BAE Systems shares shed gains after EADS merger talks

Shares in the UK defence contractor BAE Systems and the European aerospace firm EADS have both fallen a day after they revealed they had entered merger talks.

Shares in BAE, which rose 7% on Wednesday before rumours of discussions were confirmed, closed down 7.3% on Thursday.

EADS shares dropped 10.2% - adding to the drop of 5% on Wednesday.

With governments holding stakes in the two companies, politicians were weighing the merits of the move.

Germany and France hold stakes in EADS, and the UK has a special "golden share" - a holding that blocks unwanted takeovers - in BAE.

The three governments would receive special shares in the new company also designed to stop hostile takeovers.

German Chancellor Angela Merkel said the possible merger was being investigated and the UK government is looking at whether the plan is in the public interest.

EADS has aerospace and defence operations in France, Germany and Spain, and owns the planemaker Airbus, which makes aircraft wings in the UK.

Its major shareholders include the French media-to-aerospace group Lagardere, which together with the French state holds 22%, Germany's Daimler, which owns 22%, but has pledged to sell a third of this to the German government, and the Spanish government which owns a further 5.5%.

The head of EADS's Airbus unit, Fabrice Bregier, told employees in a letter that the move would provide them with a stronger employer: "Such a combination would strengthen EADS and BAE Systems - thereby making Airbus part of a stronger company overall."

Lagardere said it was scrutinising the terms and conditions of the deal, while Daimler said it might provide it with the chance to sell its stake on the open market.

The US Pentagon said it would examine the implications of such a move if it was asked to.

US aerospace and defence giant Boeing is a major competitor and has had a number of long-running battles with Airbus, including over whether the support the two receive amount to illegal government subsidies.

A merged BAE and EADS would overtake Boeing in terms of sales, which, based on last year's data would be in the region of $93bn (£58bn; 72bn euros), compared with Boeing's $68.7bn and its fellow US group Lockheed Martin's $46.5bn.

Boeing has said the tie-up could increase the Europeans' presence in the US because of BAE's work in the country, but says it does not see a merger as something that would threaten it "fundamentally".

BAE and EADS have said that a merger "offers the prospect of significant benefits for customers and shareholders of both companies".

Under the code of the UK's Takeover Panel, the two parties must now announce a decision on the outcome of their talks by 17:00 BST on 10 October.

BAE usually pays shareholders a higher proportion of its earnings as a dividend than EADS.

As a result, if the merger were to go ahead, EADS would pay £200m to its shareholders before completion.

The Unite union, which represents BAE workers, said it was vital the government ensured the move would not involve job cuts.

Cuts to defence budgets in certain countries, including the US and the UK, are making life harder for defence firms.

BAE reported a 14% fall in sales last year while profits fell by 7%.

In May, BAE announced it would cut more than 600 jobs and close its Newcastle factory.