May 4, 2004

Air France succeeded on Tuesday in its bid to create the world's biggest airline by revenue, winning nearly 90 percent of Dutch rival KLM in an unprecedented takeover that heralds a new era for the industry.

In a joint statement, the airlines said KLM shareholders had tendered 41.76 million shares, or about 89.2 percent of the airline's capital, in the offer valued at nearly EUR850 million (USD$1.03 billion) which closed on Monday night.

That was well above the 70 percent threshold that Air France management had said it needed to call the takeover a success. The offer was extended on unchanged terms because Air France needs 95 percent before it can take KLM off the share market.

The combination represents the first cross-border merger of major European airlines and creates a company that ranks ahead of Japan Airlines System as the largest airline in the world by sales.

Air France-KLM will rank third behind American Airlines and United Airlines in terms of passenger traffic.

Many analysts have applauded the deal as a trend-setter and predicted other airlines in Europe and elsewhere could follow suit in the coming years.

The tie-up leaves Italian carrier Alitalia, which had pushed hard to be included, on the tarmac as it seeks to avoid bankruptcy. The government-controlled airline faces court administration if it fails to reach an accord with its workers on the terms of a rescue plan.

COST CUTS

KLM and Air France believe their deal will allow cost cuts and enhance revenues, helping to battle overcapacity in the market and face off growing competition from no-frills carriers.

They have forecast EUR600 million (USD$725 million) in annual long-term merger benefits, while playing down the risk to jobs.

According to a deal originally unveiled last September, the two airlines will form a joint holding company under which the Air France and KLM brands will co-exist for three years.

The company, Air France-KLM, will own 100 percent of both airlines but KLM will remain Dutch, with 51 percent of its voting rights held by the state and two foundations. That structure will allow KLM to retain its foreign landing rights.

The stake of the French state in Air France will fall to 44.7 percent from some 54 percent. Air France staff hold 10.5 percent of the new company and former KLM holders 17.3 percent. Some 45 percent of the firm will be traded on the market.

Some analysts have criticized the dual holding structure, cautioning that the deal could limit Air France's flexibility in responding to external market shocks.

"It is a merger only in name as they are not combining large elements of their cost bases," said one London-based analyst who requested anonymity.

"Given the structure I think they could run into trouble if there were an industry shock and they wanted to take out a lot of capacity and costs."

Shares in a combined Air France-KLM are due to begin trading on Wednesday in Amsterdam, New York and Paris.

The carriers said a second acceptance period would begin on Tuesday and run until May 21 under the same terms. Air France needs to win 95 percent of KLM to force a so-called squeeze-out of KLM minority shareholders and de-list the Dutch carrier.

(Reuters)