British Airways (BA) and Spain's Iberia are in talks to create the world's third-biggest airline, which could form the basis of a three-way transatlantic tie-up and trigger a fresh wave of industry deals.

The carrier said on Tuesday the talks were about an all-share merger, boosting shares in both groups. The talks have the support of both company boards but are expected to take several months, BA added.

Iberia's 23 percent shareholder Caja Madrid is supportive of the tie-up, a source close to the matter said. BA's 8.4 percent shareholder Standard Life also backed the deal.

BA Chief Executive Willie Walsh also confirmed to reporters that the two carriers were still in talks with U.S. carrier American Airlines about a transatlantic agreement.

"Over the medium term, they should reap significant rewards in terms of both synergies . and also in terms of maximising revenues," said NCB analyst Neil Glynn of the proposed deal.

"It also possibly brings a three-way transAtlantic arrangement closer between BA, Iberia and American Airlines."

BA's shares were up 5 percent at 246-3/4 pence by 1:10 p.m. British time, valuing the company at 2.8 billion pounds. Shares in Iberia soared 20 percent to over 1.9 euros to value the business at around 1.8 billion euros (1.4 billion pounds).

A fresh wave of consolidation has been expected among European airlines seeking to fight the twin threats of soaring fuel costs and falling consumer demand.

Air France and Dutch carrier KLM became Europe's biggest carrier by merging earlier this decade, while a string of airlines such as privately-owned bmi are seen as future targets.

There has also been a rush to take advantage of the newly launched 'Open Skies' agreement, which has freed up restrictions on carriers flying between the United States and European hubs.

NEW ERA

BA's Walsh said the move was not a life-saving tie-up, but made sense in current market conditions.

"I don't see this as a matter for survival but as two strong companies coming together. We do not see this as the end game but as the start of a new era," he told reporters. "The combined balance sheet, anticipated synergies and network fit between the airlines make a merger an attractive proposition."

Walsh said the opportunity provided by Open Skies had helped facilitate the deal. "(This is a) consequence of liberalisation of the aviation industry. Hand in hand with liberalisation is the need for consolidation," he said.

The combined group would have revenue of 16.5 billion euros, nearly 450 aircraft and around 200 destinations. Air France/KLM had turnover last year of over 24 billion euros.

BA was part of a consortium led by private equity group TPG which withdrew a 3.4 billion euro bid for Iberia last November. TPG declined to comment on Tuesday, while Walsh said the current proposal was "very different" from last year's.

"From an industrial point of view the deal makes the same sense as it did a year ago, but there are still a lot of details that need to be worked out," said BPI analyst Joaquin Garcia-Romanillos.

BA has been a shareholder of Iberia for nearly 10 years and owns 13.15 percent of the Spanish carrier. Iberia has a 2.99 percent direct stake in BA on top of exposure to 6.99 percent via contracts for differences linked to BA's share price.

BA said both parties were confident of securing regulatory approval, adding that the European Union had already allowed the duo to cooperate widely.

However, a spokesman for BA rival Virgin Atlantic criticised the deal. "This potential merger will only fuel BA's dominance at Heathrow . We all know that dominant players offer less choice and push up ticket prices," he said.

BA and Iberia would control nearly 45 percent of take-off and landing slots at Heathrow, the core hub for flights between Europe and the United States.

Morgan Stanley and UBS AG are advising Iberia and British Airways, respectively, a merger, a banking source close to the deal said.