Berlin – In what would be the biggest step in aerospace consolidation since the 1997 Boeing /McDonnell Douglas combination, EADS and BAE Systems are exploring a “combination of their businesses.” The implications for both the European and U.S. aerospace sectors would likely be significant: The combination would be certain to up the pressure on further global consolidation efforts.

EADS and BAE Systems confirmed Wednesday that they are talking about combining their businesses. If completed, the merger would enable EADS to achieve the duel goals of balancing out revenues from Airbus with more military sales and greatly expanding its presence in the large U.S. defense market.

The proposed merger would also create by far the world’s largest aerospace and defense company. In 2011, the two companies had combined revenues of $96.8 billion.

EADS’ existing shareholders would control 60% of the combined entity while BAE Systems would account for the remaining 40%. The company would have a dual listing, but “there would be a unified board and management structure,” BAE Systems said in a statement. “ BAE Systems and EADS have a long history of collaboration and are currently partners in a number of important projects, including the Eurofighter and MBDA joint ventures,” BAE said. “The potential combination would create a world-class international aerospace, defense and security group with substantial centers of manufacturing and technology excellence in France, Germany, Spain, the U.K. and the USA.”

EADS said that among others, the transaction still needs the approval of EADS ’ board of directors, and that it is uncertain the talks will lead to a deal. The two sides will have to reach an agreement by Oct. 10 or state that they will no longer pursue it, according to the City Code on Takeovers and Mergers. However, BAE Systems has already pointed out that it intends to request a deadline extension if the two companies are still in discussions by then.

“You could be looking at the most significant European consolidation that has yet been and probably will be,” says Douglas Barrie, a senior fellow for military aerospace at the International Institute for Strategic Studies. “This could create a genuine European powerhouse on the defense side.”

Barrie suggests that consolidation is inevitable in Europe given the shrinking budgets around the continent. And, it could prompt a reconciliation of some competing product lines into single, and potentially more globally competitive, designs. The area of unmanned aerial vehicles, for example, has far more concepts in the works than appetite or budget of would-be customers. Such a merger could force Europe’s large aerospace companies to select specific designs not only for European customers, but also those that would have a better chance of competing with U.S., Israeli, Chinese and Russian options.

“If you look at the European market and what budgets [it] can support, it is kind of inevitable,” Barrie says. “The debate becomes how many defense aerospace manufacturers can we credibly afford to support.”