The end of November should see British Aerospace complete its protracted £7.9bn takeover of GEC's Marconi defence arm. The deal, which is a key part of BAe plans to create an aerospace and defence company capable of competing with the main players on the world stage, was announced in January of this year. Since then it has been severely delayed by the regulatory process, both in the UK and the US. The Farnborough-based company, which sells its products to customers in 72 countries, now hopes to complete the deal with Marconi Electronic Systems to create the world's third largest aerospace and defence company. Initial delays were caused by the company's attempts to account for the deal, now due to be completed on 29 November, as a merger. City analysts predicted BAe's frantic attempts would fail because of the regulatory hurdles it would face, hitting its profits by £350m as a result. Finance director George Rose conceded last week that accounting for the deal as a merger could not work due to Accounting Standards Board regulations. FRS6 sets out a series of tests for whether or not companies can account for such a deal as an acquisition or merger. The central point is whether an acquirer can be identified. 'The driver behind the decision is that the transaction structure has two breaches of technical requirements for merger accounting,' Rose says. The first breach occurred because a controlled subsidiary cannot be treated as a merger. As Marconi was a controlled subsidiary of GEC before the transaction, it could not be called a merger. 'We would have had to merge with the whole of GEC which was beyond contemplation. We just want the defence activities of GEC. So we failed that test,' Rose explains. The second test concerned the way in which the shares for the merger were structured. An element of consideration goes to GEC shareholders under the complicated capital amortising loan stock structure. 'This will give GEC shareholders £440m of cash consideration over the next four years,' Rose says. 'I have had discussions with shareholders. I have gone round, particularly in the early part of explaining the transaction, and they are fundamentally onside,' he adds. While the blow to profits under acquisition accounting will not now be as big as expected, BAe still faces a large bill to put goodwill on the balance sheet and amortise it. That will hit profits to the tune of £310m a year. The goodwill, calculated at £6.2bn, will be written off over 20 years. If completion goes ahead at the end of November, more than £275m in cost savings can be achieved by the year ending 31 December 2002. The board expects approximately £55m of cost savings by the 2000 year end, with £150m of savings in the following year. But any further delay, while not affecting the total cost saving, may have an impact on the accounting period in which the cost savings accrue. Other considerations for BAe include which accountancy firm should take over the auditing of the merged company. BAe uses KPMG, which it has also used in a consultative capacity on accounting issues during the merger, but Marconi's audit is carried out by Deloitte & Touche, which also audits parent company GEC. It may seem sensible to assume KPMG will take on the Marconi audit once the deal is completed, although Rose would not confirm that will be the case. The long-term future of finance staff across the company is also uncertain following the merger. When asked if redundancies would emerge post-merger, Rose says: 'There is probably some inevitability about that, but both companies are so busy with such large order books.' In the short term, Rose says finance staff will be occupied in finishing the completion accounts. 'We're going to have Marconi doing a year end, probably a bi-year end, to change their accounting date when they normally wouldn't do one until March so we're going to be in a very busy period,' he explains. But he warns: 'There could be some changes in the longer term.' In the short term, the main hurdle Rose faces is getting the deal past US Department of Justice regulators who are examining the deal. British regulatory approval was granted in September by trade secretary Stephen Byers who had rejected an Office of Fair Trading demand for an investigation concerning the takeover. But Byers also said that he would allow the deal if BAe promised to address competition and other public-interest concerns. With the US anti-trust clearance still to be granted, any further delay to the deal could prevent completion on 29 November. But once the complicated merger arrangements have been given final clearance, the future for BAe looks bright. The company has entered a new phase in its life cycle and the purchase of Marconi will allow it to broaden its strategic options.
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