MoD hires Warburg for BAE health check

The Ministry of Defence has hired UBS Warburg to assess the financial strength of the UK's largest arms manufacturer, BAE Systems.

The appointment of the investment bank indicates that the Government is concerned that problems with two large defence contracts could have a severe impact on a company vital to the UK's defence capability.

Last week BAE admitted that the construction of two nuclear-powered submarines, called the Astute programme, and the upgrade of the Nimrod surveillance aircraft would be greatly delayed and that costs would be substantially affected. Analysts have predicted the cost to BAE could be up to £1bn. BAE says it will not know the amount until February as it is negotiating with the MoD on how to change the contract to reduce the financial impact.

However, the Government has warned that BAE must face up to its responsibilities.

BAE has already taken a £300m provision to cover extra costs on the Nimrod programme. Last week, analysts at Goldman Sachs said it was "alarming" that this provision had been exhausted and predicted £1.5bn of cash would bleed out of the company between now and the end of 2005, which would increase the debt burden to £3.6bn. UBS Warburg is believed to have been appointed a week before the trading statement on Wednesday.

The timing of the statement is becoming increasingly controversial and has infuriated some investors and analysts. The Financial Services Authority (FSA) is investigating whether this broke Stock Exchange rules which require information that will affect the share price to be released "without delay".

Negotiations with the MoD and BAE on the contract over-runs have continued since the beginning of November. BAE was advised that until the exact cost to the company is known, it should not issue a trading statement. Though it does not yet know the exact figure, it released a statement on Wednesday. The event that prompted this appears to be a letter the MoD sent to BAE on Wednesday morning. The contents are classified as top secret, as are the details of why the contracts are going wrong.

However, the cost and time over-runs were not classified and it is not clear why Wednesday's statement could not have been made earlier.

It was clearly price sensitive because the company's shares fell nearly 40 per cent on Wednesday and Thursday. Rumours had circulated all week that the company was about to announce something big and bad. But BAE has repeatedly denied the fact when questioned by analysts and journalists.

In fact, a reporter was told on Tuesday: "If the question is, are we going to issue a trading statement, the answer is still the same as the answer was yesterday – no. Everyone seems to want us to do this, but we're not doing this."

The FSA is also probing why trading in the shares was high at the start of the week – prior to the announcement.