By Silvia Aloisi

ALITALIA began scaling back flights at Milan's Malpensa airport yesterday in line with a takeover plan by Air France-KLM and ahead of talks with combative unions whose backing is crucial to close the deal.

Talks with unions resume today after Air France-KLM agreed to fewer job cuts at the loss-making Italian airline than previously planned, a concession the labour groups have rejected as inadequate.

The two airlines had set March 31 as the deadline for winning union support and overcoming other hurdles to the takeover, which has met resistance from Italian politicians and Milan's airport operator.

But Alitalia, which regards the deal with Air France-KLM as one of its last hopes of averting bankruptcy, signalled on Friday it would extend the deadline for a few days after scraping together €148m of extra liquidity.

On Sunday, Alitalia began cutting 70pc of its flights from Milan's Malpensa and boosting operations at Rome's Fiumicino, in line with its own "survival" strategy. The cuts downgrade the airport's status as a hub for the airline in favour of Rome and have triggered a $2bn (€1.27bn) lawsuit from airport operator SEA which Air France-KLM wants dropped before going ahead with the deal.

The Franco-Dutch carrier said it would retain 4,191 out of about 7,400 employees at Alitalia's AZ Servizi ground services unit, compared with 3,300 in an earlier draft.

In a joint statement, all major Alitalia unions except one criticised the offer as changing little.

Air France-KLM confirmed plans to cut about 1,600 jobs at Alitalia's airborne operations.

Alitalia loses more than €1m a day and on Friday said its net debt had risen to €1.37bn.

The Agony of Italy's 'Cursed' Airline

Music to the ears of its shareholders, Air France-KLM steps away from negotiations to take over Alitalia. Its sights may now be on Spain's Iberia

by Mark Scott

After a 15-month effort to find a buyer for beleaguered Italian airline Alitalia (AZPIA), the proposed sale suffered a heavy setback late on Apr. 2 after Air France-KLM (AIRF), the world's largest airline by revenue, pulled out of takeover talks due to protracted difficulties settling terms with Alitalia's unions.

The decision leaves little maneuvering room for Alitalia, which is losing around $1.5 million a day and must raise more than $1 billion by June to avoid collapse. But Air France-KLM shareholders greeted the news with delight after many had expressed misgivings over the wisdom of incorporating the ailing Italian airline into the Franco-Dutch carrier (BusinessWeek.com, 12/11/07).

Their relief filtered into the markets, with Air France-KLM shares trading up as much as 5% in Paris on Apr. 3 before finishing the day up 2.4%. Alitalia's stock was suspended on Apr. 3 after the airline's chairman, Maurizio Prato, resigned and the board met in emergency session to discuss the limited options left open to the Italian carrier.

"The company is cursed; only an exorcist can save it," Alitalia union officials quoted Prato as saying after negotiations between Air France-KLM and airline workers broke down.

FRUITLESS RESCUE EFFORT

Many industry watchers would agree. Air France-KLM's plans to buy the Italian government's 49.9% stake in Alitalia have been plagued with difficulties since they were first announced on Dec. 6, 2007 (BusinessWeek.com, 12/6/07). In a deal that valued the airline at around $1.15 billion, the Franco-Dutch carrier wanted to cut 2,100 jobs, sell off Alitalia's cargo business, reduce its airline maintenance unit, and change the business focus from midrange to long-haul flights. A takeover also would have accelerated the decline of Milan Malpensa International Airport, as Air France-KLM shifted flights to a beefed-up Rome hub.

"Air France-KLM was seen as the perfect carrier to come in and rescue the situation at Alitalia," says Leigh Bailey, airline analyst for Standard & Poor's, which like BusinessWeek is a unit of The McGraw-Hill Companies (MHP). "If they have walked away, it's doubtful that the conditions [surrounding Alitalia] would satisfy anyone else."

That certainly seems the case after Germany's Lufthansa (LHAG)—another perennial potential suitor for Alitalia—reaffirmed on Apr. 3 its unwillingness to put forward a bid for the carrier.

With no interest from larger rivals, the Italian airline's future is looking bleak. On Mar. 28, Alitalia said its cash reserves and short-term credit as of February, 2008, stood at $281 million, down 40% from the previous month. The carrier's net debt during the same period rose to $2.18 billion, up 7% from January, 2008. Analysts say the airline will be forced into bankruptcy unless a new injection of cash can be found quickly.

POLITICAL FACTORS

No movement is likely before the Italian parliamentary elections set for Apr. 13 and 14. Front-runner Silvio Berlusconi, a former Prime Minister and one of Italy's richest men, has openly criticized the proposed Air France-KLM takeover. Instead, he is promoting an Italian-led deal possibly centered on domestic low-cost carrier Air One, which was the only other airline to show interest in buying Alitalia as of the end of 2007.

An Italian deal isn't a forgone conclusion, though. The European Commission has taken a strong stance against the use of state funds to bail out money-losing airlines. In 2005, for instance, Brussels ordered troubled carrier Olympic Airlines to repay $250 million to the Greek government for breaching competition laws.

At the same time, any privately funded domestic rescue plan for Alitalia would have to overcome the same hurdles that killed the Air France-KLM deal. Along with outstanding union difficulties, the Italian carrier's aircraft need to be upgraded at an estimated cost of $1 billion. Long-standing management problems—nine chief executives have run the company over the last 15 years—also must be resolved before Alitalia returns to the black.

EYES ON IBERIA

With so many problems, it's no wonder Air France-KLM shareholders welcomed the end of takeover negotiations. While the Franco-Dutch carrier left the door open to restart talks, market watchers figure the company will instead turn its sights to potential deals with Europe's other midsize airlines (BusinessWeek.com, 8/14/07).

Peter Morris, chief economist at Ascend, a global air transport consultancy in London, believes Spain's Iberia (IBL) tops the list of possible takeover targets. "It's a prize because of its links to Central and South America," he says. "That's a huge growth region that would fit into the consolidation plans for either Air France-KLM or Lufthansa."

Unlike floundering Alitalia, Iberia reported pre-tax 2007 profits of $696.6 million on sales of $8.6 billion, well ahead of its $409.2 million pre-tax profit the previous year. The Spanish airline's return to health—and the rich potential of its route structure—has long caught the eye of other European airlines, but no takeover deal has been consummated. If Air France-KLM makes a run at Iberia, it could awaken stiff competition from British Airways (BAY.L), which upped its stake in the Spanish airline to 13.5% on Mar. 18. British Airways has danced around Iberia for years, but also has other issues on its plate (BusinessWeek.com, 4/2/08) that could forestall a pitched takeover battle.

Gobbling up Iberia could be just the ticket for Air France-KLM, which has twice tried and failed to buy Alitalia—and clearly has an itch to continue expanding. For Italy's former state carrier, on the other hand, the endgame is near. If no suitable suitors come forth, it may be time to say arrivederci to Alitalia.