADS a deadline of 10 October by which they must confirm whether or not they’re intending to go ahead.

Thinking like a banker

Mix and match?

There’s good synergy here, which is normally a sign of a great deal waiting to happen. However, I’m thinking that a BAE - EADS merger might not be as good as it first seems. Cost reduction is often a major reason for any merger, but there mightn’t be much to save here because the companies operate in different parts of the world. The two also operate in largely distinct sections of the aerospace market, so perhaps the new entity would be more insulated against market downturns. But what would happen if both the military and civil sides of the business were to decline at the same time, a prospect which doesn’t seem all that far-fetched?

Thinking like a lawyer

Public good

The governmental approvals required are undoubtedly the greatest legal hurdle to the deal, though I think the French and Germans are likely to cave in eventually. The new entity will be more integrated into the private sector than EADS currently is, but, if the deal goes ahead, the French, German and British governments are likely to have the right to veto the acquisition of more than 15 per cent of the company by any third party. This kind of provision might usually breach European free trade regulation, but the EU makes a special public interest exception for companies in the defence sector.

Thinking like an accountant

Clearly a problem

Corruption is a big issue in the defence industry. The secret payments involved can be easily concealed through the use of the complex corporate and financial structures that we in the accounting industry often employ for legitimate purposes such as tax efficiency. In a recent survey by anti-corruption organisation Transparency International, BAE was ranked pretty highly, at fourth overall. EADS, on the other hand, did considerably worse – and one of its subsidiaries is currently under investigation by the Serious Fraud Office for making mysterious payments to a Cayman bank account and giving luxury cars to the Saudi royal family and military officials.

Thinking like a consultant

Playing politics

There’s no doubt that the corporate strategy involved in this deal is as much about politics as business. BAE in its current form represents the close military ties between the UK and the US. So if the coalition government were to approve this deal, it would mean taking a big step away from America and into Europe. Given the ambivalence David Cameron has shown towards strengthening business ties between Britain and Europe since he came to power, this would be a slightly odd move.