British Airways and Iberia, the Spanish flag carrier, are holding talks they hope will lead to a merger before the end of the year, the two airlines said yesterday.
A deal between the two companies, whose boards have both already approved the merger talks, would create the world's third largest airline and is also likely to kick start a new round of consolidation in the global airline industry.
BA, which has had code-sharing agreements with Iberia for 10 years, already owns 13.15 per cent of Iberia, and the Spanish airline said yesterday it has taken a 2.99 per cent direct shareholding in its partner. Iberia also now owns contracts for difference that give it exposure to a further 6.99 per cent of BA's shares.
The British airline considered making a takeover bid for Iberia last year, as part of a consortium fronted by Texas Pacific Group, the US private equity concern, but eventually changed its mind and ruled out any further investment in the Spanish company.
Yesterday, however, Willie Walsh, BA's chief executive, said the aviation industry had changed significantly. In part-icular, the cost of jet fuel has soared since the beginning of the year, in line with a near-doubling of oil prices.
"The aviation landscape is changing and airline consolidation is long overdue," Mr Walsh said. "The combined balance sheet, anticipated synergies and network-fit between the airlines make a merger an attractive proposition, particularly in the current economic environment."
Fernando Conte, Iberia's chairman and chief executive, said: "A merger would be good news for our customers and enhance our existing relationship."
Although BA, with a market capitalisation of £2.9bn (€3.6bn), is significantly larger than Iberia, which is worth around €1.6bn, the two companies billed the deal as a merger of equals.
The deal is to be structured as an all-share merger, with no cash changing hands. A single holding company will list on both the London and Madrid stock exchanges, but the two airlines will retain their brand identities and their separate managements for day-to-day operations.
BA and Iberia said yesterday that no decisions had yet been taken on who would take the role of chief executive in the combined entity, although Mr Walsh, as the man in charge of the larger of the two companies, would have a stronger claim to the job than Mr Conte. "We share a common vision," Mr Walsh added. "You're not going to find any clash of personalities here."
BA and Iberia envisage some cost savings from combining IT systems and procurement, for example, but the two airlines are more interested in their geographical fit. Iberia has particularly good traffic to South America and Africa, while BA brings a strong presence on North American, Middle Eastern and Far Eastern routes.
BA is also attracted to Iberia because that airline's Madrid base has much more potential for expansion than BA's Heath-row headquarters. The deal would also be a boost to the Oneworld alliance, of which BA and Iberia are both members, along with American Airlines, Qantas and Cathay Pacific.
However, the merger will have to be planned very carefully to avoid infringing their rights to landing slots and routes in many parts of the world. While the Open Skies agreement has liberalised traffic between the European Union and the US, other areas of the globe are not covered by any such agreement.
"We must structure this in a way that secures the existing traffic rights we both have," said Mr Walsh, who believes the model adopted by AirFrance-KLM, which merged in 2004, could be a suitable template. The merged company operates through a trust company set up in such a way as to preserve the two airlines' pre-existing rights.
Mr Walsh also said the combined group would like to get involved in further deals. "We see this as the start, rather than the end-game," he said. "We'll be in a strong position to participate in further consolidation."
More airline mergers have been widely predicted by industry analysts as the aviation sector struggles to cope with mounting costs. More than 25 airlines around the world have already gone bust this year, with BA itself warning it could lose as much as £50m over the coming year, unless there is a significant fall in oil prices.
In the US, major airlines have conducted a string of deals, with Delta and Northwest, the latest merger, expected to complete before the end of this year, but the pace of consolidation has been slower in Europe. The AirFrance-KLM tie-up was followed by the takeover last year of Swiss Air by Lufthansa, but further deals are now likely on a global scale.
"A deteriorating industry has pushed people together a lot quicker than they would have done in the past," said Leigh Bailey, airline analyst at Standard & Poor's in London. "High oil prices and a desperate situation for earnings have made airlines look at cost structures to improve performance."
BA and Iberia said they did not expect their merger to run into regulatory difficulties, though rivals have already begun to voice concerns. A spokesman for Virgin Atlantic said: "This potential merger will only fuel BA's dominance [at Heathrow]."