`UK first' deal that could set Europe at war

News Analysis: France doesn't like it, and Germany is simply livid

AT LUNCHTIME on Monday Denis Ranque, chief executive of Thomson CSF, touched down at Heathrow airport and sped straight to GEC's Mayfair headquarters by chauffeur-driven car. The head of the French defence electronics group was ostensibly in town for a private dinner, but first he had some business to attend to - a last -itch attempt to wrest Marconi from the hands of British Aerospace.

Mr Ranque said he was prepared to raise his offer from the pounds 6bn already on the table. Lord Simpson, chief executive of GEC, listened politely, but the French entreaties were to no avail. As Lord Simpson said yesterday: "Marconi was the pretty girl at the defence consolidation dance. While there may be a Harvard Business School case to support a Thomson-Marconi merger, the fact is we could not agree either on structure or price."

Later that afternoon the full GEC board met and agreed to sell Marconi to BAe. At 3am yesterday morning the deal was signed in the City offices of SBC Warburg Dillon Read, GEC's advisers.

It was a signal moment, not just for the British defence industry but for the aerospace sector right across Europe. If the French were upset that BAe and Marconi had opted for a "UK first" approach to the restructuring of Europe's aerospace and defence industry, the Germans were livid. Until a month ago, it had seemed certain BAe would merge not with Marconi but with DaimlerChrysler Aerospace (Dasa) of Germany.

When Sir Dick Evans, the chairman of BAe, broke the bad news by telephone to his opposite number at Dasa's parent company, Jurgen Schrempp, the reception was cool. "Jurgen was disappointed, as you might expect," said Sir Dick.

But BAe shows no signs of being fazed, either by the ripples it has caused across Europe or by the negative reaction its pounds 16bn deal has received in Downing Street and the stock market.

With one bound BAe has become Europe's dominant defence and aerospace company, with an order book of pounds 33bn and sales of pounds 13bn a year encompassing everything from Tornado aircraft and Trident submarines to Airbus commercial jets, howitzers and state-of-the-art military radar.

In terms of size, it will be streets ahead of its nearest European rival, the state-owned French group Aerospatiale. On a global scale, it will have only half the sales of Boeing, the biggest defence and aerospace contractor. But it will, for the first time, be within sight of Lockheed Martin and Raytheon, the two other US defence leviathans.

More importantly, it brings Britain's two prime contractors together in an alliance spanning both military platforms and the combat systems that go on them. As Richard Lapthorne, BAe's vice-chairman, says: "Up until now, foreign defence contractors have been able to play BAe off against GEC to their advantage. This stops that game."

But there is a bigger question left hanging by yesterday's mega-merger. What is the end game? Will the BAe-Marconi merger hasten the creation of the European Aerospace and Defence Company (EADC) that Tony Blair and five other heads of government signed up to in July last year? Or will it split Europe down the middle, creating a Franco-German axis and pushing BAe closer to an American tie-up?

Alex Ashbourne of the Centre for European Reform said: "The EADC as originally planned is now dead in the water. It's very sad. BAe-Marconi is now such a powerful entity that it does not need the others. They won't admit it now, but they may well be more interested in transatlantic links than European ties."

Not surprisingly Sir Dick Evans takes a different view, saying that if anything it places BAe in a stronger position to drive European consolidation. "It helps enormously if just one major player speaks for each country."

Many in the market tend to agree. Despite the bellicose noises from Dasa, Chris Avery, aerospace analyst at Paribas, says: "I suspect that after some dalliances with France, Dasa will come back to the negotiating table with BAe in due course. BAe and GEC have concluded that shareholder interests are not best served by doing deals with French companies that are state- owned or part state-owned. Dasa will learn the same lesson."

Indeed others, such as Terry Taylor of the International Institute for Strategic Studies, believe the BAe-Marconi deal leaves the French in danger of being overrun by an Anglo-German-US alliance.

BAe would rather like to have it both ways. On the one hand it points out that the enlarged company will have "home markets in four other European countries - Sweden, France, Germany and Italy - because of alliances already forged with contractors such as Matra of France, Finmeccanica of Italy and Saab of Sweden.

On the other hand, Sir Dick is apprehensive about a "fortress Europe" policy developing. He points to the scale of business the enlarged BAe will have in the US, where it will have 18,300 employees and sales of $4.6bn, thanks in large part to GEC's acquisition last year of the defence electronics business, Tracor.

Given the brinkmanship that has characterised this first round of defence consolidation, it is impossible to second-guess the outcome of the next round. But it is hard to believe BAe will not be at the centre. Sir Dick likens the Marconi acquisition to BAe's sale of Rover five years ago. " That deal unlocked us from the past. This one opens up an entirely new future."