Canada's Alcan Aluminium, France's Pechiney and Switzerland's Algroup said yesterday that they were in "advanced discussions" for a three-way transnational merger that would create the world's biggest aluminum company.

If the deal is completed, the new company will have annual revenue of more than $24 billion, including non-aluminum businesses--way ahead of the current leader, Pittsburgh-based Alcoa Inc., with $15.3 billion in revenue last year.

"The merger will create an entity that has balance-sheet strength, product diversity and management strength," said Vahid Fathi, metals and mining analyst at ABN Amro Holding NV.

The combined company would produce about 2.6 million tons of aluminum a year, compared with the total global output of 25 million tons and Alcoa's output of 2.5 million tons.

The chemical business that Algroup would bring to the merger is expected to be either sold to another company or spun off to the public. Pechiney has already sold to the public more than half ofits beverage-can manufacturer, American National Can Group.

Alcan is expected to remain the listed company for trading purposes and its Montreal headquarters the seat of power for the merged companies. Sources said preliminary talks began as early as last October, and the companies began to seriously consider a merger in May.

From the market point of view, the merger would pave the way for an entity that has a wide product portfolio. Besides its own bauxite and alumina, the new company would have a presence in the fabricated-structures market and be a supplier to the aerospace, automobile, construction and packaging industries. Alcan is more of a flat-rolled-aluminum maker, Pechiney has a strong aerospace customer base, and Algroup caters more to the packaging industry.

Globally, companies manufacturing commodity products, which include aluminum, are merging in a bid to reduce costs and expand their product portfolios.

In the aluminum industry, prices have been under pressure because of weak demand. As a result, aluminum prices on the London Metal Exchange have been more or less flat. The current aluminum price of 70 cents per pound is only 3 cents more than the average price in 1994. The merger "is certainly a response to the trend of secular deflation in commodity prices," said Fathi of ABN Amro.

Another factor that is forcing commodity companies to pursue economies of scale is the consolidation in their user industries--such as the automobile industry, a big aluminum purchaser. As customers grow bigger, they demand volume discounts, and small suppliers are not always able to lower costs without cutting into their profit margins.

"It's much harder to be a local supplier to a global consumer like, say, DaimlerChrysler," said Daniel Roling, senior mining and metals analyst with Merrill Lynch Global Securities.

It's unlikely that a merger would yield significant cost savings, since the key costs are labor and energy. Although the merger would raise the combined company's head count to almost 100,000 employees, analysts do not expect any layoffs, but they do expect substantial reductions in administrative and purchasing costs. Besides, both Alcan and Pechiney recently have been through restructurings, and Algroup earlier this year unsuccessfully tried to merge with a European company, Viag AG. Therefore, the scope for cost savings is limited.

"Reductions in work force will come more through attrition than downsizing," said Fathi of ABN Amro.

The merger plan is subject to approval by federal regulators both in the United States and Europe. When Alcoa acquired the No. 3 industry player, Alumax Inc., it was forced by the Justice Department to sell some of Alumax's operations. But since a Alcan-Pechiney-Algroup combination would have strong competitors in each of its business segments, analysts do not expect the merger to be blocked.

Aluminum Strength

If Canada's Alcan, France's Pechiney and Switzerland's Algroup merge, they will have combined sales of more than $24 billion, surpassing the United States' Alcoa.

1998 revenue, in billions

Alcoa $15.3

Pechiney 10.5

Alcan 7.8

Algroup 6.5*

*Based on current conversion rate

SOURCES: The companies