Jeremy Warner's Outlook: British Airways' Willie Walsh drops off in Madrid en route to New York

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Michael O'Leary's idea of airline consolidation is to destroy the competition, or at least to beat the fares down so far that Ryanair is left as the last airline standing in the low-cost sector. At British Airways, Mr O'Leary's compatriot, Willie Walsh, is pursuing the more gentlemanly approach of merger.

The intended, nil-premium deal announced yesterday with Iberia makes eminent sense on most levels, though it is a moot point as to quite how "nil-premium" it will turn out to be. The jump in Iberia's share price yesterday turned what would have been a 70/30 split into a 67/33 one. Already, there is an implicit 10 per cent premium in the Iberia share price, making it look more like a takeover than a merger. Yet despite the obvious disparity in size, merger it must be if Spanish sensitivities are not to be offended.

Other potential obstacles include that most countries outside the EU still demand reciprocal landing rights, which means that Iberia must remain a Spanish airline if Iberia's enviable Latin and Central American routes are not to be jeopardised. However, both Air France, with its acquisition of KLM, and Lufthansa, with Swiss, have shown that with the right structures, these barriers are not insurmountable. In any case, Mr Walsh is confident of gaining all the necessary regulatory approvals.

Cost synergies are not yet specified, but BA says the attraction is the potential for revenue gain and more efficient fleet management rather than the savings. With most mergers, claimed revenue synergies can be taken with a pinch of salt, but the still strongly regulated nature of airlines makes them a bit different. There are likely to be real benefits to be derived from putting together the strengths of BA's Heathrow hub, in North American and Asian routes, with Iberia's Madrid connections to Central and Latin American destinations.

For BA, full-scale merger makes a lot more sense than the previous approach, where BA was pursuing an unsatisfactory takeover as part of a private equity consortium. The effective price is also about half what was being proposed by private equity last year.

First stop Madrid, next stop New York. For BA, Iberia is just a staging post in the bigger ambition of merger or takeover of American Airlines. Anti-trust approval of trans-Atlantic co-operation is already pending. The whole shebang awaits only full-scale open skies, which may be little more than two years away.

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