Air France finally agreed to take over smaller Dutch rival KLM in a 784 million-euro ($914 million) all-stock deal that will create Europe's biggest airline company.

The merger, designed to cut costs and enhance revenues to help them battle overcapacity and growing competition from no-frills carriers, sent shares of heavily indebted KLM soaring as much as 20%.

Air France shares slid as much as 7.4%. A successful combination of Europe's second- and fourth-ranked airlines, which smaller Alitalia may join later, could serve as a model for tie-ups between other full-service airlines such as British Airways and Iberia.

The merger will bring KLM into SkyTeam, the global airline alliance that includes Air France, Delta and Alitalia.

Analysts say this will probably lead to KLM's US partners, Northwest and Continental, joining at a later date, allowing SkyTeam to overtake the oneworld alliance led by BA and American Airlines and challenge the top-ranked Star Alliance grouping led by Lufthansa and United Airlines.

''There is a need for some consolidation in the airline industry, but we try to safeguard consumer interest"

European Competition Commisioner Mario Monti

No layoffs

Northwest and Continental have already joined Delta in a US-wide domestic alliance. Northwest said on Tuesday it welcomed the KLM-Air France deal but its longstanding alliance with the Dutch carrier would continue to compete with SkyTeam.

At a joint news conference in Amsterdam's Schiphol airport, Air France Chairman Jean-Cyril Spinetta forecast 600 million euros in annual long-term merger benefits and said no layoffs were planned.

But some analysts said Air France's offer, valued at 16.74 euros per KLM share - a 40% premium over Monday's closing price - was too rich given that merger savings would be limited by the pair's plans to continue operating as separate branded entities.

Leapfrog

Air France-KLM will leapfrog British Airways to become Europe's largest airline in terms of traffic, and will be the world's number three carrier behind American Airlines and Delta.

In an innovative solution to prevent KLM from losing its key landing rights, Dutch entities will hold a majority of voting rights in the KLM unit for the next three years.

The Air France/KLM deal appeared a short-term disappointment for Italian carrier Alitalia, a partner of Air France which has lobbied for weeks not to be left parked on the tarmac.

Tales of two cities: Amsterdam
and Paris

Spinetta said the three airlines had struck an accord which would allow the Italian carrier to cooperate with the new entity and combine their cargo businesses, though declined to say when Alitalia would be fully integrated. Alitalia shares ended down six percent.

The European Commission said on Tuesday it was likely to examine the planned Air France-KLM tie-up to see whether passengers in Europe would be left with enough choice.

Expressed concerns

"There is a need for some consolidation in the airline industry, but we try to safeguard consumer interest," European Competition Commisioner Mario Monti said during an appearance at the European Parliament.

Some analysts said savings on aircraft maintenance might be limited because, while KLM flies mostly Boeing planes, Air France has a mixture of Boeings and Airbuses.

KLM unions also expressed concerns over possible job losses in the future.

"We don't see enough job guarantees in the assurances given by Air France," said Hank de Fries, the head of the VNV pilots union.

Air France is being advised in the deal by investment bank Lazard and SG Corporate and Investment Banking, while Dutch bank ABN Amro and Citigroup are advising KLM.