United Airlines parent UAL Corp will buy Continental Airlines Inc for $3.17 billion in an all-stock deal that will form the world's largest carrier and potentially prune excess capacity in the airline industry.

The widely anticipated deal, announced on Monday after three weeks of talks, sent most airline shares higher, even though some analysts said the capacity cuts could be minor.

It's helpful, S&P analyst Jim Corridore said of the merger. But it's not going to be the one thing that makes the industry fundamentally sustainable.

The airline industry has been hammered in the past two years by volatile fuel prices, low-cost competition and overcapacity.

UAL said the acquisition will help it attract more business travelers because the merged company will fly to 370 destinations and have 10 hubs worldwide, with Houston as its largest.

A JP Morgan Chase & Co analysis estimated the combined company will be able to lop off 8 percent of their capacity and cut expenses by 5 percent.

By combining operations, it will benefit the airlines where it will solidify their ability to price, said Ray Neidl, an independent airline consultant. But it also will benefit the whole system in that we'll have larger airlines to better serve their customers.

If approved by regulators, the new airline would be known as United Airlines and be based in Chicago. It will have over $29 billion in annual revenue and a workforce of nearly 90,000.

The deal is the first major U.S. airline merger since Delta Air Lines Inc's 2008 purchase of Northwest and caps months of speculation that more industry consolidation was ahead.

Experts said American Airlines, the AMR Corp unit that was the No. 1 U.S. carrier just two years ago, might eye Alaska Air Group Inc or US Airways Group Inc as a result of this deal. Alaska Air shares jumped 9 percent to close at $45.20 and US Airways ended the day 4.5 percent higher at $7.39.

UAL previously was in talks with US Airways. It was those talks that prompted Continental to enter discussions with UAL. But some analysts said US Airways may not be the fit for American that Continental is for United because US Airways does not have a robust enough international network.

Eighteen months from now when you have a single carrier with United-Continental, maybe that would be time to bring in the remaining Star Alliance partner that would be US Airways, said airline consultant Robert Mann with RW Mann & Co.

Morningstar equity analyst Basili Alukos said AMR might be a good match for JetBlue Airways Corp after they announced a code-share partnership.

I would imagine that's a first step toward a merger, he added.

ALL-STOCK DEAL

The deal is expected to produce between $1 billion to $1.2 billion in annual revenue and cost benefits by 2013.

Much of this comes from $800 million to $900 million in incremental annual revenues. The combined company will also cut costs by $200 million to $300 million.

Continental shareholders will receive 1.05 shares of United common stock for each Continental common share they own. Based on United's $21.60 closing price on Friday, and Continental's 139.6 million outstanding shares as of April 21, United would pay $3.17 billion for Continental, or $22.68 a share.

That is a 1.5 percent premium over Continental's closing price on Friday. Based on current shares outstanding, the combined company would have 314.5 million shares and UAL shareholders will own roughly 55 percent. UAL stock closed 2.4 percent higher at $22.11, while Continental was up 2.3 percent at $22.86.

Continental Chief Executive Jeff Smisek will be CEO of the holding company called United Continental Holdings Inc. Since he took the reins of Continental in January, the airline has added fees for meals and exit row seats -- changes the company might have balked at earlier, analysts said.

UAL CEO Glenn Tilton, who has been a long-time proponent of consolidation, will be nonexecutive chairman.

In a message to employees on Monday, Tilton said there would be some reductions in the salaried and management workforce at both companies. But Smisek told Reuters rank-and-file staff would see little impact on their numbers.

The Air Line Pilots Association, which represents pilots at both UAL and Continental, has indicated tentative support for the deal. But the International Association of Machinists and Aerospace Workers said it was concerned about the effect of the merger on benefits and job security of its more than 26,000 members at both carriers.

Both ALPA and IAM have seats on UAL's board of directors.

One-time merger costs of about $1.2 billion are expected over three years. The companies expect to receive government approval and complete the transaction by the end of 2010.

We do not believe there are any material antitrust concerns, Smisek said. We have a high degree of confidence that this transaction will close.

Smisek, 55, will become executive chairman when Tilton steps aside, expected two years after the merger closes.

(Reporting by Kyle Peterson in Chicago, Deepa Seetharaman in New York and Karen Jacobs in Atlanta; editing by Derek Caney, John Wallace and Andre Grenon)

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