If you’ve ever felt the urge to chuck it all in and fly to Rio, you might want
to do it now. Thanks to the £4.6 billion merger between British Airways and
Iberia unveiled last week, BA will at some stage over the next few years
stop flying to the Brazilian city — and to Sao Paulo and Buenos Aires, other
South American destinations on its network.
Instead, London passengers who want to experience the delights of carnival
will have to make a stop in Madrid and change to an Iberia plane. This
rejigging of the network is one of the driving forces behind the merger,
contributing part of the €400m (£358m) a year the companies plan to generate
by pooling their operations.
There was a sense of déjà vu about last week. The two airlines first announced
the deal 14 months ago, but negotiations became bogged down by the
recession, which battered both their share prices, and uncertainty over BA’s
large pension deficit. The talks got going again a few months ago, when a
new management team, led by chairman and chief executive Antonio Vazquez,
arrived at the Spanish carrier.
Willie Walsh, BA’s chief executive, told analysts the appointment of Vazquez
was the key moment. “He brought a new energy and a lot of enthusiasm to the
talks. We were able to deal with a lot of the complex issues around
governance and structure, and make a lot of progress early on. Before that
we had been stuck in a bit of a rut.”
The combined group will be the world’s sixth-largest airline as measured by
revenue (£13.4 billion a year) and Europe’s third biggest behind Lufthansa
and Air France/ KLM. It will have 418 aircraft, serve 205 destinations and
carry 62m passengers a year.
Thanks to the airline industry’s odd legal structure, with route rights
governed by questions of sovereignty, the BA/Iberia tie-up is quite a
different beast to a normal City takeover. It is modelled on a similar
merger engineered five years ago between Air France and KLM. The BA and
Iberia brands will stay, as will the separate operating companies, with
separate boards. The companies will only come together at the very top
level, with the creation of a new holding company that will own all the
shares in the two airlines.
Shares in the holding company will be listed in London, with a possible
secondary listing in Madrid. Walsh will be chief executive. The current
investors in BA and Iberia will see their shares converted into holding
company shares, with BA’s owners taking 55% of the merged company. To add to
the complexity, there will be separate “national interest” companies that
will own majority voting rights in the two airlines. This should stop either
airline losing its route rights because they are no longer controlled by
nationals of the home country.
BA has been on the hunt for a big deal for most of the past two decades.
Acutely aware of the airline’s reliance on a single airport, Heathrow,
successive chief executives have sought merger partners. It has looked at
deals with (among others) US Airways, United Airlines and Air France, and
more recently talked to Qantas and to airlines in India. Analysts say the
lack of synergies from the merging of the two networks — apart from BA’s
Latin American routes, there is little overlap — shows that BA had started
to run out of options. “It’s not easy to see what other option they had,”
said Douglas McNeill, transport analyst at Astaire Securities.
The attractions to shareholders come from the €400m a year in synergies the
two companies are promising. Two-thirds will come from cost cuts, with the
combination of back-office functions and elimination of jobs, and one-third
through network rationalisation and extra sales.
Walsh said the certainty about the synergies was key to winning shareholder
approval, rather than the size of the stakes being taken by the two sides.
“The merger ratio was never really the big issue, in my view. Shareholders
were much more interested in whether we would be able to get a deal where we
could guarantee synergies. That was really what they wanted, both here and
in Spain.”
The deal was also about growth, he said. BA had identified three or four more
destinations it wanted to serve in North America, and other potential
destinations in Asia. While it didn’t have the runway slots at Heathrow to
start services now, a link with Iberia would free up space at the London
airport by allowing BA to shift some services — like those to the Latin
American cities mentioned previously — to Madrid.
“We will be able to focus the two hubs where they are strongest,” said Walsh.
“For London, that means North America and Asia, and for Madrid it means
Latin America. We will make decisions about services that are in the
interests of the combined entity.”
There was also the prospect of other deals, as the international airline
industry continued to consolidate. “I wouldn’t rule out another deal in
Europe,” said Walsh. “And I would include BMI [the UK airline that is the
second-biggest player at Heathrow] in that, if Lufthansa decide they want to
sell it.”
One large obstacle still remains. Iberia has retained the right to walk away
if BA is unable to conclude an agreement with the trustees of its retirement
schemes on how to fix the group’s yawning pension deficit. Actuaries are
putting the final touches to a triennial valuation of the two schemes, with
some analysts expecting the final deficit to be more than £3 billion, more
than BA’s stock-market value.
The figures is likely to be made public before the end of the year, with BA
facing a statutory deadline of June to agree a way of solving the pension
problem. If it is not happy with the arrangements, Iberia could withdraw.
Walsh has another, more immediate problem, in the shape of a dispute with
cabin crew. The airline wants to cut the equivalent of 2,000 out of 14,000
jobs through voluntary redundancies and part-time working, to take one crew
member off many flights, and to introduce for new staff a fresh employment
contract with inferior pay and conditions.
Unite, the trade union that represents flight attendants, will begin a ballot
for industrial action tomorrow, raising the prospect of disruption to
flights at Christmas. If that were not enough to contend with, American
regulators are expected to give their long-awaited verdict on a commercial
alliance with American Airlines within the next few weeks.
Analysts say BA’s management faces a long list of challenges, but that the
agreement with Iberia at least gets one out of the way. Andrew Lobbenberg,
an analyst at Royal Bank of Scotland, wrote: “There is a feast of catalysts
imminent that have binary outcomes. A whole loaf’s worth of thick buttered
toast is currently spinning through the air.” After the Iberia deal was
announced, he said: “The first piece of toast has hit the floor
buttered-side up.”
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