British Airways and Iberia are right to merge: 400 million euros of synergies will go some way to help them survive dreadful conditions in the airline industry. But the combined group will need more than cost savings and revenue benefits to lift it out of the red. And BA’s pension fund deficit could yet derail the long-awaited deal.

 There is no sign of the clouds that have engulfed the world’s airline industry lifting quickly. With losses of almost 600 million pounds forecast for this year, BA is not expected to return to pre-tax profit before 2012. The outlook is only slightly brighter for Iberia, with a return to the black in 2011. As synergies will take up to five years to achieve, these won’t provide any immediate relief.

BA’s chief executive Willie Walsh and Iberia chairman Antonio Vazquez — who will be CEO and chairman of the new company respectively — are banking on better use of their London and Madrid hubs to increase revenue. The airlines will concentrate on North American and Asian routes from BA’s base at Heathrow, with Madrid’s Barajas acting as the gateway to Latin America.

BA and Iberia are probably underestimating the benefits. Indeed, Walsh’s external advisers have apparently told him that the revenue synergy targets should be exceeded. Air France <AIRF.PA> and KLM identified 385 to 495 million euros in annual synergies when they merged in 2004. That figure has increased since.

The big stumbling block is BA’s huge pensions hole. This totalled 3 billion pounds at the end of the first half, but is likely to rise as a result of the latest actuarial review, which should be completed before Christmas. BA will then spend several months thrashing out with its pension trustees just how much it will have to contribute and over what timeframe.

BA will presumably argue that it is stronger with Iberia than without and therefore represents a lower risk. But under the convoluted holding company structure proposed for the merged group, the pension fund’s claim will be on the British subsidiary, not the merged group. Discussions with the trustees have to be concluded by June next year, and Iberia can walk away if it doesn’t like the outcome.

Given the uncertain outlook for asset prices and the airline industry as a whole there is some serious horse trading to be done. In the meantime, both airlines  will have to keep up the cost cutting. This is needed just to survive the downturn and the fierce competitive threat posed by the low-cost carriers in their home markets. Further battles with unions in both companies are inevitable — regardless of whether the merger happens or not. A deal is better than BA or Iberia continuing to fly solo. But they are nowhere near cruising altitude.