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The deal is critical to BA's efforts to compete with larger European rivals and will create a combined group with 408 planes flying to 200 destinations and carrying more than 58 million passengers every year.
The two airlines will retain their existing operations and their individual brands, but both will be owned by a new holding company called International Airlines Group (IAG).
BA's chief executive Willie Walsh will be the chief executive of the new group. Antonio Vazquez, his opposite number at Iberia, will become IAG's first chairman.
BA shareholders will receive one ordinary IAG share for each BA share, while Spanish investors will receive 1.0205 shares for every Iberia share. The arrangement leaves BA's stockholders with 55 per cent of the new company, Iberia's with 45 per cent. IAG will be listed in London, but it will be taxed in Spain and its shares will be traded in both countries.
Mr Walsh yesterday stressed the benefits of the deal to passengers. "The merged company will provide customers with a larger combined network," he said. "It will also have greater potential for further growth by optimising the dual hubs of London and Madrid and providing continued investment in new products and services."
But its central aim is to cut costs, and the merged company is aiming for annual savings of up to €400m (£350m) by its fifth year. Mr Vazquez said: "This is an important step in creating one of the world's leading global airlines that will be better equipped to compete with other major airlines and participate in future industry consolidation."
Negotiations over the merger dragged on for nearly 18 months before a memorandum of understanding was finally signed last November. Part of the problem was a protracted wrangle over the two companies' respective shares of the new organisation, as BA's profits tumbled, its share price dived, and its pension deficit ballooned in the second half of 2008.
The vast pension deficit soon became an obstacle in its own right. By December 2009, the black hole stood at a whopping £3.7bn. And the merger agreement makes the specific point that Iberia retains the right to terminate the deal if the pension recovery plan agreed between BA and its pension trustees is not satisfactory, "in Iberia's reasonable opinion".
Civil aviation authorities in both Britain and Spain have signed off the deal, but it still needs to be cleared by Europe's competition authorities. If all goes according to plan, the deal will be put to a shareholder vote in November and will take effect one month later.
The merger is vital if BA is to catch up with the rash of consolidation as major European rivals fight to survive in the intensely competitive global aviation industry. Without Iberia, the company cannot maintain its position as a major player, according to James Halstead, an independent aviation expert.
"BA's unique position at Heathrow could help it survive for a short while, but in the long run it needs more than just Heathrow," he said. "The main point of the Iberia deal is to be able to cut costs and put the combined company in the position that Air France-KLM and Lufthansa are already in."
The next step is BA's planned tie-up with American Airlines (AMR), which is under review by competition watchdogs on both sides of the Atlantic and facing bitter opposition from Virgin Atlantic.
from London, for Independent minds