The board of Air France voted on Monday to give a preliminary go-ahead to a tie-up with Dutch carrier KLM that could lead to the first cross-border merger of leading European airlines.

Air France and KLM, Europe's second and fourth-ranked carriers, have held alliance talks for over a year and the groups finally looked set to announce a deal on Tuesday morning.

Air France planned to issue a statement at 07:00am (05:00 GMT) after approving a letter of intent to team up with KLM, Yvon Toul, a representative of the CGT union on Air France's board, told reporters after a board meeting.

Third largest

The airline planned another board meeting in two weeks to finalise the deal, Toul said.

KLM could be merging soon with
the French national carrier

KLM declined to confirm that its board held a simultaneous meeting and declined to say if it also backed the agreement.

If approved by regulators, the two will create the world's third-largest airline in terms of traffic, behind American Airlines and Delta. It would become Europe's biggest, overtaking British Airways.

Alitalia had hoped to be included in the merger of KLM and Air France, its partner in the SkyTeam marketing alliance, but Toul said the Italian state-controlled airline would be left in the cold, at least in the first phase.

In what appeared to be a contradictory statement, Alitalia said its board, which also met on Monday, still gave its Chief Executive Officer Francesco Mengozzi the mandate to sign a three-way deal with the heads of Air France and KLM "in the next few hours."

Effective takeover ..

French union members, who were briefed on the details of the agreement, said Air France and KLM planned to create a joint holding company that would be supervised by an evenly split committee of eight members, with a tie-breaking vote going to Air France's chairman.

"The strategic committee will decide on all major strategic decisions, including the makeup of of the combined fleet, network and alliance issues," said Toul.

But he added that the stakes the two airlines will take in the holding company would reflect their respected market valuations, which suggests an effective takeover of KLM by its larger rival.

Combined, the two airlines have a market capitalisation of 3.6 billion euros ($4.1 billion), with KLM accounting for 16% of the total.

"I am waiting with great interest to find out what technique will be used to prevent KLM from losing its 'Dutchness'"

Chris Avery,
JP Morgan analyst

The airlines would retain their separate identities, a prerequisite for preserving their international landing rights, and the Dutch government is expected to keep its golden share in KLM for the time being.

Air France management told unions at a works council meeting that KLM would retain its flying rights at Amsterdam's Schiphol airport for eight years.

Go Dutch 

Analysts said they were still not certain how a holding structure that gave KLM shareholders a minority stake would prevent the Dutch airline from losing its international landing rights, which are negotiated bilaterally between governments on behalf of their airlines.

"I am waiting with great interest to find out what technique will be used to prevent KLM from losing its 'Dutchness'," said JP Morgan analyst Chris Avery.

Air France shares ended up 1.26% at 13.69 euros while KLM stock was up 0.84% at 11.96 euros.

Because of concerns about preserving the landing rights of each airline the deal will stop short of a full merger, making cost savings more elusive.

Air France had estimated a deal to be worth around 400 million euros in synergies over five years but told unions on Monday these benefits would be wort0 million.

ABN AMRO analyst Andrew Lobbenberg said in a research note that while a tie-up between the two airlines could leave operational staff numbers unchanged, synergies could be had in head-office and marketing functions.

A successful Air France/KLM combination could serve as a model for other full-service airlines struggling with an economic slowdown and growing competition from no-frills airlines in an already overcrowded market.

Even many governments, which had once seen the existence of flag carriers as a matter of national pride, now recognise the need for consolidation.

A tie-up would bring KLM into SkyTeam and pave the way for KLM's Us partners, Northwest and Continental, to come onboard at a later date.

This would make SkyTeam bigger than the oneworld alliance of carriers led by British Airways and AMR's American Airlines and narrow the gap between SkyTeam and the top-ranked Star Alliance led by Lufthansa and United Airlines.