Array of concerns soured Germans on defense mega-merger

Concerns about the fate of German production sites, the reaction of investors and the symbolism of creating a giant military firm in a country with deep pacifist strains turned Angela Merkel against the European defense merger that collapsed on Wednesday.

EADS, the Franco-German parent of jetmaker Airbus, and British defense group BAE Systems announced after weeks of intense talks they were abandoning plans for a $45 billion deal that would have created an aerospace and defense giant bigger than Boeing.

Bankers involved in the deal, officials in Paris and at EADS all blamed Germany for the failure, saying Berlin had been offered crucial concessions in the final days of the negotiations, only to quash it nonetheless.

The German government has rejected that narrative. Officials in Berlin, many speaking on condition of anonymity, paint a more nuanced picture, without hiding their ultimate verdict - that the deal made little sense.

The officials said initial enthusiasm for the deal and EADS chief Tom Enders' plan to give the German, French and British governments golden shares in the combined group gave way to doubts when the French, who own 15 percent of EADS, insisted on retaining a substantial stake.

Fearful that German know-how, jobs and plants would be compromised, Berlin decided it needed to keep parity with Paris in order to defend its interests.

But behind the scenes German officials - especially Chancellor Merkel's Free Democrat (FDP) coalition partners - remained leery about buying a substantial stake in the firm, two senior German sources said.

They were convinced that the new group would be penalized in the U.S. market - where BAE enjoys privileged status - if the French and German governments took big shares, and that sales of civil jets to countries like China and Indonesia could suffer as a result.

Officials in Berlin also worried about the sharp fall in EADS shares that occurred when news of the secret negotiations leaked in mid-September, and the reservations of the big private stakeholders, including German carmaker Daimler and French media group Lagardere.

"We started asking ourselves, does this deal really make sense," said one senior German official. "The market went down, investors were against it, the synergies were unclear, as was U.S. market access with the big state shareholdings."


Compounding the doubts was growing unease with the idea of turning EADS, which is seen by most Germans as a civil aerospace firm despite its military interests, into a huge defense concern by bringing in BAE.

Defense exports are already a controversial issue in Germany, a country where many people remain uneasy about military trade nearly 70 years after World War Two ended.

The risk-averse Merkel, who faces an election one year from now, and her entourage had concerns about how the deal would go down domestically, sources acknowledged.

"This would have created the biggest defense company in the world," said a second source close to the chancellor. "But defense is an especially sensitive subject in Germany."

The complexity of having three different governments involved also gave the Germans pause, but ultimately they say, the different parties were unable to resolve the shareholding issue to everyone's satisfaction.

Paris wanted to retain the option of going up to 13.5 percent by buying the stake held by Lagardere at a later date. German officials insisted they be able to follow suit.

But the British wanted a cap of 10 percent each, concerned that the Germans and French could approach a blocking minority if they went above that level.

As a Wednesday deadline approached for deciding whether to extend the talks or end them, the Germans determined the risks were too high, and that further negotiations would only prolong the agony.

When EADS and BAE came out and announced the deal was off, instead of expressing regret, Berlin's coordinator for aerospace Peter Hintze made clear what the government had come to believe in the final weeks of talks that Germany's interests were "best guaranteed" by sticking with the status quo.

"We had reservations about the deal but so did the others," the first official said. "Everyone had their red lines, everyone wanted the headquarters. When the question came of whether to extend the talks or not, we thought the negatives outweighed the positives."

(editing by Janet McBride)