The group, which has for years had ambitions to expand its naval activities, said the deal was based on sound industrial and financial logic. John Weston, chairman of British Aerospace Defence, said the acquisition would complete the jigsaw, enabling the group to act as prime contractor in large naval projects, a capability that it already has in air systems.
Lord Chalfont, chairman of VSEL, said the deal would allow the yard at Barrow-in-Furness, Cumbria, to secure new work, on which the employees' future depended.
VSEL, formed through a management buyout in 1986, is preparing to bid for a pounds 2.5bn contract for Trafalgar class submarines for the Ministry of Defence and an alliance with a larger partner is seen as key to its success. About 2,500 VSEL jobs are thought to depend on securing the Trafalgar work.
The Ministry of Defence, which holds a golden share in VSEL, will approve the takeover subject to acceptance by shareholders and undertakings from BAe. Among the requirements are a guarantee that nuclear submarine production will remain under British control.
Under the proposed deal BAe is offering 2.727 new BAe ordinary shares for each VSEL share, valuing the latter at pounds 12.60. BAe said the offer represented a premium of 30.2 per cent to the VSEL share price of 968p on 27 September, the day before press speculation over a merger began. There is a full cash alternative of pounds 11.40 per VSEL share, giving a premium of 18 per cent on the 27 September price.
Investors are being tempted by a forecast from BAe of a final dividend for this year of not less than 6p, compared with 5p last time.
VSEL shares rose 82p to pounds 13.10 after the bid was announced. Shares in BAe rose by 12p to 471p.
Some analysts, who had been sceptical about the logic of a merger in the run-up to the announcement, said they were now more positive and regarded the price as fair. Wyn Ellis, engineering analyst at SG Warburg, said: 'Many people had regarded this as little more than a disguised BAe rights issue, but BAe have now acquitted themselves well in explaining the industrial logic.'
Another analyst said that the price on offer was fair in the light of VSEL's limited prospects in winning new contracts if it did not find a substantial partner. The consensus was that GEC, which had looked at VSEL at one stage, would not mount a counter-bid.
BAe said that financing the acquisition through expanding its equity base would strengthen the group's position in competing for new business. VSEL has net cash of pounds 288m compared with BAe's net debt of pounds 91m. Richard Lapthorne, BAe finance director, said that the pro forma gearing of the enlarged group would be 10 per cent, compared with BAe's 39 per cent.
BAe also said that VSEL earnings would be sheltered from tax for the foreseeable future because BAe had tax credits, related in part to capital allowances and written- off advance corporation tax.
BAe declined to say whether the deal would mean redundancies, but a VSEL spokesman said: 'There is no prospect of job losses as numbers have been reduced . . . over the last few months.'
Unions at the Barrow yard, which has seen the workforce more than halved since privatisation, gave a guarded response to the takeover news despite assurances that conditions of employment, pension rights and redundancy terms would remain unchanged.
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