Air France is going ahead with a takeover of Dutch rival KLM in a long-awaited but premium-priced EUR784 million (US$912.9 million) deal that both companies acknowledged could also expand eventually to include Alitalia.

Financed through a share-swap that will give KLM investors 19% in a new, renamed Air France-KLM, the takeover agreement should be finalized within the next two weeks. The arrangement -- telegraphed for weeks (DAILY, Aug. 20, Sept. 10, 15) -- will create Europe's largest, and the world's third-largest, airline with about EUR19.2 billion (US$22.4 billion) in revenues.

"Air France is paying a higher- than-expected premium for its stake in KLM," Julius Baer analyst Edmund Shing said. The Air France offer is 40% higher than KLM's market capitalization as of Monday evening and 77% above KLM's average valuation in the past three months.

Air France shares fell 4.3% in afternoon trading yesterday, while KLM shares rose 12.4%, reflecting investors' concerns about the transaction's true value for Air France and concerns about potential regulatory problems.

Air France and KLM will continue as the brands for two subsidiary airlines within the Air France-KLM holding company. Assuming KLM shareholders accept the swap, they'll control a 19% share, diluting the French state's stake from today's 54.4% to 44%. Remaining Air France investors will hold a 37% stake.

Alitalia will have one seat on the new board of directors, and "in the medium term, the group could be reinforced by the potential integration of Alitalia," Air France and KLM said in a joint statement.

"We have always been convinced of the necessity of consolidation in the airline industry," Air France Chairman Jean-Cyril Spinetta said. Creating Air France-KLM will "bring significant benefits to customers, shareholders and employees," he said.

As part of the takeover, KLM will join SkyTeam. Spinetta will be Air France-KLM's chairman and CEO, while KLM CEO Leo van Wjik will be vice chairman. Air France has given KLM assurances over the number of routes operated out of Amsterdam Schiphol Airport for the next five years and to the Dutch state about the status of the airport as an international hub for eight years.

The two airlines believe their networks are largely complementary. "In medium-haul, Air France has a strong position in Southern Europe and KLM has developed a strong position in Northern and Northeastern Europe," the companies said in their joint statement. "Of the 101 long-haul destinations the two carriers serve, 31 are common." The two carriers plan to introduce full code sharing on each other's flights.

Compared to remaining separate, Air France-KLM is expected to create annual savings of EUR385 million-495 million, beginning in 2008 -- significant, in Spinetta's eyes, though disappointing to some analysts, given the size of the prospective company.

The deal elicited cautious reactions across the industry.

"We are urging the competition regulators to look very closely at the proposals and be especially vigilant to make sure the deal doesn't reduce competition across North Atlantic routes," a spokesperson for British Airways said. Gert-Jan Geels, an asset manager at Amsterdam-based Eureffect, said: "I have doubts whether the merger will work -- there are more failed mergers than successful ones, and in the airline industry I don't even know of a deal like this at all."