BAE Systems plc is currently in talks with EADS over a possible merger. A merger would create ‘a European aerospace behemoth comparable to Boeing’ as Investec Securities states in a research paper listed today.  First an interesting chart on the potential merger courtosey of  Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB):

BAE systems and EDAS merger

However, is this good or bad? Naturally, investors should be skeptical of any merger. of  Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB):

Mergers many times create value destruction, to quote Warren Buffett:

The acquisition problem is often compounded by a biological bias: Many CEO’s attain their positions in part because they possess an abundance of animal spirits and ego. If an executive is heavily endowed with these qualities—which, it should be acknowledged, sometimes have their advantages—they won’t disappear when he reaches the top. When such a CEO is encouraged by his advisors to make deals, he responds much as would a teenage boy who is encouraged by his father to have a normal xxx life. It’s not a push he needs.

What makes this potential meger even more interesting (possibly unheard of) is the fact that sell side analysts are actually downgrading the stock. In fact, Investec Securities now recommend a sell for BAE Systems plc (LON:BA) (PINK:BAESY).

Under the proposed dual-listed structure, they do not envisage major competition issues although a drawn-out approval process is inevitable. The share prices already broadly reflect the proposed ownership split and, given the time frames to complete and execution risk (political hurdles), they advise BAE Systems plc (LON:BA) (PINK:BAESY) shareholders to cash-in.

For the record EADS/BAE NewCo will be a c€40bn market cap entity with combined revenues of €80bn+ and net cash of €12.5bn base on Investec’s forecast and Bloomberg consensus.

Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB) Research asks is this  ‘creating a beast or a beauty?’ They ask further, the confirmation of merger discussions between EADS and BAE came as a material surprise. Whilst we recognise some of the potential positives the deal could bring, it carries with it significant integration risk. We see the benefits of the transaction more clearly for BAE Systems plc (LON:BA) (PINK:BAESY) than  EADS NV (EPA:EAD). With risks overhanging to EADS from the potential deal they cut their recommendation from Buy to Hold with the TP cut from E38 to E30. They maintain their buy on BAE Systems plc (LON:BA) (PINK:BAESY) on the basis that other potential suitors could emerge.

Another interesting chart from Deutsche Bank, which focuses on the geography of the companys’ sales.

BAE systems and EDAS sales by each region

Finally, Citibank also issued a downgrade today. They note that they are downgrading EADS from Buy to Neutral. Given 23% performance YTD and the risks associated with the potential merger of  EADS NV (EPA:EAD) with defence focused BAE systems, plus the strengthening of the € vs. the $, they view this as an opportune time to downgrade. Citigroup Inc. (NYSE:C) believes that the potential merger, rather than  EADS NV (EPA:EAD)’s fundamental performance, will be the focus of the market for the foreseeable future. They also removed  EADS NV (EPA:EAD) from Citi’s Europe Focus List.

The Boeing Company (NYSE:BA) shares are up 0.85% to $71.56. BAE Systems plc (LON:BA) (PINK:BAESY) closed at  338.79  -24.81 (-6.82%) in the London Trading session. EADS NV (EPA:EAD) shares closed at 25.15  -2.85 (-10.20%) on the Paris Stock Exchange.

(Disclosure: No position in any securities mentioned)