Airlines: would BA and Iberia make a happy couple?

British Airways CEO Willie Walsh might not know it, but there are shades of the Peninsular War about the proposed tie up between his airline and Iberia.

Unfortunately though, unlike the Duke of Wellington, who rode to Spain's rescue against the French at Vimeiro in 1808, Walsh isn't coming to the Spanish airline's aid. But he might be coming to BA's.

Pummelled on all sides by rising fuel costs, falling passenger demand and the ever-present problem of competition from budget airlines, BA, in common with other airlines, is battening down the hatches. Its fuel bill alone, which accounted for 10% of costs in 2000, now stands at 40%. Clearly, savings have to be made. And by merging with Iberia, BA will be able to make significant cuts in plane purchases, while cutting down on the number of costly routes they both share.

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So BA, which already owns 13.15% of Iberia, will get access to the Spanish flag carrier's unrivalled South American network, while offering a bigger foot in the door at Heathrow to its new partner. Together they will control 45% of the airport's coveted landing slots.

"It will strengthen its network coverage, particularly in Latin America, and increase its level of diversification in long-haul markets, which are highly reliant on North American routes," said Leigh Bailey and Eve Greb, analysts at Morningstar, in a research report.

However, there is no doubt who will be the senior partner in any merger. BA has a current market capitalisation of about €3.4 billion, while Iberia's stands at around €1.5 billion. Walsh, just like Wellington at Vimeiro, will be the man in charge, even if a good chunk of his foot soldiers are Spanish.

But should investors take merger talks as a sign to get back into the airline sector? After all, Iberia's share price shot up 21% yesterday on the news, and BA's climbed a respectable 6%.

In a merger-starved market, probably not.

Any talk of tie-ups and deals is enough to get traders bristling with excitement in today's market - hence the steep rise in the share price of both companies. So you should probably stay out for the time being. Because although oil prices are falling, airlines are facing even bigger problems - such as how to deal with fewer passengers after years of growing their fleets. Already this year, 24 carriers have gone to the wall, according to the International Air Transport Association (IATA), with more likely to follow.

Walsh has done a good job at BA, raising profits there to £883m in the year to 31st March. And his decision not accept a bonus after the AWOL luggage debacle at Terminal 5 is admirable in an era where fat-cat execs seem to view their time in office much as your stereotypical African dictator has in the past: To line your pockets while you can.

However, just like Wellington, Walsh has more battles to come. For the Duke, it was 7 years later at Waterloo. For Walsh, it will probably take until the end of this recession before we see a long-term turnaround in the fortunes of BA's share price.