Air France and KLM to Form Huge New Alliance

Air France’s effective takeover of KLM, the Dutch flag carrier, has reached the preliminary agreement stage according to statements released by both companies on Tuesday. If the deal goes through to completion it will create Europe's biggest airline, the world's largest by turnover and will be a move unprecedented in the history of the European air industry.

If the merger goes ahead, the new Air France-KLM will have a combined turnover of €19.2 billion ($22.4 billion) and a workforce of around 106,000. The two airlines said the deal was expected to generate synergies that would result in an improvement in operating profits of between €385 million ($449 million) and €495 million ($577 million) after five years.

The new partnership will serve 226 destinations worldwide, operating a fleet of 540 aircraft within a international network centred on the airlines’ two main hubs of Paris Charles de Gaulle and Amsterdam Schiphol airports.

SkyTeam turns up the heat

The impact of the deal will not stop there. Once KLM joins the French giant, it will become part of the SkyTeam global airline alliance led by Air France and U.S. carrier Delta Air Lines. KLM’s inclusion in the alliance will assist in SkyTeam’s growing bid to rival and usurp its competitors Star, led by Germany's Lufthansa and United Airlines of the U.S., and oneworld led by British Airways and American Airlines.

The Dutch carrier will bring its own network of partners closer to the SkyTeam fold. KLM’s close transatlantic alliance with U.S.-based Northwest Airlines is likely to continue as Northwest and Continental Airlines are expected to stick with their European partner. Ties with SkyTeam are already strong through the domestic marketing alliance both Northwest and Continental already have with Delta Air Lines.

Alitalia could strengthen the alliance grip

If that wasn’t enough to worry the big guns in the air industry, Air France announced that in "the medium term," the new group could be expanded further by the "potential integration" of Alitalia, the majority state-owned Italian airline.

Such plans have aroused the interest of the European Commission which is already scrutinizing the Air France-KLM proceedings for breaches of competition law, while rival British Airways has urged investigators to closely examine the terms of the tie-up.

"We are urging the competition regulators to look very closely at the proposals and be especially vigilant to make sure the deal doesn't reduce competition across North Atlantic routes," said Cathy West, a spokeswoman for British Airways in a statement to the press.

In the face of such a potentially powerful partnership, rival European carriers are watching closely. However, according to analysts, airlines such as Germany’s Lufthansa and British Airways have little, initially, to fear.

Worries unfounded say analysts

"Some people may be worried that the likes of Lufthansa, Iberia and British Airways may get left behind but these worries are overdone," one analyst told the Financial Times Deutschland. "The merger benefits from the KLM and Air France deal, like capacity and headcount numbers, are not going to start to come through for quite a while and when they do, it will be good for the industry,” he said.

Others are not yet convinced that the proposed merger will get off the ground. Gert-Jan Geels, an asset manager at Eureffect BV in Amsterdam told Bloomberg.com: “I have doubts whether the merger will work. There are more failed mergers than successful ones, and in the airline industry I don't even know of a deal like this at all.”

Lufthansa remains unconcerned

Lufthansa said the company was not surprised by the move and did not fear the competition of a combined airline that would be the world's largest in terms of turnover. "This concentration is a process which had been on the cards for several years," Lufthansa spokesman Thomas Jachnow said.

The European airline market will now be dominated by the big three of Lufthansa, British Airways and the new Air France-KLM, he said. "We will remain with our Star Alliance the number one among the alliances," Jachnow added.

But the news that the deal was progressing hit Lufthansa shares on the Frankfurt stock exchange. Lufthansa shares fell 1.3 percent to €11.57 as investors showed their concern that the new Air France-KLM would eat into the German company’s market share. British Airways shares rose 1.9 percent to 171.75 pence.

Wake-up call for European carriers

Financial watchers consider the deal a wake-up call to the European market which will have to accommodate the new and powerful industry force. "If it really ends in a merger, then Lufthansa is left empty-handed. It will produce a strong competitor," said one Frankfurt-based trader. "Lufthansa will now have to try to find another U.S. partner to cooperate with."