6 Essential M&A Cases: BA & Iberia Merge to Form IAG

This M&A briefing note provides an overview of the merger of British Airways and Iberia which led to the formation of a new firm - International Airlines Group (“IAG”)

Background

- BA and Iberia had developed strong links over many years:
- BA acquired a 13% stake in Iberia in 1998
- BA & Iberia started co-operation and route-sharing in 2003
- BA first made a bid for Iberia in 2007
- Impact of the continued economic downturn led to the resumption of merger talks in 2009

The Deal

The initial announcement:

- Merger of British Airways and Iberia announced in November 1999.
- BA shareholders get 55% of the new company; Iberia shareholders get 45%
- BA and Iberia to continue their existence as airline brands
- New company called IAG plc, with shares listed on both the London and Madrid stock markets
- IAG initially estimated £349 million of annual cost savings by the fifth year after the merger
- A quarter of the cost savings to come from IT and back office efficiencies + savings on maintenance and purchasing
- Implementation cost of the merger estimated at £350 million.

The final merger agreement

- Definitive (legally binding) merger agreement finally signed in April 2010:
- Merger details took two years of complex and often strained negotiation
- Creates Europe’s third-largest airline group: behind Lufthansa (90 million passengers p.a.) and Air France-KLM (70 million passengers p.a.)
- Combined scale would have an aircraft fleet of 408 planes, carrying more than 58 million passengers a year
- Willie Walsh (previously CEO of BA) to become the new CEO of IAG
- On the day that the shares of IAG first traded (Jan 2011), the market capitalisation of the firm was £5.6bn

Key motives and drivers of the merger:

- Very much a merger that looks to the long-term.
- Industry consolidation - a process that has already begun and is expected to continue over the next 10-20 years
- 2010: combined airline losses (whole industry) of almost $3bn in 2010
- BA and Iberia seen as well-matched businesses that complement each other
- BA strength: North American & Asian routes and destinations; Iberia strength: Latin America
- BA gains better coverage of key routes in Latin America
- Structure designed to allow IAG to participate in “further consolidation” (i.e. more takeovers)
- Further takeovers by IAG would be judged on whether they could meet or enhance a target of 12 per cent return on capital.

What happened next?

IAG takeover of British Midland International (BMI)

- Announced November 2011
- BMI - a loss-making subsidiary of Lufthansa (losing approx £160million per year)
- Deal subject to clearance from the Competition Commission and the European Union
- Significant opposition from Virgin Atlantic - the main competitor affected by the deal
- Main rationale - BMI’s extensive landing slots at Heathrow - which will be used to add British Airways flights to destinations in emerging markets
- A possible short-term drawback to IAG: the takeover adds to the groups capacity at a time of weak demand for air travel

The main risks facing IAG

- Unforeseen external events (e.g. disruption to travel caused by volcanic ash)
- Industrial relations - a constant thorn in the side of management at BA & Iberia
- BA’s pension fund liability - a shortfall of £3.7bn
- The global economy - demand and profits closely linked to the global economic cycle

Key quotes relating to the merger

Prof Peter Morrell (Cranfield University):

“They’ve come up with various cost savings that they can get out of the merger of the companies. These are on things like procurement, IT, maintenance. These are the things they can get from a merger which aren’t really available from alliances.”

Ashley Steel, head of transport at KPMG:

“the creation of IAG heralds the start of an exciting era of airline consolidation, with further marriages of convenience as pressures on costs and revenues continue to increase.”

Willie Walsh on the day the merger was confirmed:

“Our goal is for more airlines-but, importantly, the right airlines-to join the group. Today is the first step towards creating a multinational, multi-brand airline group.”