Germany will study security aspects of proposed defence merger

By Gernot Heller and Victoria Bryan

BERLIN (Reuters) - A proposed Franco-German defence merger to create Europe's biggest maker of tanks and other ground armaments would be scrutinised to see if it threatens Germany's security interests, the German economy ministry said.

The deal between France's Nexter and Germany's Krauss-Maffei Wegmann (KMW), announced on Tuesday, was heralded as a means of cutting costs among arms suppliers at a time when defence spending is under pressure.

But Germany said a merged company would not be able to evade export restrictions designed to control the sale of arms abroad.

Governments in theory like the idea of consolidation in the arms sector, but in practice often find deals such as the proposed linkup between BAE Systems Plc and EADS (since renamed Airbus) unpalatable for security or domestic political considerations.

Nexter, state-controlled maker of the VBCI armoured fighting vehicle and the Leclerc tank, and family owned KMW, which makes the Leopard tank, plan a merger that would involve their owners each taking a 50 percent stake in a combined group.

The tie-up would create a combined company with sales of almost 2 billion euros ($2.7 billion) and a workforce of more than 6,000 and could help the two battle dwindling defence spending by their main European customers.

"We have highlighted on several occasions that in times of shrinking defence budgets consolidation is imperative," analyst Michael Raab at brokerage Kepler Cheuvreux said in a note to clients, noting that ground forces and therefore companies involved in land systems were among the most affected by downsizing of armies.

But the German economy ministry warned that KMW would not be able to use the deal to circumvent German controls on weapons exports and that any deliveries from Germany as part of a merged group would have to be approved.

Germany said last month it would adopt a more cautious approach towards arms exports after a 24 percent surge last year helped by deals with Saudi Arabia, Qatar and Algeria - which could be bad news for KMW, which gets 95 percent of its revenue from arms, but also for more diverse defence companies such as Rheinmetall and Airbus.

NEED FOR CONSOLIDATION

Economy Minister Sigmar Gabriel, whose Social Democrats (SPD) share power with Chancellor Angela Merkel's conservatives, has been vocal in his plans to restrict exports, provoking anger from the industry, with Airbus chief executive Tom Enders warning German jobs may be lost.

On Wednesday, the Christian Democrats' economy committee said Gabriel's comments created the impression that the arms industry was not important and that there was a risk German defence companies would move abroad, leading to job losses.

However, while governments and industry agree on the rationale for consolidation in the European sector, getting deals done is a different matter.

In the most high profile example of a failed deal, a planned 2012 merger between Britain's BAE Systems and Airbus - then called EADS - collapsed after political disagreement.

"While the will is there, putting this tie-up into place will be difficult," Commerzbank analyst Stephan Boehm said, adding it was unclear who would lead the merger given the two were of an equal size.

Further, French influence could be diluted if Rheinmetall, which partners with KMW, should want to get into any new defence project with a merged KMW-Nexter. "And then you may have a similar situation as to what happened to the failed BAE/EADS merger," Boehm added.

A person familiar with the deal said the two companies had worked on the merger for several years. "Of course, it's about synergies, but that does not necessarily mean job cuts," the person.

The main drivers were to share technology and develop new products to expand the business. "There are francophone and anglophone countries, and Nexter and KMW have their own strengths in these countries," the person added.

Rheinmetall, which said its own attempts to merge with KMW had fallen on deaf ears, said its legal department was checking the possible consequences of a KMW-Nexter tie-up to see what effect it would have on joint projects.

(Additional reporting by Arno Schuetze and Anneli Palmen; Writing by Alexandra Hudson; Editing by Stephen Brown)