American Airlines is in talks to take a minority stake in Japan Airlines (JAL) <9205.T> and form a joint venture with the struggling airline, a source said, pitting it against a rival bid from Delta Airlines .

JAL, Asia's largest airline by revenues, lost about $1 billion last quarter and has been seeking investors to prop up its finances for a state-supervised overhaul likely to include heavy job cuts, a reduction in routes and asset sales.

American Airlines, a unit of AMR Corp , has held talks with JAL over several weeks on forming a joint venture under which the two would share revenues on flights and offer business customers joint contracts, the source said.

The source, who has direct knowledge of the talks, spoke on condition of anonymity because the negotiations are not public.

JAL is also weighing an offer from Delta, a source told Reuters last week. According to Japanese media, Delta would inject up to 50 billion yen ($551 million) into JAL and wants a tie-up that would include code-sharing on international flights.

The proposed venture between American and JAL hinges on the enactment of an open skies agreement now being discussed by the Japanese and U.S. governments which would allow for close cooperation on flight scheduling and sharing of profit.

I'm not talking about hugs and kisses. I'm talking about economic value to Japan Airlines, the source said. What we've been talking about is actually expanding the relationship not just maintaining it.

JAL and American have had a code-sharing agreement for a decade and are both members of the Oneworld alliance, which pools frequent flyer incentive schemes. Other members of Oneworld are British Airways and Cathay Pacific Airways <0293.HK>.

A JAL spokeswoman declined to comment on specific talks with other airlines, including media reports that Air France-KLM may also look to invest in JAL.

We are looking at a wide variety of measures, and that may include tie-ups with airlines, JAL's Sze Hunn Yap said.

DEFECTION?

American is keen to preventing JAL from forming a tie with Delta, which became the world's largest carrier when it bought Northwest Airlines last year and could use JAL to increase its international footprint.

Delta operates a hub at Narita airport but is without a Japanese partner. It could try to get JAL to defect from Oneworld for the SkyTeam alliance, which along with Delta includes Air France, Korean Air <003490.KS> and Russia's Aeroflot .

In addition to the size of any capital injection, American Airlines will be pushing JAL executives to consider what they see as more compelling long-term economic benefits of joining hands with American as opposed to Delta.

These include less direct competition in Asia and a relationship that would be on a more equal footing, the source said, adding a senior executive would be in Tokyo this week to continue their discussions with JAL.

Delta, now that they've hooked up with Northwest ... have significant hub operations here in Narita. So the question is for JAL is would it end up being a junior partner to Delta, the source said.

JAL is headed for its second straight annual loss in its year to March 2010, hit by the global economic downturn and heavy fixed costs. It is due to submit a restructuring plan this month, a condition of a 100 billion yen state-backed credit line secured in June.

The airline is also considering raising an additional 250 billion yen by March to help fund restructuring, the Nikkei business daily reported on Sunday. That would include about 100 billion yen through an issue of new shares, the paper said.

Shares would help bolster its shareholders' equity ratio, which fell to 9.3 percent at the end of its first quarter on June 30, about half that of rival All Nippon Airways <9202.T>.

Any investment by American or Delta would likely serve as seed money that helps get other investors motivated, the source said, indicating other investors would be involved.

JAL also plans to ask aircraft makers, trading houses, investment funds and the Development Bank of Japan to buy shares, the Nikkei said.

Japan Airlines American Airlines