Boeing, McDonnell in Talks to Combine : Aerospace: Early negotiations could reportedly lead to a limited deal, or a full merger with uncertain prospects for U.S. approval. An industry juggernaut could be born.

Boeing Co. and McDonnell Douglas Corp. are in the early stages of talks on combining segments of their operations, or undertaking a full-blown merger that would turn the aerospace world upside-down, industry sources said Thursday.

An outright merger, which experts said is highly uncertain, would create a global aerospace giant with annual sales of $35 billion and a command of such diverse markets as combat airplanes, piloted spacecraft and commercial jetliners.

Boeing is the world’s biggest maker of jetliners, and McDonnell is one of the world’s biggest defense contractors and also the only other U.S. manufacturer of commercial aircraft. Any merger would thus face intense scrutiny from antitrust experts--but might also yield a U.S. company far better able to compete with Europe’s Airbus consortium and emerging Asian rivals.

Boeing and McDonnell, which trace their origins to the earliest days of aviation, are both among the most important U.S. exporters and serve as economic linchpins in such diverse regions as Southern California, Seattle, St. Louis and Philadelphia.

A merger would have major implications for the Southland’s battered aerospace sector, but experts were sharply divided on whether it would be a boon or a bane for major facilities such as Douglas Aircraft’s Long Beach airplane factory and McDonnell’s Huntington Beach space systems facility.

The Boeing-McDonnell talks come after several years of fast-paced merger activity in the aerospace industry, where competitors have been joining forces to compete for reduced Defense Department dollars in the post-Cold War era.

The biggest such merger so far came only last year, when Lockheed Corp. and Martin Marietta Corp. merged in a $10-billion deal to form Lockheed Martin Corp. A merged Boeing-McDonnell would easily eclipse Lockheed Martin as the biggest U.S. aerospace firm.

The talks, being held in New York, do not involve the chief executives of the two firms, but rather other officers and attorneys--suggesting that a swift, bold deal is not at hand. The two companies did not deny they are holding talks, but said that as a matter of policy they never comment on merger speculation.

The close strategic fit of the two companies, particularly in commercial airplanes, was lauded by securities analysts and aerospace experts.

“It is too early to predict, but the possible outcomes are so interesting that the companies will work hard before they give up on these discussions,” said analyst Joseph Campbell of the investment firm Lehman Bros. in New York.

McDonnell President Harry Stonecipher has broadly hinted that his firm, cash-rich after a run of highly profitable quarters, is looking for the right deal--and that the only kind of deal that counts is a big deal.

Investors were clearly pleased with news of the talks, first reported by The Wall Street Journal: McDonnell shares jumped $4.375 a share, to close at $90.625, while Boeing rose $1.875 to $75.875 in trading on the New York Stock Exchange.

Stonecipher and Boeing Chairman Frank Schrontz have been close friends for at least 20 years, going back to the days when Stonecipher was selling jet engines for General Electric Co. and Schrontz was his customer at the Pentagon.

“It’s more than a casual friendship,” said an industry official who knows them.

Since so little is known about the talks, the value of any future deal is highly uncertain. But analysts expect McDonnell shares would soar to more than $100 per share if Boeing makes a direct acquisition, resulting in a transaction valued at more than $11 billion.

Possible antitrust problems loom large over any deal. A merger of the firms’ commercial aircraft lines, combining Boeing’s 55% worldwide market share with McDonnell’s 10%, would give the surviving entity a 65% share--and would reduce the number of international competitors to just two, the merged company and the European consortium Airbus Industries.

An antitrust expert in Washington who declined to be identified said federal regulators will have a hard time blessing any deal that increases one company’s hold on a market to nearly 70%. But one attorney familiar with the two companies said that if the merger talks result in a deal, it would ultimately win federal approval. The firms’ military businesses do not compete with each other, he noted, and they will assert that the commercial lines should be exempted because of it is part of a “sick industry.”

Under the sick-industry argument, antitrust rules would be waived because the effect on the economy, jobs and technology would be worse without a merger than one that may seem anti-competitive.

C. Donald Scales, an aerospace expert at the consulting firm A.T. Kearney, said a Boeing and McDonnell merger would represent the next logical step in the consolidation of the industry and “tell the remaining players the train is moving and has almost passed them by.”

Moreover, Boeing and McDonnell are facing increasingly stiff competition from Airbus, which has won significant market share from McDonnell and forced Boeing to cut its prices.

Asian firms, meanwhile, are demanding and winning important subcontracts on new aircraft programs--including persuading McDonnell to allow them to build the nose of its new MD-95 100-seat jet. Usually, the nose section is the highest-technology part of aircraft manufacturing and the MD-95 deal is the first time a nose has been awarded to an outside supplier.

But for all the concern triggered by the talks, many analysts said they were doubtful that the discussions would lead to a total merger.

Wolfgang Demisch, an analyst at BT Securities in New York, said he rated the odds of a merger at just 10%, and he even rated a deal of much smaller scope at less than 50%.

Byron Callan of Merrill Lynch & Co. likewise noted that “these kinds of discussions take place much more often than people realize...I don’t think anything is imminent.”

George Shapiro of Salomon Bros. was quoted by wire services as saying he believes the talks, at best, would lead to a deal involving the two firms’ helicopter businesses, which would be a major disappointment given the attention the talks have attracted.

Jack Modzelewski, PaineWebber Inc. aerospace analyst, said the talks are being driven by the companies’ need to address different problems. Boeing would like to get more involved in defense. Meanwhile, McDonnell cannot support its strong stock prices, based on future defense spending and the difficulty of improving its commercial aircraft business without an outside partner.

“It is a perfect fit,” Modzelewski said. “It is just what they want.”

McDonnell has been trying to find help for its Douglas Aircraft unit for several years, seeing previous deals in Asia for an investment or a partnership fall apart. Is is ironic that Boeing,the company that took away leadership of the commercial aircraft industry from Douglas in the 1960s, would finally be that partner.

The effect of a merger on the Douglas’ huge Long Beach operation, whose prospects have actually improved in recent years as the firm has cut its costs and managed to earn small but continuous profits, is uncertain. If Boeing were to own the unit, it almost certainly would elect to cut operations redundant with those in Seattle, possibly including product support offices, administration and engineering.

Ultimately, some experts believe that a merger would be a death sentence for the entire Long Beach operation. But other experts said Boeing might want to keep the plant open as aircraft sales expand in the late 1990s.

Similarly, it’s uncertain how any merger would affect McDonnell’s large facility in Huntington Beach.

Vartabedian reported from Washington and Peltz from Los Angeles.