By Brad Haynes and Anthony Boadle
BRASILIA (Reuters) - Boeing Co <BA.N> is working to overcome the Brazilian military's objections to its proposed tie-up with Embraer SA <EMBR3.SA> with alternatives that would preserve the government's strategic veto rights and ensure safeguards for its defense programs, four people familiar with the matter told Reuters.
The U.S. planemaker was forced back to the drawing board after Brazilian officials balked last week at the idea of turning Embraer into a subsidiary such as those that Boeing operates in Australia and Britain, according to the sources, who requested anonymity to discuss the negotiations freely.
"Boeing came to buy Embraer, not for a partnership or a joint venture that we are open to, but to take control of the company. This was rejected," said one of the sources, a government official. "It is up to Boeing to come back with a new proposal."
Boeing's proposed tie-up with Embraer, the world's third largest planemaker, would give it a leading share of the 70- to 130-seat market and create stiffer competition for the CSeries program designed by Canada's Bombardier Inc <BBDb.TO> and run by European rival Airbus SE <AIR.PA> since last year.
Since the news broke last month that it was in talks with Boeing, Embraer's shares are up 22 percent in New York, where 51 percent of its stock is listed, bringing its market capitalization to $4.6 billion.
Boeing's proposal would value the company at $5 billion to $6 billion, a person familiar with the negotiations said.
New York-listed shares in Embraer <ERJ.N>, which were down 1.6 percent in afternoon trading, erased losses after the Reuters report to gain as much as 0.5 percent.
Boeing's plan has snagged on concerns in Brasilia that Washington would get final say over Brazilian defense programs and use of technology developed in the country, including satellite and air-traffic control systems.
The Brazilian government holds a 'golden share' in Embraer giving it veto power over strategic decisions involving military programs and any change in its controlling interest.
Boeing would be willing to preserve the government's golden share in Embraer, the people familiar with the matter said, but that may not be enough to win support.
Embraer and Boeing declined to comment on the matter.
Representatives for the Defense Ministry, which is coordinating talks with the government, did not immediately reply to requests for comment.
AIR FORCE RESISTANCE
Officials at the Finance Ministry and development bank BNDES, which owns 5 percent of the planemaker, have been supportive of the deal, but military officials are far more skeptical, according to the sources. The BNDES declined comment and the ministry did not respond to a request for comment.
"The Air Force is the main source of resistance," said an aide to President Michel Temer. "The military oppose any split up of Embraer." The aide said Jungmann has not yet made a recommendation on the Boeing deal to the president.
In an emailed comment, the Air Force said it "considers Embraer a strategic company that is fundamental for our national sovereignty, so a possible partnership with Boeing should also be studied from this point of view."
Air Force commander Lt Brig Nivaldo Luiz Rossato joined Defense Minister Raul Jungmann last week in Brasilia at a meeting with senior Boeing executives including Chief Financial Officer Greg Smith, which failed to sway the Brazilians.
Embraer's special relationship with Brazil's Air Force dates back to its creation in the 1960s as part of a government push to create a domestic aviation industry. The planemaker was opened to private capital in 1994 and fully privatized in 2006, but it still works closely with the Air Force, which is now financing development of the KC-390 military airlifter.
Boeing, which struck a joint sales and services agreement on the KC-390, has underscored to officials that a tie-up would help to market Embraer's defense products globally and bolster Brazil's nascent space program, one person said.
Yet government officials are steering Boeing toward a more narrow joint venture with Embraer focused on commercial aviation — an idea Boeing has dismissed because it would limit long-term flexibility, according to two people familiar with the talks.
Neither the government nor the companies want to entirely split off Embraer's commercial or defense operations, given the integration of their technology and engineering resources, the sources said.
With a presidential election looming in Brazil this year and airlines delaying orders until the shape of the industry is clear, all sides of the negotiations are eager for a resolution. Still, government officials are keen on pressing their hand.
"We think Boeing will end up agreeing to a partnership or a joint venture because they have been weakened by the Airbus-Bombardier deal," said the official familiar with the talks. "They have no other possible partner and need a quick fix."
(Reporting by Brad Haynes and Anthony Boadle; Additional reporting by Ricardo Brito and Jake Spring; Editing by Christian Plumb and Susan Thomas)