Airlines plot a difficult course

There are two key questions raised by the confirmation that Qantas and British Airways are exploring a potential dual listed company merger. The first is whether it can be done. The second is whether it should be done.

The first question is quite complex, given that there are several layers of complexity that would have to be negotiated before a merger, even a dual listed company (DLC) merger could be consummated.

Airlines, particularly international carriers, carry their national flags. They are closely regulated by their governments and their routes are negotiated on a bilateral, government-to-government basis.

To protect their national carrier status and those bilateral access arrangements governments generally legislate shareholding restrictions to ensure they remain majority owned and controlled by their home market. In Qantas' case there has been a 49 per cent ceiling on foreign ownership, with sub-ceilings in the form of a 25 per cent limit on the shareholdings of individual airlines and a 35 per cent cap on the aggregate holdings of foreign airlines.

Yesterday's green paper on aviation policy flagged the removal of the sub-ceilings but the 49 per cent overall limit on foreign ownership will remain.

Even if it were removed, however, it is unlikely a true merger could be executed without massive risk because of the bilaterals. Qantas and BA could lose access to routes if they lost their national carrier status – if their "Australianness" or "Britishness" were seen to be diluted.

If they can structure their way around that problem they would still confront the probability that other carriers and their governments will attempt to exploit the merger to their own advantage.

It would not be a surprise, for instance, if the US not only sought an open skies agreement with Australia in exchange for leaving the existing bilaterals in place but again sought so-called "fifth freedom" rights – the ability to fly, not only to Australia but through Australia to third-country destinations – on behalf of its carriers.

If it could be done – and DLCs are very complex structures and the governance arrangements for a Qantas/BA DLC would be further complicated because of the need to protect the bilaterals – the remaining question would be whether it should be done.

BA may no longer have a shareholding in Qantas – BA had a cornerstone shareholding in Qantas for just over a decade, before the need to reduce a threatening debt burden led it to sell in 2004 – but the carriers do have a joint services agreement (JSA) on the "Kangaroo" route between Australia and the UK.

That agreement allows them to coordinate their scheduling, marketing, sales, freight, customer services and pricing on the route. The arrangement has competition policy authorisation.

Thus, the core conventional synergies from a merger are already available through the JSA.

The airlines are complementary. BA is very strong in Europe, on the transatlantic routes and in the Middle East. Qantas dominates Australasia, and routes between Australia and Europe and Australia and the US. It is also very strong within the wider Asia Pacific region.

A merger would give them global network coverage, although exploiting that with different brands and products could be quite difficult.

Both have opted for the Airbus A380s as their core long haul product and have reasonably complementary fleet strategies, which might proffer some cost synergies in the engineering and maintenance areas.

Ultimately, however, a merger would be driven by strategic issues rather than by simple synergies.

Former Qantas chief executive, Geoff Dixon, has argued for years that the industry has to consolidate and would eventually find a way through the maze of obstacles, including the bilaterals. He foresaw a future in which there would be a handful of global mega-carriers.

Qantas has tried for years to negotiate a merger or an alliance supported by cross-shareholdings with regional carriers including Singapore Airlines, Malaysia Airlines and, it is suggested, quite recently with Cathay Pacific. So far it has been unable to do the deal that would create a dominant regional player.

In an era of major consolidation – and the financial crisis and the creeping spread of open skies agreements in the northern hemisphere – Qantas' status as arguably the world's strongest airline would be irrelevant. It would ultimately be stranded as a small end-of-the-line carrier.

The negotiations with BA, initiated by Qantas, are clearly a way for Qantas to try to exploit its strength while it can. This moment, with the global industry under severe pressure as a result of the crisis, the impact of high jet fuel prices and the global economic slowdown, probably provides it with the best leverage it has ever had.

A merged group would have scale, a far more comprehensive and strong global network, access to two capital markets and some ability to finesse its deployment of capacity across the larger network. It would also have the third low-cost carrier brand in Jetstar to expand onto routes that don't make sense for the parent brands.

It would be well-placed, particularly if it subsequently brought one of the North American carriers, and perhaps a mainland European group, into the structure, to create the kind of mega carrier Dixon envisaged.

The complexities of merging the two carriers, the involvements of governments, the inevitable opportunism from rival carriers, the potential for a third party to gate-crash the discussions and the "social issues" that are elevated in a DLC and would be intense in a merger of two national carriers/icons means there is no certainty that the discussions will lead to a deal.