Carnival must improve offer to win Princess's hand

With just a few days remaining before US competition regulators rule on whether P&O Princess Cruises can jump into bed with either of its two would-be American suitors, knives are being sharpened in the opposing camps in readiness.

If, as sources have hinted, the Federal Trade Commission clears the friendly merger with Royal Caribbean and the hostile bid from Carnival Corporation, analysts expect both companies to come under pressure to improve the terms of their offers.

At today's levels, the all-share offer from the market leader Carnival, run by the Florida-based billionaire Micky Arison, values P&O Princess at about 475p a share, or £3.3bn. This, analysts point out, is barely a premium to P&O Princess's current 455p share price; plus it carries little extra muster for the fact that it is a hostile bid by a US company, which will force UK institutions holding P&O Princess stock to sell up.

On the plus side, Carnival's bid, which was made pre-conditional both on regulatory clearance from Brussels and Washington and on the UK group extricating itself from a hefty and complicated "poison pill", carries a partial cash option of 250p. This, say analysts, could tip the boat in the US cruise giant's favour if shareholders are asked to choose between the two.

Yet there is potentially more upside for investors from the proposed merger with Royal Caribbean, the number three in the cruise market. Analysts estimate this nil-premium deal values an enlarged P&O Princess at up to 550p a share when projected cost savings of at least $100m (£70m) are taken into account. In addition, by establishing a dual-listed structure, UK fund managers can continue to share in the projected future growth of the industry, which has proved its investment attraction by bouncing back from the effects of 11 September as other tour operators continue to struggle.

An unconditional green light from the FTC will have caught most industry observers on the hop. While Carnival's bid for P&O Princess was thought more likely to sail into trouble with the European Commission than Royal's, both bids were widely expected to have been blocked by the US, where cruising is a more developed pastime and where critics argued there was more potential for a larger player to dominate the market. However, reports from sources close to the FTC have suggested that the economics behind the cruise industry make it unviable for companies to raise prices significantly because of the extent to which they rely on additional revenues from on-board purchases to boost their top lines.

Although Carnival arguably has more scope to raise its offer than Royal Caribbean, sources close to the number three player reckon it is unlikely to walk away from what has already been a 10-month bid epic. Under the current terms of the deal, P&O Princess shareholders will own 50.7 per cent of the merged entity to Royal Caribbean shareholders' 49.3 per cent.

Yet if Mr Arison decides to up the ante, the three families that control Royal may have to surrender more of their company to P&O Princess, if as the company has consistently argued, the combined might of Carnival/ Princess truly does leave the market with a weak number two.

The big unknown, in what looks sets to be a fight to the end, is the so-called poison pill penalty fee enshrined in Royal's agreement with P&O Princess. Most of the $484m to $1bn pill that a victorious Carnival could have to pay concerns a joint venture set up between Royal and Princess, originally intended to exploit the Adriatic. While in practice, the joint venture is already a non-runner – it dissolves automatically if by January 2003 bookings represent less than 15 per cent of its non-existent capacity – Royal Caribbean is likely to pull out all the legal stops possible to make life difficult for Carnival.