A Wave of Airline Mergers May Be on Europe's Horizon

Ownership restrictions, stubbornly high fuel prices and mounting competition haven't quelled demand for ownership of European airlines, with numerous potential buyers lurking -- from the U.S. to Qatar to Russia.

There's speculation that Lufthansa and British Airways could work out a swap, with BA exchanging its Iberia holding for Lufthansa's stake in BMI.

Meanwhile, British Airways itself has become the subject of takeover talk. There's speculation the largest Arab airline, Emirates, may try to buy it.

"That's certainly possible," said Westwood, who sold his British Airways holdings at 5 pounds a share, which is just a shade under its current price. "Emirates is doing incredibly well and expanding rapidly, and I'm sure they would love to get their hands on a great British brand like that."

Elsewhere, Finnair and SAS would be natural partners, if political considerations would allow a tie-up between the Helsinki- and Stockholm-based airlines.

Ryanair Holdings (RYA) launched a bid for Aer Lingus (AERL) shortly after the latter's initial public offering, though that bid has been thwarted by both Aer Lingus shareholder opposition and European Commission competition concerns.

For the most part, the low-cost carriers -- such as Ryanair and Air Berlin (AB1000) -- aren't being targeted by the flagship carriers, though the low-cost carriers themselves could consolidate.

"The low-cost carriers keep out of the way of the flags, and vice versa, for the most part," said Watson. Since the likes of Ryanair fly to smaller regional airports, rivals like Lufthansa wouldn't extract any network benefits from acquiring them.

Too late to buy?

Even amid the M&A chatter, fund managers have been wary of recommending the purchase of shares in European airlines, pointing to the tremendous gains already racked up by such stocks.

Bid target Iberia has rallied 47% this year. From 2003's lows, British Airways shares have jumped sixfold.

Westwood of Threadneedle said he prefers such low-cost airlines asRyanair and easyJet (EZJ) to the merger plays.

"I still favor the low-cost airlines over the former state-owned airlines," he said. "Air traffic is so cheap now, and a lot of regional airports are opening up."

Westwood does acknowledge that airlines may be able to continue to ratchet up fares. With growing emerging-market demand for aircraft, Boeing (BA) and EADS unit Airbus are booked up for years, restricting airlines' ability to add capacity.

"The problem at the moment is that you can't order any new planes," he said. "[British Airways CEO] Willie Walsh will have to wait until 2013 for new planes."

Mellon's Shant invests less in airlines than his fund's benchmarks call for, though he is a fan of Alitalia, he said.

"There's a risk that you're getting involved rather late in the cycle. It's a fascinating space, but one which has proven to be exceptionally cyclical in the past."

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