One of the benefits of the unity coalition deal that Bibi Netanyahu struck with Shaul Mofaz and Kadima is that it strengthens Likud. Kadima’s dropping poll numbers and its new participation in the coalition mean that it will likely merge back with Likud before the next elections, which sets up Likud to gain more seats in October 2013 than it would have in September 2012. From an electoral standpoint, Likud is poised to come close to its 1981 highwater mark of 48 seats if Kadima dissolves and it is in an extremely strong position.
From a structural standpoint, however, Likud is not doing so well. Netanyahu presides over a fractious party that contains a serious split between the older generation of Likud princes and the younger generation of hardliners. Bradley Burston noted the sharp change in tone from previous Likud conventions, in which the head of the party was treated like a king, to Sunday’s Likud convention packed with mutineers who excoriated Netanyahu for not being sufficiently rightwing. Bibi was unable to even secure the position of convention chairman, and it must be a haunting irony for him that he strides the Israeli world like a colossus but cannot manage to impose the same iron will over his own party. Potential challengers like Moshe Feiglin and Danny Danon attack him on his right flank and make all sorts of veiled threats over perceived insufficient support for settlements, keeping Barak in the cabinet, and other issues on which Netanyahu is believed to be wobbly and not fully trusted. It is a maxim of Israeli politics that it is the right that brings down the right, and surely this is a fate that Netanyahu does not want to suffer, explaining his current flirtation with a bill that would override the High Court’s order to demolish Ulpana. Part of bringing Kadima into the government is that Netanyahu will have some space to maneuver should he want to tack to the center on selective issues.
Ultimately though, Netanyahu is going to face a choice over how far to go to placate his hardliners, and that may come sooner rather than later as the High Court’s Migron and Ulpana orders come to call. In light of all this, I will not be shocked if at some point before the 2013 elections we see Netanyahu move to kill off his own party and form a new one. This move is of course not without precedent in Israeli political history; Ben Gurion did it when he felt he had insufficient support from his Mapai colleagues leading to the creation of Rafi and then Labor, and more recently Ariel Sharon did it when he broke away from Likud to form Kadima in order to carry out the Gaza disengagement. Netanyahu is in a similar situation to Ben Gurion in that he clearly does not have an ideal level of support within the Likud ranks, and if he decides that he wants to make a serious move toward peace with the Palestinians he will find himself facing Sharon’s dilemma as well. Netanyahu is also now perfectly poised to form a new party from a position of strength since he would take all of the Kadima members with him should he bolt Likud to form a new party and would take more than half of the Likud MKs as well.
I don’t think this is something that anyone should expect to occur as it would be a huge gamble, and Netanyahu is historically not a gambler. The deal with Kadima though demonstrates a newfound propensity toward bold moves, and creating a new party would eliminate the various Likud thorns in Netanyahu’s side. I think the salient question on this issue is how serious Netanyahu is about making real strides on a Palestinian state. As I have noted before, Netanyahu is in many ways a prisoner of his party and his coalition. He has now solved the latter problem, but has not solved the former one. If Netanyahu does indeed have some more moderate inclinations aching to escape, then cutting off his rightwing flank and forming a new party is the obvious, and maybe only, move to make. Again, this is all theoretical at best and a little too pie-in-the-sky to probably occur, but given the utter surprise that greeted all analysts of Israeli politics on over the past two days, nothing can or should be ruled out anymore.
Ottomans and Zionists 
Why form a new party over just bolting Likkud for Kadima outright? In some ways he would be able to leverage Sharon’s legacy while very clearly stating his intentions/positions on various key issues (i.e the Haredi situation, settlements and the peace process and national security). It also would not seem as if he would be embroiled in a real fight for party leadership even if Mofaz, or even Lipni, decided to try to gain control of the new look Kadima.
It would be a strange move for Bibi to make given that be broke with Sharon over the formation of Kadima and refused to come along with him. Kadima is also somewhat of a damaged brand at this point.
But isn’t the damage to Kadima primarily a function of the absence of Sharon and a lack of identity in his absence? On Bibi and Sharon, since Sharon is not in the picture it would seem as if the previous history wouldn’t be such an issue given that ego would be the primary driver. Sharon and what Kadima represented under him, I believe is still a popular notion amongst the general public. It would appear that Netanyahu defecting to Kadima would give it that identity again, as well as send a positive signal, assuming he is now fairly aligned with the vision that Kadima represented back in the middle of the last decade. Since as you stated almost all of the Kadima MKs would follow him to a new party, which in and of itself speaks to Bibi’s shift over the past 7 years, I guess I just don’t see the issues you laid out as being major barriers.
It may just be my perceptions but it seems as if there has been much more party instability in Israel over the past few years in regards to the dominant parties fading to some extent and influential politicians forming new parties, sometimes with the intention of being a single person party. Given that, I could see an added benefit of Bibi utilizing an established major party. Again though, party continuity and stability may be totally irrelevant to Israelis and Israeli politics, as this last thought is bot based on any credible set of facts.