Nicholas Watson in Prague -

The Russian-owned AirBridge may have won the tender for the Hungarian flag carrier Malev, but the hard work remains ahead of it to first finalize the deal with the government and then to turn round the distressed airline.

The privatisation agency announced Thursday it had chosen the Hungarian investment vehicle for Russia's KrasAir to continue talks about selling Malev rather than the other remaining bidder Lithuania's FlyLAL Group.

The reason the agency gave in a statement was that FlyLAL's offer suffered from "a lack of financial guarantees."

David Keresztes, FlyLAL's Hungarian representative, was quoted by Reuters earlier this week as saying the bidders were supposed to submit an offer that included three elements: the purchase price, investment, and debt assumption. Keresztes said FlyLAL's bid was €120m, which compares with the reported sum of €160m from AirBridge. Of that sum, AirBridge said earlier this month it would inject $30m-50m into Malev immediately, with more to come later.

"We made the best professional and financial offer for Malev, which we backed up with guarantees," said a statement from Boris Abramovich, an ex-Aeroflot engineer who is one of the core shareholders in Russia's KrasAir, which controls AirBridge. "We are ready to conclude negotiations."

Analysts reckon it's probably a done deal, though AirBridge has been here before. In 2005, the holding company reached the final round of a previous tender for Malev, but couldn't conclude the talks after protests from unions and opposition parties, who claimed the government was selling off the airline too cheaply. That failure was one in a long line of such attempts to offload the airline.

The number of attempts Hungary has made to sell Malev may be greater than elsewhere – this is the seventh time - but failure to sell these flag carriers is nothing new in this part of the world.

Malev, like many other flag carriers in the region, has struggled in an operating environment that is a much more competitive and hostile place to do business than before 9/11 and the arrival of the budget airlines, which now criss-cross the continent.

As well as being squeezed at the bottom by the budget airlines, these mid-sized flag carriers have since failed to benefit from the spike in demand for premium business travel, which is buoying airlines such as Air France/KLM and Lufthansa. ABN-AMRO analyst Andrew Lobbenberg says the big European carriers are riding a wave of premium traffic, which isn't there to support the likes of Malev, Poland's LOT and other carriers with home markets in secondary hubs that have less premium-class demand.

So why is AirBridge and its parent KrasAir so interested in Malev?

Join the big-boy's club

The future for these flag carriers like Malev and Romania's Tarom is to give up on the prestigious long-haul flights that were once the preserve of national carriers, and begin targeting the more mundane, but potentially lucrative, regional flights.

KrasAir is one of five regional Russian airlines that comprise the AirUnion alliance, which is benefiting from Russia's economic boom that is rippling out from Moscow and into the regions. In 2006, the AirUnion alliance carried 3.34m passengers, up 4.0% from the year before.

According to KrasAir, Malev will open up the lucrative market of Western Europe for the alliance. Not everything is going badly for Malev; on January 9, American Airlines announced it has begun the process to allow Malev to join the OneWorld Alliance, which will allow the two airlines to code-share flights and have reciprocal frequent flyer agreements.

Access to the OneWorld alliance, which also includes giants such as British Airways, Qantas Airways and Cathay Pacific, is a club that KrasAir would definitely like to join.

Even so, turning around Malev won’t be easy.

The CEO of Malev, Janos Gonci, told the MTI news service on Tuesday that Malev could become profitable within two years after its privatisation and the injection of fresh capital, while Pyotr Leonov, a board member of AirBridge, was quoted by Bloomberg Friday saying that his airline plans to make Malev profitable in just one-and-a-half years.

That could be optimistic. Leaving aside the vulnerability of the airline business to the fallout from terrorist attacks, Malev is saddled with debts of some HUF30bn (€117m), while it had operating losses of HUF8.97bn in 2005, 44.7% more than the year before.

The situation at the airline may be worse than thought. A group of Irish investors shortlisted by the government suddenly pulled out of the race to buy Malev on January 15 and a few days later FlyLAL's Keresztes moaned to the local press about how the losses at Malev have turned out to be even bigger than revealed at the start of privatisation negotiations.

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