The year ended with most in the aviation industry expecting International Consolidated Airlines Group (IAG) to make another attempt to buy Aer Lingus after the Irish company's board rebuffed its first approach in mid-December.
News of IAG's interest caught the markets off guard, largely because the group's chief executive, Willie Walsh, who once held the same role at Aer Lingus, had several times denied that his operation was interested in buying his old employer.
Nevertheless, IAG approached Aer Lingus late on Sunday, December 14th, indicating that it was willing to buy the airline for somewhere over €1.1 billion. The board rejected this within days on the basis that it fundamentally undervalued the company.
While it should not be taken for granted, the industry was left believing that this was just the first round and that IAG, owner of British Airways and Spanish carriers Iberia and Vueling, would try again.
The sort of valuations tossed around in the days following the news indicated that a bid of €2.50-€2.60 a share would have a more realistic chance of succeeding. An offer in that region would value Aer Lingus between €1.34 billion and €1.39 billion. It floated at €2.20.
Whether Walsh and IAG would be prepared to go that far is a matter of speculation. However, there are a number of factors that make the Irish airline attractive to his group, which may justify paying the sort of price that would win over the board and the major shareholders, namely the Government and Ryanair.
Heathrow slots
The first is its ownership of 23 slots at London Heathrow Airport. If IAG were to get those, it would consolidate its dominant position in Europe’s biggest international hub. Sources suggest they alone could be worth about €400 million. On top of that, Aer Lingus should have net cash of almost €400 million, once it has paid €191 million as part of deal to end the row over its pension.
Ending that dispute, caused by a €750 million hole in the Irish Airlines Staff Superannuation (IASS) pension scheme, would add to its attractiveness, as it rids Aer Lingus of a permanent industrial relations problem and a potential liability that analysts argue acts as a drag on its real value.
That value is tied to its day-to-day business. Aer Lingus’s actual operations are likely to have delivered a profit of more than €60 million in 2014. Its short-haul business is holding its own but its transatlantic arm is expanding. Passenger numbers on it had grown by 18.7 per cent to 989,000 by the end of September. Fare revenue from those long-haul operations was up 25 per cent at €374 million over the same nine-month period.
In 2014, the airline increased its transatlantic capacity by 28.8 per cent. In the first nine months of the year, that had translated into 24 per cent higher passenger volumes. In the third quarter, the airline sold 92 per cent of the available seats on those services, meaning that on average it almost filled every single craft during that time.
Long-haul services
Part of this growth is coming from regional airports in Britain, where Aer Lingus has been selling its transatlantic services from Dublin as a viable alternative to going through Heathrow. The strategy of feeding passengers from there into long-haul services from Dublin crystallised in 2013. The indications are that so far it is working. Around one third of those flying on its long-haul services came from Britain or the continent in 2014.
Outgoing Aer Lingus chief executive Christoph Mueller told the Future of Air Transport conference in London recently that the airline plans to continue growing its transatlantic services and is very confident that it can fill the extra capacity in 2015. He also pledged that the airline would continue to be the cheapest flying the Atlantic, at around 30 per cent less than any other.
Of course Mueller is not going to be around to see it. He is leaving to take the helm at Malaysia Airlines. He announced his departure – but not his destination – in May. By the time of the IAG approach, chief strategy officer Stephen Kavanagh, architect of Aer Lingus's revived transatlantic business, was seen as the frontrunner in the race to succeed him.
While Mueller is leaving, Michael O’Leary, his opposite number at Ryanair, Aer Lingus’s biggest rival and shareholder, is committed to staying for another five years. He was never really expected to go, but there were high-level changes around him that sparked some speculation.
Early in the year, deputy chief executive Michael Cawley, a long-time O'Leary lieutenant, retired. He is now chairman of tourist body Fáilte Ireland. Head of finance Howard Millar subsequently announced his intention to leave the company. His deputy, Neil Sorahan, is replacing him.
Ryanair also hired its first chief marketing officer, Kenny Jacobs, who is now responsible for a lot of its communications and whose appointment early in the year signalled that the airline's conversion to customer service was as much about winning new customers as anything else.
While Aer Lingus stole the headlines towards the end of the year, Ryanair’s regained momentum was a recurring theme in 2014. It issued two profit warnings in 2013/14. Its actual profit for the 12 months ended March 31, its financial year, was 8 per cent down at €523 million, the first such fall it had reported in five years.
Its latest forecast for the current financial year is for profits in the €750 million-€770 million range. That is based on forward booking trends and its first-half performance. The airline is putting the renewed growth down to its success in winning new customers. It is chasing business travellers in particular and is moving increasingly into premier airports, taking up slots vacated by flag carriers, which are pulling back from short-haul.
It has recently opened new bases at Athens, Brussels Zaventem, Lisbon and Rome Fiumicino, as well as Cologne, Gdansk and Glasgow. It also says that apart from Heathrow, Charles De Gaulle in Paris and Frankfurt Main, all others are on the table.
Ryanair is now doing what it had intended doing with Aer Lingus, if any of its three bids for the airline had succeeded. O’Leary recently acknowledged this and indicated that his company’s interest in taking over its rival had waned.
It is still challenging a ruling by the UK's Competition and Markets Authority that it must reduce its 29.8 per cent stake in Aer Lingus to 5 per cent. The British Court of Appeal is due to rule on that in the new year. Whatever the result, it looks sure to involve further legal tussles. A reasonable IAG offer could look good in light of this.
If that offer materialised and Ryanair were to accept, that would in all probability leave the State's 25 per cent stake between IAG and ownership of Aer Lingus. Minister for Transport Paschal Donohoe has said the Government's position is that it will sell only when "market conditions are favourable and on terms and at a price that are acceptable".
Only the Government can tell us what those terms are. However the fallout from a takeover could include the loss of jobs, a ceding of control over those Heathrow slots and the potential for some unforeseen consequences. It could spark a political crisis, something the coalition will not want with an election looming. A lot of people will be watching IAG’s next move very closely.
