The Thing Is: Air France-KLM

BA ready to fly serenely in slipstream of merger

No longer the world's favourite airline and now, quite possibly, no longer Europe's biggest. The news that Air France has succeeded where British Airways failed, in agreeing a merger with KLM, could have been a big blow to the UK airline. Air France's all-share takeover of its Dutch counterpart values the combined group at €3.5bn (£2.4bn) and is set to create Europe's biggest airline, with 540 aircraft serving 226 destinations. Added to that, Alitalia is keen to join the party next year.

But the deal is not clear cut. With stringent rules still preventing consolidation in the industry, the new business - imaginatively titled Air France-KLM - has had to be structured in a unique way. A holding company has been created but, within that, both carriers will maintain their national status. On top of that, the Dutch government and two domestic foundations will retain 51 per cent of the voting rights for the next three years. The French government will reduce its holding from 54 to 44 per cent, though that is likely to be sold down further to 20 per cent (the new business hopes to list in Paris, New York and Amsterdam in March 2004).

Whether the structure will be enough to satisfy European Union regulators remains to be seen, however. In addition, both carriers have alliances with US rivals - Air France with Delta and KLM with NorthWest. With transatlantic mergers frowned on, the relationships will be closely scrutinised by both European and US authorities.

Even if Air France-KLM does get the green light, more worries lie ahead. Put simply, it is very hard to integrate two separate companies that are just that - separate companies. Air France has said the merger synergies will rise from between €65m and €75m in 2004-05 to €385m to €495m in 2008-09, but there are no plans to cut jobs. And that is what has got alarm bells ringing for some analysts. If any merger is to work, costs need to be slashed - which usually includes large-scale job losses - and for airlines, capacity would also need to be cut. After all, that is what numerous airlines have already had to do over these past few tough years.

Says one analyst: "I'm a bit surprised they haven't been more aggressive in their cost-saving plan and I'm a bit surprised they haven't thought about any job losses. It's one plus one but whether it will actually equal two is debatable."

All that aside, this is yet another problem to be thrown into the path of BA. The carrier has already been afflicted by high costs, growing competition from budget rivals, the US terrorist attacks, economic downturn, war in Iraq and Sars. A merger of two of its European rivals cannot be good news with a recent history like that.

BA, however, remains upbeat. For a start, its Future Size and Shape review has ripped out costs and capacity, as well as putting in place a new strategy focused on improving its cheaper short-haul operation. That, the airline points out, is something Air France-KLM will not be able to do under the terms of the deal and is, so BA claims, the main reason why talks between itself and KLM broke down two years ago.

Chief executive Rod Eddington was also quick off the block, telling a Spanish newspaper that if BA was going to do a European merger, it would be with its "oneworld" partner Iberia, in which it already has a 9 per cent stake. He then appeared in BA's weekly staff newsletter, expressing his hope that new talks between European and American authorities over air treaties could prove to be, in his words, "a momentous period". The message was clear: not for BA a domestic deal - it is aiming higher, skipping Europe in favour of bigger spoils in America.

And that is, at heart, everyone's hope - that Air France, KLM and ultimately Alitalia's deal will signal the long-awaited go-ahead for consolidation across the airline industry.

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