Flying in formation

tauringhuang.

Jul 31st 2008
From The Economist print edition

British Airways and Iberia bow to economic and strategic necessity


THERE is nothing like high oil prices, it would seem, to free a European airline from protective national sentiment. Late last year British Airways (BA) backed away from a bid it had made with four private-equity firms for Iberia, Spain’s flag carrier, after Caja Madrid, a Spanish bank with political connections, bought a large defensive stake. This week, with the price of oil up 25% and BA and Iberia shares down 25% and 37% respectively, the two firms said they were in talks about an all-share merger. Both companies’ boards support the deal, as does Caja Madrid.

In July Martin Broughton, BA’s chairman, said the firm faced “perhaps the biggest crisis the aviation industry has ever known”. As well as soaring fuel costs, airlines are bracing themselves for weakening consumer demand. Cost savings and revenue gains from a merger will help BA and Iberia mitigate the pain.

From a strategic point of view, too, both BA and Iberia badly need more bulk. The smaller of the two, Iberia has lost market share in Spain and is struggling to compete with low-cost carriers. Europe’s two biggest airlines, Air France-KLM and Lufthansa, both completed cross-border mergers in recent years, relegating BA from first to third place in Europe, and making it look increasingly left out as the industry consolidated. Had Iberia fallen to one of BA’s European rivals, its position would have been badly weakened. And BA needs a new avenue for growth now that a third runway at Heathrow looks unlikely. Iberia will bring it extra capacity at Madrid Barajas airport, which has four runways, and fast-growing long-haul routes between Spain and Latin America.

As is customary in cross-border airline mergers, BA and Iberia will merge financially, but not operationally—at least in the short term. “They’ve put rings on each others’ fingers, but we may have to wait for several years for the consummation,” says Rigas Doganis, an aviation-industry commentator. A holding company will own the two airlines, but their brands will survive, and day-to-day operations will be managed separately.

Savings will come from combining back-office activities and from joint purchasing of aircraft, fuel and ground services. Joint purchasing of aircraft, potentially the biggest source of savings, may take some time, however, says Robert Cullemore of Aviation Economics, a consultancy. Air France and KLM, he points out, still announce their orders for new planes separately, four years after merging. On the revenue side, the merger will reduce competition on routes where BA and Iberia both operate, letting them raise prices.

Similar “half merger” strategies produced better results than expected for Air France-KLM and Lufthansa, which took over Swiss International Airlines in 2005. But industry observers question whether BA and Iberia will reap similar benefits. The two airlines already operate an alliance on the London-Madrid route and divide the profits, notes Geoff van Klaveren, an aviation analyst at Exane BNP Paribas, so there are few further synergies to be had there. And they have fewer long-haul flights in common than Air France and KLM did when they merged, so there is less scope for combining flights.

Now that Spain has allowed economic reality to prevail over politics, another struggling airline stands out all the more starkly: Italy’s flag-carrier, Alitalia, which is losing over