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BA (OTC:BAIRY), the flagship British Carrier, and Iberia (OTC:IBRLF), the Spanish airline, have agreed to a merger of equals. The new group will become the third largest airline globally after KLM / Air France and Lufthansa (OTCQX:DLAKY) and will operate 419 aircraft to 205 destinations.

In a statement released on Friday, BA predicts the combined group would enjoy cost synergies of around Euro 400 million a year, with five years of the venture compared to an one-off merger cost of Euro 350m.

Approximately one third of the synergies are expected to be revenue related (joint selling, network and revenue management benefits) with the balance coming from cost synergies in areas such as IT, fleet, maintenance and back office functions. Analysts praised the ambitious plan, citing BA’s strong links to North America and Asia would complement Iberia’s dominant South and Latin America links. Both firms would retain their brands though a new holding company would be formed, Topco, and domiciled in Spain for tax purposes. Shareholder meetings and most board meetings will be held in Madrid.

British Airways shareholders will receive one new ordinary share in TopCo for every existing British Airways ordinary share held by them and Iberia shareholders will receive 1.0205 new ordinary shares for every existing Iberia ordinary share held by them. British Airways shareholders will hold 55 per cent of TopCo and Iberia's shareholders will hold 45 per cent.

Each airline will contribute seven directors to a 14 strong board. The merger will be completed by November 2010, management predicted.

Antonio Vázquez, Chairman and CEO of Iberia, said:

It has been a long process where many people, both at British Airways and Iberia, have worked very hard to reach this agreement. But in the end it was worth it. This agreement is a giant step in the history of both Iberia and British Airways. We are laying the foundations of what will be one of the most important airlines in the world, a real global airline. I believe that, thanks to this transaction, which is the most important in the European airline industry in recent years, we are more prepared than ever to face future challenges.

Willie Walsh, British Airways chief executive, said:

The merger will create a strong European airline well able to compete in the 21st century. Both airlines will retain their brands and heritage while achieving significant synergies as a combined force.

BA shareholders, among the most patient in the investment world, can now look forward to better times ahead as the global recession eases, with a better strategic position secured and long term cost benefits highly likely to be delivered via the merger enhancing earnings.

The agreement is still subject to shareholder approval and regulatory clearances. A resolution also needs to be found regarding British Airways' pension fund deficit, but with both parties determined to close the deal solutions to the remaining challenges are highly likely to be found.

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Disclosure: No interest.

Source: British Airways and Iberia: A Merger of Equals