BAE Systems is in talks with Airbus aircraft manufacturer EADS to create the world’s biggest aerospace and defence company.
BAE said a tie-up with European Aeronautic, Defence & Space (EADS) would form a "world class" firm in its sector, with combined sales of £60bn and around 220,000 staff. The merged group would employ around 48,000 in the UK alone.
BAE's statement initially sparked an 11 per cent jump in its share price but it has now pulled back to stand 6 per cent lower, as analysts raised concerns about the complexity of a potential deal. As well as the sensitive nature of national security work handled by the two firms, the success of the deal also hinges on various government approvals.
The UK government, which has a so-called golden share in BAE that allows it to veto deals that are seen to put the public interest at risk, has already said it will seek to ensure UK interests are "properly protected".
Andrew Gollan, analyst at brokers Investec, advised BAE investors to sell their shares in the wake of the announcement.
"We do not believe competition and approval issues are insurmountable. Practically, however, combination will be complex. Approvals will be required from multiple global governments.
"Perhaps of more significance, agreement by UK, French and German governments on ownership structures and protection of national interests, for example nuclear deterrent, will prove politically sensitive issues."
BAE said the proposed deal would be a merger, but would see BAE shareholders own 40 per cent of the combined group and EADS shareholders own 60 per cent.
The two groups are working on plans to create a combined firm that would retain its dual listing.
BAE said: "BAE Systems and EADS have a long history of collaboration and are currently partners in a number of important projects, including the Eurofighter."
It added: "The potential combination would create a world class international aerospace, defence and security group with substantial centres of manufacturing and technology excellence in France, Germany, Spain, the UK and the USA."
BAE said that the firms were in talks with governments worldwide about the implications of such a deal, given the sensitive and secure nature of their work.
Under City takeover rules, both firms have until 5pm on 10 October to announce a deal or walk away.
BAE is an expert in the field of defence, security and military, whereas the majority of EADS's work is in the commercial sector.
EADS, which is a consortium of aerospace and defence manufacturers from France, Germany and Spain, is headquartered in Paris and Berlin.
BAE produces Astute nuclear-powered submarines and is the largest supplier of land vehicles to the US army.
But BAE has been under pressure, reporting a 14 per cent fall in sales last year as military spending in the US and UK was cut. This saw 2011 profits fall 7 per cent to £2bn.
The group said defence spending had reduced in its largest markets – the UK and the US – while it was also hit last year by a delay in an order for Eurofighters to Saudi Arabia.
Keith Hazlewood, national officer of the GMB union said: "This is a worrying development as so much of our high-end engineering and manufacturing skills are embodied in this company.
"The UK government must play a proactive role as this company contains the skills vital to the defence of our nation. It is as important to our defence as the armed services which shows what is at stake here."
A government spokesman said: "We are aware of this proposal. The business benefits of any such arrangements are a matter for the companies involved. However, given the nature of the companies' activities we would of course want to ensure that the UK's public interest was properly protected.”