Nov. 13 (Bloomberg) -- British Airways Plc agreed to a $7 billion merger with Spanish carrier Iberia Lineas Aereas de Espana SA, ending more than a year of talks on a tie-up aimed at fighting a slump in travel and closing the gap with competitors.

Under the all-share deal, British Airways investors will own about 55 percent of the business, to be led by Willie Walsh, the U.K. carrier’s chief executive, the companies said. The merger won’t be completed until late 2010 and can be called off by Iberia if BA fails to resolve pension-deficit issues.

British Airways needs a bigger network to compete with larger rivals Air France-KLM Group and Deutsche Lufthansa AG. The combination will meld the U.K. company’s web of U.S. routes with Iberia’s Latin America services, extending its leading position in the lucrative trans-Atlantic market and consolidating its status as Europe’s third-largest airline.

“BA and Iberia will be stronger together than they are alone, particularly in terms of their networks,” said Gert Zonneveld, an analyst at Panmure Gordon in London with a “hold” rating on British Airways. “The pension deficit shouldn’t be an obstacle to this because it’s built into the share price.”

According to a memorandum of understanding signed by the companies, British Airways investors will get one share in the combined entity for every existing share they hold and Iberia investors will get 1.0205 shares for each Iberia share.

Separate Brands

The two carriers will continue as separate brands and operating divisions under a holding company registered in Madrid but with its main offices and primary stock-exchange listing in London. Iberia Chairman Antonio Vazquez will hold the same post at the new business, according to a statement released yesterday after markets closed.

British Airways rose 0.9 percent to 217 pence in London trading, valuing it at 2.5 billion pounds ($4.2 billion). Iberia declined 3.2 percent to 2.15 euros for a value of 2.05 billion euros ($3.05 billion).

Shares of the Spanish carrier jumped 12 percent yesterday and BA added 7.5 percent after the pair said that their boards were meeting to approve a deal.

“There is a compelling strategic rationale for the transaction,” the companies said, adding that the combination will create a carrier with 15 billion euros in sales and 62 million passengers based on 2008 figures. The company will have 419 aircraft serving 205 cities.

Savings

The deal will cost 350 million euros and generate synergies of 400 million euros by the fifth year, they said, two-thirds from combining computer, fleet, maintenance and back-office functions and the rest from revenue gains from joint selling.

An unspecified number of jobs will be eliminated as part of the combination, BA chief Walsh said in a Bloomberg Television interview, adding that the merger is a vital step in his efforts to catch up with Air France and Lufthansa.

“The concern was that our big competitors have been involved in that process for a number of years and the risk to us was that we were getting left behind,” Walsh said.

The agreement is subject to regulatory and shareholder approval and the deal may be terminated “if the outcome of the discussions between British Airways and its pension trustees is not, in Iberia’s reasonable opinion, satisfactory.”

Pension Shortfall

British Airways said Nov. 6 that its main pension plan had a deficit of about 2.66 billion pounds, up from 1.17 billion pounds in March. Nick Cunningham, an analyst at Evolution Securities in London, had estimated a gap of 3 billion pounds and said the new figure was “quite helpful.”

The U.K. carrier’s actuaries will provide an updated number in a few weeks, Walsh said in the Bloomberg interview, adding that Iberia’s concern is not with the scale of the shortfall but “the plan that’s put in place to address it.”

British Airways and Iberia said in July last year that they were in talks about an all-share merger. Negotiations were delayed by the pension deficit and disputes over the balance of control between the two companies. BA is being advised by UBS AG and the Spanish carrier by Morgan Stanley.

The transaction will require approval from the European Commission, which sent antitrust complaints in September to the carriers and to AMR Corp.’s American Airlines regarding a proposed three-way alliance on routes across the Atlantic.

“As with any such merger, it’s the responsibility of the companies to verify whether the transaction falls within the merger regulation,” Jonathan Todd, a spokesman for the European Commission, said today.

‘Monster Monopoly’

Virgin Atlantic Airways Ltd., BA’s biggest competitor on long-haul flights, said the Iberia deal would increase its rival’s dominance at Heathrow, giving it 44 percent of takeoff and landing slots based on this winter’s schedule.

“It is impossible for any other airline to replicate their scale,” Virgin said in a statement. “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.”

Spending cuts from the merger may help the companies revive earnings that have been hurt by the global slide in air travel.

British Airways had a record 217 million-pound loss in the six months through September as sales slumped, and is pushing back aircraft orders and increasing job cuts to trim costs.

‘Two Drunks’

“It reminds me of two drunks leaning on each other,” Michael O’Leary, CEO of Ryanair Holdings Plc, Europe’s largest discount carrier, said in an interview. “If you put one high- fare, loss-making airline together with another high-fare, loss- making airline, you will get an airline with higher fares making much bigger losses.”

Iberia today reported a third-quarter net loss of 16.4 million euros. Airlines may lose a combined $11 billion this year, according to the International Air Transport Association.

The Unite union, which represents more than 90 percent of BA’s 14,000 cabin crew personnel, said today that it would only back the merger if the carrier commits to avoiding firings and guarantees passenger service standards.

“It is imperative that both companies sit down as soon as possible with the unions here and in Spain to discuss how jobs and standards can be safeguarded,” Steve Turner, Unite’s national officer for aviation, said in an e-mailed statement.

Air France created Europe’s biggest airline by passenger traffic with its 700 million-euro purchase of KLM Royal Dutch Airlines NV in 2004. The Paris-based company also has a 25 percent stake in Alitalia SpA, Italy’s biggest airline.

Lufthansa, BMI

Lufthansa ranks second after growing through the purchase of smaller carriers Swiss International Air Lines, Austrian Airlines AG and the U.K.’s BMI, the second-biggest holder of takeoff-and-landing slots at London Heathrow airport, the main base of British Airways. It also has a stake in Brussels Airlines, the largest Belgian carrier.

British Airways, by contrast, has completed two purchases this decade. It bought L’Avion, a French business-class carrier with one route, for 54 million pounds in mid-2008 and took over franchise operator British Regional Airlines in March 2001.

The combination with Iberia is Walsh’s second attempt at merging British Airways with an overseas peer. Talks on a tie-up with Sydney-based Qantas Airways Ltd., Australia’s largest airline, collapsed in December after the companies failed to agree on the division of control in the partnership.

British Airways, Iberia and Fort Worth, Texas-based AMR agreed in August last year to create an alliance that would allow them to operate as a single carrier on routes linking the U.S., Canada and Mexico with destinations in Europe.

The companies want antitrust clearance to coordinate prices, capacity, schedules and routes, in addition to sharing revenue on flights between Europe and North America.

To contact the reporter on this story: Steve Rothwell in London at srothwell@bloomberg.net

Last Updated: November 13, 2009 11:59 EST