BAE scraps transatlantic merger plan to focus on sorting out UK problems

Signing of £3bn carrier deal delayed in new 'de-risking' approach

BAE Systems abandoned its quest for a transatlantic defence merger yesterday and pledged instead to concentrate on putting its UK house in order to prevent a repeat of the crippling cost-overruns that have hit military programmes such as Eurofighter and Nimrod.

In a move that startled seasoned observers of the company, Mike Turner, BAE's chief executive, claimed that a transatlantic merger had never been its priority and said the number one goal now was to achieve acceptable levels of profitability in its Ministry of Defence programmes.

Although Mr Turner said BAE would seek to continue growing its US business, which now accounts for around a fifth of its £12.5bn a year turnover, a transforming merger with one of the five prime American defence contractors was no longer high on the agenda.

"We spend less than 1 per cent of our time talking to US companies. It has not been a priority for myself or my team to do a merger. Absolutely not," he said.

He was speaking as BAE reported a £233m pre-tax profit for 2003 - compared with a loss of £616m the previous year when the company took an £800m write-off on the Nimrod and Astute submarine programmes.

BAE's hopes of forging a transatlantic defence giant had been seriously undermined anyway by the decisions first of General Dynamics and then Boeing to rule out a merger with the UK company. It is also an issue that has riven the BAE board, with Paolo Scaroni, a long-standing opponent of a merger, due to quit as a non-executive director after May's annual general meeting.

The AGM will also see the departure of BAE's chairman Sir Dick Evans, who has been the biggest advocate of all of a US merger. The front-runner to replace him is Lord Hollick, the chief executive of United Business Media and himself a former BAE board member.

The new BAE chairman will inherit a company whose priority will be to "de-risk" its MoD contracts, which account for some 20 per cent of group sales. One of the first signs of this approach is BAE's refusal to sign a firm contract to build two aircraft carriers for the Royal Navy until the design, capability and cost of the vessels has been settled and BAE and its partner Thales have agreed how the risk of cost overruns and delays will be apportioned between the MoD and the two contractors.

This is likely to mean the "main gate" signing of a firm deal being delayed by up to 12 months until spring next year. The original plan has been to sign off the deal this April based on a costing of £2.9bn for the two 65,000 tonne carriers and an in-service date for the first vessel of 2012. But BAE's own estimate is that two carriers of that size would cost at least £3.5bn, which means that the MoD will have to compromise either on size or budget. "We are not going to rush into any firm dates or prices, no chance," said Mr Turner.

BAE has also made it clear it will not sign development and production contracts for a second tranche of 236 Typhoon Eurofighter jets until it is satisfied with the terms of delivery for the first tranche of 148 aircraft and the specification they will be built to. The Eurofighter was conceived in the Cold War era as an air defence aircraft but the RAF now wants the first jets to enter service with ground attack capability. Out of an order for 620 aircraft agreed by Britain, Germany, Italy and Spain, the RAF is due to take 232 costing £20bn.

Sir Dick said the £20bn figure was "set in stone" but it could end up buying fewer aircraft depending on how negotiations proceed. The aim of BAE's European partners is to reach agreement on the second batch of Eurofighters by the middle of the year but BAE is being more prudent. "It would be reasonable to expect a conclusion this year but there is no guarantee," said Steve Mogford, BAE's chief operating officer for programmes.

Although a full-blown transatlantic merger is on the back-burner, BAE urgently needs Britain to agree a technology transfer deal with the US to allow it access to sensitive American defence technology. It needs this to bid for work on the US Joint Strike Fighter - the aircraft which will be deployed on the two carriers BAE and Thales are building for the Royal Navy.

The French president Jacques Chirac announced earlier this month that France too would build a new conventionally propelled carrier opening the way for potential industrial collaboration between the UK and France. That could help reduce the costs of the two Royal Navy carriers. But ironically, it would almost certainly dash BAE's hopes of a technology transfer deal governing the JSF because of the enmity between the French and Americans. "You could say goodnight to anything on JSF," says Mr Turner.