(Adds comment from Transat shareholder, analysts, rewrites throughout)
By Allison Lampert
MONTREAL, May 16 (Reuters) - Air Canada's bid to buy Canadian tour operator Transat AT would boost its leisure travel business at a time when the carrier faces a potential turnaround in rival WestJet Airlines, but the deal could attract regulatory scrutiny.
Canada's largest airline said on Thursday it is in exclusive talks to buy the parent company of leisure carrier Air Transat in an all-cash deal valued at C$520 million ($387.5 million), marking the second aviation deal in Canada this week.
Transat shares surged as much as 18% after the two Montreal-based companies agreed to a 30-day period of negotiations to finalize a deal, in which Transat shareholders will receive C$13 a share, a premium of 23% to Wednesday's close.
Air Canada shares were up 1.7%.
Canadian Transport Minister Marc Garneau said in a statement that a formal request for a transaction would likely "be subject to provisions" of the Competition Act.
Air Canada's plan to grow its strong-performing leisure business and Montreal hub through the Transat deal is subject to several conditions, including approval from regulators concerned with protecting fares and service for travelers in a country where the cost of air travel is padded with fees and surcharges.
"It is then within the minister of transport’s authority to determine whether the transaction warrants a public interest review," he said.
Air Canada's bid for Transat comes days after WestJet received a C$3.5 billion buyout offer from billionaire Gerry Schwartz's private equity firm Onex Corp, which is backing the struggling carrier's growth plans.
"Our only concern about the transaction is regulatory approval, as Air Canada is already the largest airline in all the markets in which Transat is present," Cowen & Co analyst Helane Becker said in a note.
Overlap on routes flown by Air Canada and Transat would likely lead the "companies to propose some remedy in order to obtain regulatory approval," Desjardins analyst Benoit Poirier wrote in a note to clients.
But Brian Rynott, managing director at Alton Aviation Consultancy, said a combined Air Canada and Transat would not create a monopoly on leisure travel, given the emergence of ultra-low-cost startups in Canada.
"It’s prudent to review competitive matters but in my perspective, it is a well thought through deal and a strategic positive for Air Canada," he said.
Shares of Air Canada have surged nearly 50% this year, while those of Transat have jumped 78% in the year to date on the Toronto Stock Exchange. Transat's second-largest shareholder, the Quebec-based labor sponsored investment fund, Fonds de solidarite FTQ, will need to see a formal proposal before deciding on the deal, said spokesman Patrick McQuilken.
McQuilken said the fund also looks at social factors like labor conditions and the impact on the Quebec economy when evaluating a deal. ($1 = 1.3419 Canadian dollars) (Reporting by Allison Lampert in Montreal and Shanti S Nair in Bengaluru; additional reporting by Shradha Singh. Editing by Arun Koyyur, Bernadette Baum and Susan Thomas)