Published: Friday, 13 Nov 2009 | 1:17 AM ET

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British Airways and Spain's Iberia announced on Thursday a preliminary agreement for a $7 billion merger to create the world's third-largest airline by revenue.

AP

The deal, which the companies hope to close by the end of 2010, ends the British flag carrier's long pursuit of Iberia to create an enlarged group, able to cope with the industry's largest downturn in decades.

BA shareholders will have 55 percent of the combined firm, to be headquartered in London with 419 aircraft flying to 205 destinations, while Iberia shareholders are to get 45 percent.

In a joint statement, BA and Iberia said the merger would provide "enhanced scale to compete with other major airlines and participate in future industry consolidation."

The new company will combine British Airways' strong position in Europe-to-North America traffic with Iberia's Latin American business, and will potentially be reinforced by a planned alliance with AMR Corp's

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Iberia's chairman Antonio Vazquez will be chairman of the new company, while BA's Chief Executive Willie Walsh will be CEO. Each airline will have seven members on the new 14-member board.

The deal will create a new holding company, which will own the two airlines. The two companies will have dual hubs in London and Madrid, and will keep their own licences, codes and brands for the first five years of the merger.

This mirrors the structure set up by Air France-KLM from the Franco-Dutch merger in 2004, which created a holding company plus two operational units to preserve national identities and bilateral international landing rights.

Ahead of the announcement of a deal, BA shares closed 7.5 percent higher at 206.8 pence, while Iberia shares ended up 11.8 percent at 2.22 euros.

BA shares closed 0.9 percent higher on Friday and Iberia ended 3.2 percent down.

Cost Savings

The merger would create an airline with annual revenues of 13.5 billion pounds ($22.38 billion).

BA and Iberia target annual synergies of about 400 million euros by the end of the fifth year after the completion of the merger at a cash cost of up to 350 million euros.

One third of the synergies will be revenue-related and the remainder from cost savings in areas such as information technology, fleet, maintenance and back office, they said.

"BA and Iberia are a natural fit, but the ability to deliver on synergies will be key to this deal working," said one analyst who asked not to be named.

BA's Walsh has wanted to create an airline to rival Air France-KLM and Lufthansa, which has combined with Swiss International Airlines and Austrian Airlines in recent years.

The BA-Iberia deal would need regulatory clearance from the European Commission, but this would likely go through, following the precedent set by the Air France-KLM merger.

BA, which already owns 13.5 percent of Iberia, has applied to U.S. and European authorities for antitrust immunity to allow cost and revenue sharing on transatlantic routes with Iberia and American Airlines.

BA already has a code-sharing agreement with the Spanish carrier under the One World alliance of airlines, which allows them to sell seats on each other's services.

An industry consultant, knowledgeable about the U.S. review, does not believe the merger would materially alter the application since U.S. officials are mainly concerned with British Airways' operations at London's Heathrow airport.

But Virgin Atlantic, arch-rival of British Airways, said the merger would increase BA's dominance at Heathrow.

"Regulators in Europe and the U.S. need to be alert to BA's growing dominance through proposals such as its monster monopoly with American Airlines, proposals which will not be in the consumer interest," said Virgin in an email.

BA's Walsh said last week, after the airline's first-half results were announced, that he was "confident in the strength" of BA's case to win U.S. Department of Transportation approval for a sales tie-up with American Airlines and Iberia.

Pension Issue

BA and Iberia began merger talks in July 2008 in response to slowing passenger demand.

One of the main stumbling blocks had been BA's pension deficit, which stood at around 3 billion pounds at the end of its first half and has been a key negotiating tool for Iberia.

Iberia said it was reserving the right to back out of the merger if the final agreement between BA and the administrators of its pension is not "reasonably satisfactory."

Iberia is scheduled to report nine-month earnings on Friday.

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