This case study seeks to explore why M&A is taking place between British airways and Iberian airlines, taking into consideration “globalisation, rationalisation and modularisation.”
Introduction
British airways are U.K incorporated airline firm and is known for its world-class services in the airline industry. It was formed in the 1970s as the result of a merger between BOAC (British Overseas Airways Corporation) and BEA (British European Airways).From the past three decades British airways has been the flag career airline of the United Kingdom. The main headquarter is located near to London Heathrow Airport. British airway’s is the largest airline in the UK based on the size of its fleet, international flights and international destinations.
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On the other hand Iberian airlines are Spain based airline firm and are the country’s largest air transport group and the fourth-largest in Europe. Iberia is listed in the Ibex 35 of Spanish stock market. It is the only European Airline to report a profit continuously till past 13 years and one of the three airlines to be listed in Dow Jones Stock index. In addition, the company carries its social responsibility in a better and a distinguished manner.
From the year 1927 the airline is operating its business successfully and conducts mainly three operations:
Transport of passengers and cargo
Aircraft maintenance
Handling services in airports
Both the airlines firms have had their share of success but are now facing a number of industrial problems due to recession and globalisation.
Problems of the companies
There used to be a time when British airways (BA) was said as “the world’s favourite airline”, as its banners conceitedly confirmed. However, taking the present economic scenario BA is undergoing a number of problems in the industry. British airways are still struggling with the legacy of state ownership even after it has been privatised for last twenty years. Even recession has hard-hit the airline industry and to overcome the losses that British airlines had faced during recession; it had decided to cut down on its cost by reducing cabin crew and by discouraging an increase in the salary. However this acted as a catalyst in the industrial disputes and the effect of which is still very much felt in the daily business of BA; there have been a number of deadlocks and strikes within the airlines which have left passengers to decide on for other airlines.(ECONOMIST, 2009).
Due to economic crisis business coming from North American routes was hard-hit due to a fall in the business-class travel. However, this could be recovered with the recovery of American economy as well as reviving the long-haul travel which makes a major part of BA profits. One of BA’s major problems is “Pension Deficit”. BA has also been facing tough competition from low-cost airlines that have been providing customers with cheaper fares on short-haul travel.
So, the only cure to overcome such losses is seen in creating or teaming up with a low cost partner. (ECONOMIST, 2009)
Iberian airlines have been suffering from lower air cost travel demand as well. It has reported a trouncing of 16.4 million euro in the third quarter compared to revenue of 30.4 million euro earned in the earlier quarter. The standard fares of this airline have declined by 14% and even the load factor i.e. how filled the air-crafts are, declined to as much as 1.1% points to 82.1%. To cope up with the credit crunch it has decided to freeze the wages for 2010 and 2011 thus enhancing annual savings up to 37 million euro by 2011. It also plans to create new airline to cater to the needs of the traffic of Madrid Hub. (MENAFN, 2009)
British airways decided to join hands with Iberian airlines as a result of credit crunch. By coming together they would come in the league of big European airlines. The merger with the Spain based airlines was looked upon as an appealing blend a year ago. However, taking the present state of affairs it seems to be worth a joint rescue process. This is so because both of their airlines economies are still under the influence of financial crisis; struggling with costs higher than the income.
Iberia is still not moved by Mr. Willie Walsh’s, chief executive of BA, disagreements with the union. It still holds optimistic view towards BA’s major problem of “Pension Deficit”. However if we consider the articles or the memorandum of the merger which was signed in November ’09 between the two companies, Iberia has the right to call of the contract if BA is unable to meet up to the requirements of the trustees concerning the two pension funds. As recalculated on December 14th ’09 by the trustees, the shortage of the two funds was declared to be at £3.7 billion, based on March 31st ’09 valuation. Presently BA is putting in cash worth £131m a year. The Pension Regulator is helping to conclude whether the valuation performed by the trustees is satisfactory or not and what further actions are required to overcome the credit crunch. In this context, Iberian airlines say that it can decide to call of the deal if BA lands up paying more cash. (ECONOMIST, 2009)
Airlines mergers and acquisitions are based upon strategies which involves several conditions. Airlines M&A is beneficial for both travellers and airline employees. The issues which are considered while aviation M&A are “time, approvals, efficiency, competition, passenger benefits, and conflicts.”
Mergers and acquisition in airline industry is an emerging development across the world. But such M&A are extremely planned and several important factors are considered. Such important factors are:
The area covered by the airline
The services and image of the airline
Partnership of the airline with a rival group of airlines.
Merger: A strategic plan
The BA and Iberia pact will create a carrier of $25 billion, for instance. This deal makes a lot of sense and will cement the leading positions of the big three European network players. The merger seems to take place when the airline sector is badly hit by the decrease in number of passengers and cargo traffic. Apart of that the merger became the need of the hour, British airways reported a 20% decline in revenues to 4.1 billion pounds resulting in an operating loss of 111 million pounds in the six month period ending at September 2009. According to analyst Tony Shepard at the British brokerage firm Charles Stanley, the company is likely to report a 400 million pound loss for its full fiscal year ending in April 2010.
British airways important North American routes and business have been hard hit by the collapse in business-class travel. This could bounce back quickly with economic recovery in America and, provided that cost increases from environmental measures are not too onerous; the long-haul travel on which BA’s profitability depends should revive in time. But, like all former national carriers in Europe, it is facing devastating competition on its short-haul flights from low-cost airlines. .On the other hand the merger is definitely in need by Iberia also as the airlines faces hardships because airline sector in Spain is facing “exceptionally difficult” conditions amid the economic crisis and competition from high-speed rail. Iberian airlines financial position is quite weak as the company had plunged into the red in the second quarter of 2009, recording a huge net loss of 72.8 million Euros. Afterwards the company declared its third quarter results where it reported a loss of 16.4 million Euros (24.4 million dollars. Due to such extreme losses and no signs of recovery in the market, the merger was seen as a best strategic move by Iberia. The planned merger with Iberia, the Spanish airline, looked as if it would be a winning combination a year ago when it was first mooted. Today it seems more like a mutual rescue operation. Both airlines’ national economies are still in the doldrums; both firms are struggling with costs greater than their revenues. It is also reasonably sanguine about BA’s other big problem: its enormous pension deficit. But according to the merger memorandum signed, Iberia can call off the wedding if BA cannot reach a satisfactory agreement with the trustees of its two pension funds. As on 9th November 2009 there was an official announcement that both of them (British airways and Iberian airlines) reached an initial agreement for a merger which is planned to be completed by late 2010.As per the market this merger, which will need the European Commission’s seal of approval, will lead to the creation of the world’s third biggest airline. The deal would see the new company being split with Iberia being allocated a 45% stake and BA the remaining 55%. The new business would have 419 aircraft and over 200 destinations. In their last financial years, their joint revenues are approximately €15 billion. The airlines believe there is a compelling strategic rationale for the transaction, which is expected to generate annual synergies of approximately €400 million, and benefit both companies’ shareholders, customers and employees. The new group will combine the two companies’ leading positions in the UK and Spain and enhance their strong presence in the international long haul markets, while retaining the individual brands and current operations of each airline. In July 2008 there was news of pair being in talks for an all-share merger. But, because of issues such as the balance of control and the size of BA’s pension-fund deficit the discussions were put at a stop.
Market situation
As per the current market scenario passenger traffic appears to have stabilized, and airlines have been able to convince their workforces that the industry is in crisis, pushing through some labour concessions and reducing capacity. BA is making “genuine progress” in lowering costs, says analyst Nick Cunningham of Evolution Securities. As per the British airways ongoing activities it seems the situation of the company has started improving after announcement of the merger, the company has recapitalized; following a convertible bond offering over the summer last year and now has a cash balance of 1.5 billion pounds. In addition the company has seen an increase in long haul flights which is one of the major areas where airline companies make most of the profit. But still after all the positive changes British airways still face a number of issues related to their workforce.
Competitors in the market have a very mixed reaction towards the merger of both the airline. Virgin Atlantic which as per the market view faces the biggest competition from this merger its official said in a statement that the merger will “increase BA’s dominance at Heathrow with 44% of takeoff and landing slots this winter,” and added its “impossible for any other airline to replicate their scale.” Other airline companies have the view that the deal could actually help them win business. Michael O’Leary, CEO of discount Irish carrier Ryanair, told CNBC that the deal was like “two drunks holding each other up on the way home. All you get when you put two high-fare, loss-making airlines together is even higher fares and even bigger losses. Mr. Leary operates a regional carrier and doesn’t compete on long-haul flights against carriers like BA. Though these statement can be said as speculation in one sense as the true effect of this merger is still to be seen. But as per in a public announcement by BA chief executive Willie Walsh “The merger will create a strong European airline well able to compete in the 21st century”. The deal would create Europe’s second biggest airline by stock market capitalisation, and third biggest by income, with around 60 million passengers per year, As per market experts. The Times quoted various news on different dates regarding job cuts which were likely at existing head offices in London and Madrid, in maintenance facilities and the merged sales forces. In review of news Mr. Walsh will be chief executive, and Iberia airlines chairman Mr. Antonio Vazquez will be chairman of the new company to be based in London and listed on the London Stock Exchange.
MR.Vazquez hailed the agreement, saying they were “laying the foundations of what will be one of the most important airlines in the world, a real global airline.”It is said that if the merger results fruitful and the economy begins its recovery in 2010 or maybe 2011 then it will be a major boost to both of them. One thing can be predicted that If the deal gets successfully executed the customers are going to have a wide variety of destinations as BA customers would gain access to up to 59 new destinations, of which 13 will be in Latin America, while Iberia’s customers would gain up to 98 new destinations across the BA network. In addition to it the effects of merger will result in combined stock market capitalisation of some 4.9 billion Euros (4.3 billion pounds, 7.2 billion dollars).
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Ways to deal with problems
British Airways, the UK flag-carrier pension deficit was revealed and it was found that the deficit was more than double amounting to 3.7 billion pounds at the end of March, which was higher than analysts expected but it is not a bug enough to be a reason for ending up of the merger with Spanish airline Iberia. As told to Reuters by a source in Iberia airlines “We’re not surprised by this figure. It falls within the expected range,” As it is already implied before, BA’s pension deficit is the crucial area in the negotiation of merger and Iberia has the right to pull of the merger if the payment of this deficit turns to be too big. Moreover, there are chances that the deficit figure could arise till the time the valuation process is completed in next year in June because as per Britain’s Pensions Regulator the assumption which is used to calculate the deficit are too optimistic. In view of this BA said in a statement “The regulator’s provisional view is that the technical provisions may be materially below a level it feels appropriate,”
As per the problem the British airways management is trying to figure out different ways to solve the problem. As per in one of the announcements BA said that the company and the pension trustees will work together to develop a recovery plan, a process through which the company will consult its employees and their trade unions and will try to take out a decision from it by the end of June 30, 2010. The strategy which is employed now is to change the nature of any pension’s deal BA can strike with its staff and calculating the proportion of gap which can be covered by the company. As said by Deutsche Bank “The Company may be forced to renegotiate pension benefits with employees if it is to avoid using more shareholders cash,”
Merger: Theory & Practice
The reality that only 20 per cent of the acquisitions actually succeed and the rest erodes shareholder wealth (Grubb and Lamb, 2000) can highly contravene with examples of successful takeovers like Swiss by Lufthansa in 2005.Talking about mergers, they create shareholder value with most of it accruing to the resultant company. One of the important reasons behind merging a company is that it helps in increasing shareholder’s value much above the sum total of the two companies.(Watson and Head,2007)
The optimistic impact of mergers extends to and involves economies of scale or synergies, helps to gain power in the markets by creating monopolies, manages agency costs and manages risk for undiversified managers ( Gregor Anrade, Mark Mitchell, Erik Stafford, 2001).
Mergers create synergies, reduce operational costs and enhance market share. On the other hand it results in the genesis of agency problems as the managers can cause mergers for their own benefit. It also results in decentralisation of power that reduces responsibility and accountability. Merger which can be defined as when two (or possibly more) business combine. In other words one can say that ‘merger’ is defined as a situation when two companies/firms decide by mutual agreement to combine the businesses. The term ‘takeover’ holds a different meaning in comparison to ‘merger’. It means when a larger business takes over control of a smaller business and the smaller business gets immersed by the larger business. But in today’s era it is not cleared that whether the business has been merged or it has been taken over.
According to the relationship between the businesses being merged, mergers and takeovers can be divided into three parts and they are :
Horizontal merger occurs when two businesses in the similar industry, and at the
Same point in the production process decides to combine.
Vertical merger occurs when two businesses in the similar industry, but at different
points in the same production process decide to combine.
Conglomerate merger occurs when two businesses in unrelated industries decide
to combine.
As it can be implied from the academic studies supporting the article the merger between British airways and Iberia airlines is Horizontal type of merger as both the companies are from the airlines sector leading to same production process and they have got high presence at international level.
According to research, the last few years weren’t an acceptable period for the air line industry as a result of rapidly increasing fuel costs and due to economic downturn. Airline mergers and acquisitions have clustered and most of the airline bosses exclaimed “consolidation is inescapable”. The prominent examples of merger and acquisition in the industry are Air France – KLM in 2003, Swiss- Lufthansa in 2005, US Airways-America West in 2005 and Delta- Northwest in 2008. The Europeans lead the way in establishing mega-carriers. By revenue Air France-KLM is the world leader with $34 billion, followed by the Lufthansa Group at $30 billion. (The Mating Game. Airline Business, 02687615, Jan2009, Vol. 25, Issue 1). At the same time, US Airways and America West merger drained their expenses by over $250 million a year and created a company better able to weather $100-a-barrel oil. US Airways, the nation’s fifth-largest carrier–earned $427 million on revenue of $11.7 billion. (A Cautionary Tale for Airline Mergers, Palmeri, Christopher, Business Week; 3/17/2008)
Therefore it can be determined that mergers and acquisitions had sustained airline industry during the economic downturn achieving significant synergies and economies of scale.
Although the mergers and acquisitions prevented air lines from liquidation, adverse impacts can also be emphasized. Even US Airways exists bankruptcy; the expanded company still face the internal struggle of affiliating two separate airlines. The main obstacles are employee dissatisfaction and customer complaints (A Cautionary Tale for Airline Mergers, Palmeri, Christopher, Business Week; 3/17/2008 )
However the world’s airlines are forming themselves into huge alliances. Does this matter? Yes: the risk is that the airline industry is moving from one extreme and it’s time to worry about the competition.
Conclusion
According to our studies and research it can be seen the airline industry has been hit by the economic downturn. They struggled with the cost hikes higher than their incomes. Both the airlines have been faced by the problems of industrialization and globalization, the competition of other airlines such as low cost airlines and rail services like Euro Star. Most of the airlines restructured and merged and gave them a competition as well.
Pension black hole is one of the main current problems occurring in the British airways and some of the analysts say that they need more time to recover from the deficit than their estimated time of 2016.(in practice)Longer time is required for the closure of the deficit according to some analysts. But in the situations of cash in hock the company can consider making non-cash contributions such as non-monetary incentives instead of cash. If the company utilizes its assets for pension funds it might cripple the company with the same forces reducing its net worth. The impeccable size of the deficit is not known by the BA and at the same time they have released before announcing the recovery plan the size of the deficit effectively.
However, airline and trustees are now working together to develop a recovery plan to negotiate with employees and trade unions. Unless and until BA manages come up with a solution to determine the pension deficit the merger will remain unsettled.
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