One month ago, International Consolidated Airlines Group (IAG) first approached Aer Lingus with a takeover proposal. Despite the airline's board rejection of that and a second indicative offer, worth almost €1.3 billion, a third is believed to be on the way.
As well as the inevitable impact on Aer Lingus shares, the news sparked a wave of speculation about the motivations of both IAG and its chief executive, Irishman Willie Walsh, who once held the same role at the airline his employer now wants to buy.
IAG already owns BA and Spanish carriers Iberia and Vueling. There are two theories for its interest in Aer Lingus. The original was that it wants to get its hands on the airline’s valuable slots – take-off and landing rights – at London’s Heathrow Airport. Aer Lingus has 24 of these, worth a possible €400 million. Acquiring them would give IAG control of over 55 per cent of available slots at Heathrow, where space is at a premium.
These constraints gave rise the to the second theory, that IAG sees Dublin Airport as a proxy for a third runway at the London hub, which is unlikely to get such a facility for at least a decade, if ever, leaving no room for expansion in the short term.
In reality, both theories probably explain part of IAG's thinking. Stephen Furlong, analyst with Dublin stockbrokers Davy, believes the group wants Aer Lingus because it has room to grow. "Their [IAG's] long-term growth plan is 3 per cent to 4 per cent a year," he says, "but it's nearly all coming from Iberia and Vueling. BA is only growing at 2 per cent and each year it is going to get harder to add to that."
Dublin has grown to become Europe's seventh largest transatlantic hub, with more than 750,000 passengers from Britain and Europe using it to transfer to flights to North America last year. That was one in every three of those who travelled through the airport to the US and Canada.
Much of this is down to Aer Lingus taking traffic from under BA’s nose in Scotland and the English regions, aided by the useful selling point that Dublin offers US customs and immigration pre-clearance. As a consequence, the airline’s transatlantic business grew more than 20 per cent in 2014 and it is adding more capacity this year.
Furlong says Dublin’s 2.2 per cent share of the Europe-North America market could easily be swelled to 5 per cent. If IAG were to acquire Aer Lingus, it could tap that potential by feeding even more transfer passengers to the airline and through its main hub. Nonetheless, job losses could still result from a successful bid.
David Holohan of Merrion Stockbrokers says there will be some overlap between the two businesses, so there are likely to be redundancies. However, he suggests that the numbers may not necessarily be large, as Aer Lingus has already cut costs and its workforce. "It has already been turned around," he acknowledges.
The Heathrow slots – particularly those linked to Cork and Shannon – are already a flashpoint. Many fear IAG will switch them to long-haul services. When Aer Lingus floated in 2006, the Government kept a 25.1 per cent stake to secure a veto over their sale. The Heathrow slots are seen as critical to ensuring that the Republic maintains links with overseas trading partners and investors.
There is no question that they politically sensitive. When Aer Lingus axed its Shannon-Heathrow routes in 2007 and shifted the service to Belfast, the outcry that followed lasted until it was reinstated in 2009. Already, Clare Fine Gael TD Pat Breen and Shannon Group chief executive Neil Pakey have warned that those scenes could be repeated if the airport was again to lose its Heathrow link.
Furlong does not believe there is any threat. “There will be zero reductions to schedules from Dublin, Shannon or Cork to Heathrow,” he argues. The routes are profitable and feed valuable passengers to other IAG airlines such as BA, he adds. However, a decision on their fate could be out of all parties’ hands.
Declan Walsh, a lecturer in European and commercial law in University College Cork says the European Commission's competition directorate is likely to scrutinise any IAG takeover of Aer Lingus.
As both BA and Aer Lingus fly to Heathrow from Dublin, the commission could order the sale of some slots before sanctioning the deal. However, based on the precedents set during Ryanair’s three bids for the Republic’s flag carrier, Brussels is likely to look at the overall British-Irish market rather than just the services between two airports.
"The commission already has a lot of data on the UK and Ireland, which would be the principal issue in this case," he notes. Walsh says the EU would weigh up actual competition, potential new competitors and even the scope for rivalry between individual airlines that are members of the same group.
He agrees that a forced sale of some slots is a possibility, although they may not be those that the Government wants to protect. It could instead involve those that IAG acquired when it bought BMI in 2012.
Holohan suggests that a disposal may not be a bad thing, as it would allow the group to put a firm value on its overall Heathrow rights.
Ryanair, another influential player in the equation as Aer Lingus's largest single shareholder, believes a takeover could result in Aer Lingus charging higher fares irrespective of competition.
This week, the low-cost carrier’s marketing chief, Kenny Jacobs, said that when airlines consolidated, the acquiree’s prices tended to move towards those charged by the purchaser, implying an increase in this case.
Jacobs did nothing to dispel the view that Ryanair was willing to sell its 29.8 per cent holding in Aer Lingus. Instead he argued that the smaller carrier “needs a partner”.
What happens though if IAG leaves the field? A sharp fall in its share price, which recently hit €2.50, would be the immediate consequence. Previous bids by Ryanair for the airline also set its stock climbing, at one point to €3.20. However once those approaches stalled, the share price slid back to the €1.40-€1.50 range. “A defence document can come up with more or less any share price, but in the real world, it’s a different story,” Furlong says.
As an independent entity, Holohan believes Aer Lingus can continue to expand its transatlantic operation, but that it will come under increasing pressure on short-haul routes, where it is up against Europe’s biggest player, Ryanair. It also has to renew part of its fleet and is due to take delivery of 18 Airbus craft before 2020.
The €400 million net cash that it has in the bank will allow it to foot the bill for this, Holohan notes, but adds: “A deal with IAG would provide shareholders with a way out without having to spend that money.”
