A British-Spanish Merger

British Airways and Iberia have reached a preliminary agreement under which the two airlines would merge into a single company by late 2010. The new airline group would have 419 aircraft and fly to 205 destinations.

The combined airline group would continue use the existing British Airways and Iberia brands and primarily operate out of the carrier's current hubs in London and Madrid. A new holding company currently referred to as "TopCo" will be established as a Spanish company in Madrid. The majority of board meeting and all shareholders meetings will take place in Madrid. As at completion of the merger, TopCo will be tax resident in Spain. The operating and financial headquarters of the combined group will be located in London, which shall contain the principal management functions of the combined group. A further management office will be located in Madrid.

British Airways shareholders will hold 55 per cent of TopCo and Iberia's shareholders will hold 45 per cent. The combined business will be led by the group CEO, Willie Walsh, and a management team chosen equally from each airline.

Annual synergies of approximately €400m at budgeted exchange rates are expected by the end of the fifth year after the completion of the merger at a cash cost of up to €350m. The synergies will be incremental to the existing value from the airlines' joint business between the UK and Spain. Approximately one third of the synergies are expected to be revenue related (joint selling, network and revenue management benefits) with the balance coming from cost synergies in areas such as IT, fleet, maintenance and back office functions.

In 2008, British Airways and Iberia carried 62 million passengers and, in their last financial years, their joint revenues are approximately € 15 billion.

Both airlines have been loosing huge amounts of money during the economical downturn.

A British Airways Boeing 747-400 approaching Hong Kong

Eager to merge

Especially British Airways has been eager to merge with another carrier for a while now. There was a proposed tie-up between BA and American Airlines on Atlantic routes as well as a merger plan which was discussed with Australian Qantas. However, all these previous negotiations and propositions didn't lead anywhere. They were either shot down by competitors or just didn't win investor's confidence.

Both airlines have been merger candidates for years and have been in discussions for some time. They're already partners in their Oneworld Alliance and their networks fit together quite well.

An Iberia Airbus A319 in Geneva

Network potential

British Airways' growth potential at its base London Heathrow is limited. The airport is certainly a very valuable asset on BA's side, but due to capacity constraints and increasing competition, the potential is limited. Even after the recent opening of Terminal 5 and the proposed third runway, the airport is not able to handle a lot more traffic for the foreseeable future. To grow, British Airways is in desperate need of strong bases, in the UK and elsewhere.

Madrid on the other side is offering many opportunities on the capacity side. The airport is well positioned as Europe's prime gateway to Latin America and compared to London Heathrow, slots are still in ample supply. It is therefore fair to assume that the combined BA/Iberia will use Madrid for further growth. This could also mean that some established routes would be transferred from London to Madrid, mainly these to some Latin American destinations. Freed up slots at Heathrow could then be transferred to new flights with a higher yield potential.

However the network structure will look like, the main bases are attractive ones, for totally different reasons. There's London Heathrow on one side, massively congested but a real cash-cow and on the other side Madrid, an airport with lots of potential and well established geographic strengths.

Even though the network structure looks quite interesting, it's a bit early to start redeploying routes and planes. There are other obstacles which need to be taken first. The deal needs to be approved by the European Commission and British Airways needs to resolve a few internal challenges.

It's mainly the current discussions about pension funds which the UK carrier needs to resolve. Iberia will be entitled to terminate the merger agreement if the outcome of the discussions between British Airways and its pension trustees is not satisfactory.

At the moment, the two carriers do not see this as a insurmountable obstacle. British Airways and Iberia expect to present the transaction for shareholder approval at the latest in early November 2010 with completion expected to occur approximately one month following such approval.

Michael Meier