Leading Article: A lucrative mixing of air and water

WHEN a manufacturing company as big as British Aerospace embarks on a transaction as important as the proposed acquisition of VSEL, the maker of nuclear submarines, it is not only shareholders who can claim a legitimate interest in the outcome. The company that emerges from the deal will be one of the country's biggest engineering employers, and also one of the biggest defence contractors to the Ministry of Defence.

At first sight, BAe's reasons for the deal appear to disguise some short-term opportunism. VSEL is sitting on a comfortable pile of cash, while BAe was in hock to its bankers to the tune of pounds 325m, according to its last set of accounts. Buying the submarine company would also give BAe an odds-on chance of winning the coming pounds 2.5bn contract to build Trafalgar- class nuclear submarines. But there is little strategic fit between submarines and aircraft - arguably even less than there was between BAe's core business and the Rover Group, which it bought in 1988 for pounds 150m and then sold to BMW this year for pounds 800m.

Making weapons is a sharply less attractive, and smaller, business than it was during the Cold War. US defence companies have already begun to respond to cost pressures by merging - the latest example being the spectacular dollars 10bn marriage between Lockheed and Martin Marietta in August. Unfortunately, European firms have been prevented by vested interest and national pride from following suit; as a result European taxpayers are still paying more for their countries' defence than they need.

The BAe-VSEL deal goes some way towards rationalising the British defence industry. The buyer will bring to the acquisition its expertise in project management, and its prestige as a leading defence contractor to the UK government. Shareholders have also voted in favour of the deal by driving the price of both firms upwards. This is not surprising, since a greater concentration on the defence sector will make the new BAe a purer vehicle for investors who take a bullish view of the arms industry.

All the same, questions must be asked. Had VSEL been acquired by GEC, which is already in the submarine business, there would be greater scope for economies. The MoD may have feared that allowing GEC to buy VSEL would give the combined company too much monopoly power in the sector. In any event, the process of consolidation cannot long be confined within national boundaries.