City backs BAE in stand-off with Hoon over arms contracts

BAE Systems, Britain's biggest defence contractor, is gaining City support over its threat to walk away from big Ministry of Defence equipment programmes such as the aircraft carrier contract unless they are awarded on terms it regards as acceptable.

The investment bank Merrill Lynch commented: "The company appears unwilling to take on the type of fixed-price contract that got it into trouble on the Nimrod and Astute programmes - we believe this is exactly the correct strategy. Our investment strategy is based on the premise that the company is being de-risked. We would rather the company walk away from an inappropriate level of risk. If BAE Systems were to accept an increased level of risk, we would increase our risk rating on the stock."

The Merrill note came as a fresh rift emerged between BAE and the MoD over procurement strategy. Mike Turner, BAE's chief executive, is understood to have clashed with the Defence Secretary Geoff Hoon at a meeting in the MoD on Monday. BAE argued that future equipment programmes be let on a cost-plus basis and that it should have an effective monopoly on big projects as the automatic prime contractor.

A BAE spokesman refused to comment on the meeting with Mr Hoon other than to say it was a routine meeting to discuss general matters.

"We do not comment on private meetings. We meet with ministers on a regular basis and sometimes the conversations are robust bur we would hope there is a mutual desire to get best value for money for the Government, the taxpayer and our shareholders," he added.

Later, Mr Turner had a separate meeting with the Chief of Defence Procurement, Sir Peter Spencer, to discuss the contract to build two new carriers for the Royal Navy let a year ago to BAE and Thales of France. The programme was originally costed at £2.9bn but BAE now believes it will be nearer £4bn.

BAE is about to lose its prime contractor's role on the programme in favour of an "alliance approach" led by the MoD itself and involving all the UK's warship yards.

BAE denies that its decision to examine offers for its three naval shipyards - Scotstoun and Govan on the Clyde and VSEL in Barrow-on-Furness - is an attempt to twist the MoD's arm. BAE sources indicated, however, that the company had serious reservations about the way the MoD is proposing to structure the carrier contract and would walk away if it was not happy.