Air France and Klm Plan Merger

Air France and Dutch carrier KLM are planning a €784m (£544m) merger that would create Europe's biggest airline and could kickstart industry consolidation within the European Union.

The move comes on the eve of talks between the EU and the United States over the framework governing air travel between the two blocs, which could ease mergers and saw Italian flag carrier Alitalia signal it would like to join the Franco-Dutch combination.

But analysts cautioned that the existing legal and regulatory framework governing the aviation industry, which is based on bilateral arrangements between countries, would continue to make cross border mergers difficult and that the EU/US talks were unlikely to lead to rapid change.

Complex structure

Air France chairman and chief executive Jean-Cyril Spinetta, who will head the new grouping, described the deal as a "landmark", while his counterpart at KLM, Leo van Wijk, said it would provide the Dutch group with "a sustainable future".

However, the complex structure of the agreement, which will create a group with 540 aircraft and a payroll of more than 100,000 people, illustrates the problems facing airlines wishing to merge.

The two airlines said they planned to combine through an Air France takeover bid for KLM to create a group, AirFrance-KLM, in which existing shareholders in KLM would have 19% of the shares, compared to 44% held by the French state and 37% by other Air France shareholders.

However to meet existing national ownership requirements covering issues such as routes and landing rights, the new group will retain two operating companies, Air France and KLM, with Dutch interests holding 51% of the votes in the latter.

Under current rules, "ownership and control has to be the same nationality as the flag or the registration on the back of the aircraft," according to Chris Tarry, an independent aviation analyst.

The deal is certain to face regulatory scrutiny on both sides of the Atlantic. The European commission said yesterday that it would be looking at the agreement while KLM's links with North West Airlines and Air France's relationship with Delta through the SkyTeam alliance will bring the deal to the attention of American competition watchdogs, according to industry sources.

In the past, airlines have found it hard to convince regulators of the merits of stronger links as BA found when it attempted an alliance with American Airlines.

Yesterday a BA spokesman described the Air France-KLM proposal as "a step in the direction most of the industry expects [to go]. We have always predicted consolidation in Europe. If it comes off it would be a big step in that direction".

However Dominic Edridge, of Commerzbank in London, said the deal was unlikely to provide the spark for others in the near term. "We do not expect to see any further deals in Europe in the short term as the complexities of this deal indicate the extreme difficulty of airline deals in the current legal environment. Rather we would expect deals to follow the conclusion of the EU-US talks aimed at 'open skies' ... which are unlikely to end in agreement for some time."

Under the terms of the proposed deal, the Air France offer would give KLM shareholders a 40% premium on their holdings - a value which some observers see as generous, even though the two airlines are suggesting that they will be able to achieve cost savings of up to €500m by its fifth year.

Mr Tarry noted that Air France has already made commitments in terms of staffing levels and the role of KLM's home base, Schiphol. "If you put together two airlines with a degree of overlap you can't make money out of it without ripping out costs," he warned.

Mr Edridge said that part of the premium Air France was planning to pay for KLM could come from synergies but warned "these may be more difficult to achieve than many think due to the need to maintain KLM's position in the Netherlands".