Airline Hawks Are Ready To Strike

British Airways-KLM could be just the first cross-border deal

While the U.S. airline industry is no stranger to consolidation, across the pond, mergers have made nary a dent in a market overcrowded with a dozen or more national carriers. Yet the mating dance may finally be under way in earnest in the Old World. On June 7, British Airways PLC announced that it is in talks with Royal Dutch Airlines (KLM) that could lead to a takeover of the carrier.

If the talks succeed, the combination would create one of the world's biggest airlines, with $19 billion in revenues and 56 million passengers a year. But more than this, a BA-KLM merger would produce the first major cross-border combo in the European airline business. European carriers realize that deregulation and a single market mean they cannot all survive; the realistic number is probably closer to four than the current 12 or so flying now. So it's better to start merging instead of slowly wasting away. Says Corne Zandbergen, an airline analyst at brokerage Mees Pierson in Amsterdam: "You only need one brick to fall out of the wall for the process to really get started."

Even if the BA-KLM talks falter, other European carriers are bound to try something just as ambitious. One reason: If U.S. regulators give the green light to the United Airlines Inc.-US Airways Group Inc. combo, more consolidation will follow in the U.S., putting pressure on the European Union to authorize a wave of big-time mergers, too.

Investment bankers and industry execs are already making odds on which carriers will prevail. BA is a long-term survivor for sure. Even though it has fallen into the red recently, it commands Europe's busiest airport, Heathrow. Another probable winner is Lufthansa, which could take over its alliance partners, SAS and Austrian Airlines. The German carrier could also up the 20% stake it bought last year in British Midland, one of BA's domestic competitors. Swissair is showing staying power, too. It now owns 85% of Belgium's Sabena, giving it an anchor in the busy Brussels airport. Swissair also recently bought Air Liberte, a French domestic carrier, from BA.

RED INK. KLM had sought a deal with Alitalia before turning to BA. But those talks fell apart in April over executive issues and Milan's status as a hub. That sent KLM CEO Leo van Wijk into talks with BA chief Rod Eddington. BA and KLM used to be among Europe's premier airlines. But Lufthansa, Air France, and Swissair have cut costs and extended their routes, forcing big cuts in the fares BA and KLM can charge on European routes, which feed profitable long-haul flights from London and Amsterdam to the U.S. BA's loss for the year to Mar. 31 was $366 million before gains from disposals. KLM only earned $3.6 million before extraordinary items on sales of $6.1 billion in the same period.

Besides delivering big savings in operations and overhead, a BA-KLM merger would give the British carrier a third major hub at Schiphol Airport near Amsterdam. The U.S. dimension to BA's thinking is less certain. BA is part of the Oneworld alliance with American Airlines Inc., while KLM still has a linkup with Northwest Airlines Corp. If American does buy Northwest, the pieces of the puzzle might fit comfortably together. But if American's eye wanders over to Delta Air Lines Inc., the friction among all these players could be considerable. Regulators on both sides of the Atlantic might butt in, too: They have already blocked efforts of BA and American to develop even closer ties. Meanwhile, American has already irked BA by forging links with Swissair.

Worries about the U.S. may be one reason that not everyone thinks BA's pursuit of KLM is wise. A full merger would certainly require some imaginative thinking. But just by attempting it, BA and KLM stand to advance a consolidation process that needs nothing more than a final push.

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