March 19 (Bloomberg) -- TUI AG, Europe's biggest tour operator, will buy First Choice Holidays Plc to fight competition from Internet bookings and discount airlines, mirroring a combination of two rivals last month.

Hanover, Germany-based TUI will merge its tourism unit, excluding hotels, with Crawley, England-based First Choice, whose market value is about 1.6 billion pounds ($3 billion). TUI will own 51 percent of TUI Travel Plc, which will be based in the U.K. and run by First Choice Chief Executive Officer Peter Long, the companies said.

Shares of TUI, which also owns the Hapag-Lloyd shipping line, surged the most since 2003. The company, which reported a full-year loss today, last year reduced profit forecasts and announced 3,600 job cuts. KarstadtQuelle AG agreed to combine its Thomas Cook AG division with MyTravel Group Plc last month.

The transaction ``could be a very good deal for both companies,'' said Martina Noss, an analyst at Norddeutsche Landesbank in Hanover. ``TUI has good package tours and First Choice is good in special tours.'' Speculation will persist that TUI will split shipping and tourism completely, Noss said, adding that she may review her ``hold'' rating.

TUI will transfer about 875 million euros worth of debt, including pension liabilities, to the new company. The deal ``underlines our intention of pushing forward the two-pillar strategy'' of shipping and tourism, Michael Frenzel, the German company's chairman, said in a statement. He said today there were no plans to split shipping into a separate company.

`Turning Point'

``We reached a fundamental turning point for TUI,'' Merck Finck & Co. analyst Nils Lesser, who upgraded the shares to ``buy'' from ``hold,'' said in a note. ``It clearly enlarges the head start to Thomas Cook again. There is a big chance that the strong track record of First Choice can help TUI to improve.''

First Choice shares added 24 pence, or 8.5 percent, to 308 pence, the highest close since at least 1989. Europe's fourth- largest vacation provider is expanding into luxury and activity trips to avoid direct competition from low-cost airlines.

Shares of TUI rose 1.59 euros, or 9.6 percent to 18.10 euros in Frankfurt, the most since June 2003, valuing the company at about 4.5 billion euros ($6 billion).

The German company's shares declined 2.5 percent in the year to March 16, the last day of trading before the deal was announced. First Choice stock was up 22 percent in the period.

TUI Travel will sell holidays under brands including Sovereign and Sunsail to 27 million customers in 20 countries. The merged company will have ``cost competitiveness'' as ``huge amounts of business are taking place online,'' Long said on a conference call. He aims to increase profit margins to 5 percent, declining to give a time frame for that target.

TUI vs. Thomas Cook

The combination will have about 12.1 billion pounds in annual revenue, 50 percent more than the 8 billion for Thomas Cook-MyTravel. The Thomas Cook deal thwarted First Choice's own attempt at a transaction with MyTravel.

The TUI-First Choice deal could be better for shareholders than Thomas Cook-MyTravel ``because of the volume and range of holidays they can offer,'' said Christopher Kummer, director of the Institute of Mergers, Acquisitions and Alliances at Webster University in Vienna.

The deal will cut costs before tax by at least 100 million pounds ($194 million) a year, First Choice said. Much of that reduction will take place in the U.K., TUI's Frenzel said on a separate conference call. The companies declined to give a figure for possible job cuts.

The merger could be completed as early as May, First Choice Finance Director Paul Bowtell said. He doesn't expect European competition authorities to stop the deal.

TUI Loss

TUI's fourth-quarter loss was 1.1 billion euros, based on full-year numbers reported today. The loss widened from 43.6 million euros a year earlier, after a 764-million-euro charge to write down goodwill linked to tourism. TUI generates about half of its revenue from travel and the rest from shipping.

``Given the much more important announcement on the tourism strategy, the actual numbers were absolutely out of focus of the market,'' Merck Finck's Lesser said.

The German company said today operating profit from tourism, including its hotel division, would be between 450 million euros and 550 million euros in 2008.

Lazard Ltd. and Deutsche Bank advised First Choice. TUI was advised by Morgan Stanley.

Credit Quality

Contracts based on 10 million euros of TUI debt fell 25,000 euros to 215,000 euros, according to Deutsche Bank AG. Credit- default swaps are based on corporate bonds and are used to speculate on a company's ability to repay debt.

The decrease indicates investors trading the swaps expect TUI's credit quality to improve. December's dividend and profit- forecast cut prompted Moody's Investors Service to cut the company's high-risk, high-yield credit rating.

The yield investors demand to hold TUI 5.125 percent bonds due in 2012, instead of similar-maturity government debt, was little changed at 215 basis points today, RBC Capital said.

Frenzel created TUI by whittling down the industrial conglomerate Preussag AG and acquiring Thomson Travel. Former assets such as oil exploration flourished under their new owners, while tourism languished. Last year, TUI shares dropped 12 percent, their worst annual return since 2002 and the worst performance on Germany's DAX Index.

To offset demand swings in travel, Frenzel bolstered Hapag- Lloyd, whose roots date back to 1847, by buying CP Ships Ltd. for $2 billion. Shareholders may pressure Frenzen to abandon his vow to keep shipping and tourism united, Webster's Kummer said.

``It's very difficult to justify having the two different businesses,'' Kummer said. ``It would be the logical step to split them up.''

Shipping revenue rose 63 percent to 6.3 billion euros in 2006, compared with unchanged revenue from tourism, which was 14.1 billion euros. TUI said it expects 2007 tourism revenue to rise to 15 billion euros, and shipping sales to increase to as much as 7 billion euros.

To contact the reporter on this story: Amy Wilson in London at awilson23@bloomberg.net

Last Updated: March 19, 2007 13:02 EDT