Italy's flag carrying airline, Alitalia, has been in financial trouble for years. As recession grips the Eurozone and old inefficiencies continue to be problems, this airline is in need of both a turnaround and new capital.

After failing to reach a deal with Air France-KLM (OTC:AFRAF), Alitalia is now looking for an investment from the Middle Eastern carrier Etihad Airways. So why does Etihad want a piece of Alitalia, what's left to do, and which other companies does an Etihad-Alitalia deal affect?

Capital required
Alitalia was desperately in need of capital last year but was unable to come to an agreement with Air France-KLM, then a 25% shareholder. As the situation grew more dire due to Eni (NYSE:E) threatening to cut off fuel supplies, a rights issue was put together to raise capital from existing Italian banks and private investors with the remaining shares being purchased by Poste Italiane, the Italian government-owned post office.

Air France-KLM refused to inject more capital through the rights issue and saw its stake diluted to 7%. Although emergency capital was raised, Alitalia still needed a longer-term partner, and Air France-KLM was already distancing itself from the airline.

New partner
Fortunately for Alitalia, Etihad Airways emerged as a new potential partner. Etihad is the state-owned flag carrier of the United Arab Emirates, and has been expanding into Europe as it looks to become a worldwide carrier.

Etihad has also utilized equity purchases as part of its expansion strategy, taking stakes in Aer Lingus, airberlin, and Air Serbia to build equity partnerships. With Alitalia needing new capital and Etihad looking for another expansion opportunity, talks began and continued for months as the details were worked out.

The latest deal would have Etihad invest 560 million euros for a 49% stake in Alitalia along with a commitment to invest another 690 million euros during the next four years. However, not everything has been settled.  According to the Wall Street Journal, Etihad is looking to cut 2,251 staff at Alitalia.

Getting these cuts could be difficult considering the strength of Alitalia's unions. Resistance to job cuts was one of the factors that kept Air France-KLM from injecting more capital into Alitalia, and similar resistance is likely for job cuts put forward by Etihad.

Although there is some hope on the debt restructuring front, which has been an obstacle that kept Air France-KLM from further investment in the airline. The Wall Street Journal reports that Intesa Sanpaolo (OTC:ISNPY) is willing to forego part of the 280 million euros owed by Alitalia if an agreement can be reached with the unions. Considering the difficulties in reaching past labor deals, labor negotiations will play a role in how the Etihad-Alitalia tie-up goes forward and whether Etihad can get the debt restructuring it wants from Intesa.

Who benefits?
Provided a labor agreement can be reached, Etihad stands to gain from expanding into the Italian market. While Air France-KLM may play less of a role in Alitalia than it previously has, the Franco-Dutch carrier benefits by Alitalia being saved from collapse because it allows their codeshare to continue.

Eni and Intesa Sanpaolo would also gain from this deal since Eni would be able to continue selling jet fuel to a more stable Alitalia and Intesa would stand a greater chance of seeing value from its stakes in Alitalia. Without outside investment, Alitalia is almost certain to run out of cash which could force a bankruptcy. If a lack of funding does force a restructuring or liquidation, Intesa is likely to be on the losing side as the bank is both a creditor and shareholder of Alitalia.

The bottom line
The Etihad-Alitalia tie-up is not completely wrapped up but a deal to save Italy's flag carrier airline does look closer than ever. If Etihad saves Alitalia, it saves a lucrative codeshare partner for Air France-KLM while facilitating its own expansion into the Italian market.

With the airline business being very much a global one, all airline investors should keep an eye on the events surrounding Alitalia and the fate of the Italian air travel market.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.