BA, Iberia merger hinges on pension deficit

By Tracy Rucinski and Rhys Jones

MADRID (Reuters) - British Airways' pension fund deficit could yet scupper its planned merger with Spain's Iberia, as the UK airline still has to agree the size of the multi-billion pound shortfall with the fund's trustees.

Iberia, which on Friday posted a bigger than expected nine-month operating loss, agreed with BA on Thursday to create a group with a combined market value of $7 billion as they continue to battle the worst industry downturn in decades.

But BA's pension deficit was one of the main stumbling blocks in the 16-month merger talks and was a key negotiating point for Iberia, which is reserving the right to back out of the deal if the funding hole turns out to be bigger than the 3 billion pounds ($5 billion) which analysts have forecast.

BA pension trustees undertook a triennial review of the pension scheme earlier this year but the results have yet to be announced, with BA saying it expects to agree a figure with the trustees in the next two to three months.

"The market will be looking at the discount rate used by BA's trustees to calculate its pension liabilities. You'd expect them to use a favorable one to help push the deal through though, especially since the deficit is bigger than its market value right now" a London-based analyst said.

"There's still a risk that the deal will fall through. It's all hanging on BA's negotiating weight with the trustees over its pension," a Madrid-based equities sales trader said.

By 1200 GMT Iberia's shares were 2.4 percent lower at 2.16 euros, after Thursday's 12 percent gain, while BA was 1.4 percent higher at 217.8 pence.

Some analysts said they were surprised that the terms of a deal had even been announced before the pension issue has been resolved.

Analysts believe BA could insure all or part of its liabilities through a buy-out deal with a specialized insurer or hedge specific risks such as the longevity of pensioners through a swap deal or pledge contingent assets such as its real estate.

The new company will combine British Airways' strong position in Europe-to-North America traffic with Iberia's Latin American business, and will potentially be reinforced by a planned alliance with AMR Corp's American Airlines.

So far the deal looks set to give BA shareholders 55 percent of the new company, effectively giving it control, but the balance of power remains in question and could shift in Iberia's favor depending on the outcome of BA's talks with trustees over its pension deficit.

The BA-Iberia format mirrors the ground-breaking 2004 merger of Air France and KLM, which airline industry executives describe as a back-office merger designed mainly to slash costs.

Under this model, the airlines would maintain their own fleets and networks, which operate under the banner of national traffic rights, but would be owned by a common holding company.

"This is a five-year plan to get through the crisis and generate cash, and then BA will firmly take the driving seat," said Enrique Quemanda, Chief Executive of boutique investment firm ONEtoONE.

The pair, who have targeted annual synergies of about 400 million euros by the end of the fifth year, will combine BA's strong position in north Atlantic traffic with Iberia's Latin American business, which will potentially be reinforced by a planned alliance with American Airlines.