Report on proposed takeover of Deutsche Lufthansa AG's (Lufthansa) loss making British Midland International airline (BMI) by International Airlines Group Plc. (IAG)
Rationale for Acquisition
Appendix 3 IAG Financial Results Consolidated
This report will attempt to uncover understanding of this proposed acquisition, recognizing and critically discussing the business justification for the acquisition and the likely long-term motivation (success or failure) of the proposed takeover. Research findings within the report intend to cover details of the strategy from the point-of-view of both companies with outside references to empirical studies from the body of academic literature that addresses the underlying motivation to concentrate on maximizing shareholders wealth through expansion.
Identify the business rationale for the takeover from the perspective of Lufthansa and IAG
Complexity of acquisition; address the motives put forward and Managerial Motives for takeover
Evaluating the bid; the expected gains from the takeover
Discussion on Corporate objective; motivation to generate higher cash flows for shareholders.
The following report is about Lufthansa is one of Europe's largest airlines considered in regard to the number of passenger flown as well as their total revenue stream. Lufthansa's aviation corporate structure consists of five segments within the combined group; divided into Passenger Airline Group, Logistics, Technik, IT Services and Catering (Appendix 1). With generated revenues of 28.7 billion Euros and generated net losses of 13 million, illustrated by the end of year report, the organization recorded a loss of 285 million Euros in connection to the operations of British Midland Ltd. (BMI) being discontinued. This serves as the financial basis for BMI to be sold to the International Airlines Group. BMI, as a subsidiary of Lufthansa group, is a UK based airline that operates from the London Heathrow as a main hub to the main cities within the UK (Regional BMI) but also to Middle East, Africa as well as Asia. Heathrow is one of the world's busiest and best-connected international airports in the world today (Appendix 2).
International Airlines Group (IAG) is one of the largest airline groups in world. The company rates as sixth in the world and third in Europe measured by the revenue and number of the passengers they carry over the year. IAG was formed in 2011 between British Airways as a parent and Iberia, Spanish registered company. Their motto is "Stronger Together ." The companies combined offer an expanded worldwide network .Financial results so far for the company are promising as their combined operating profit doubled since the merge took place and revenue rose by more than 10% (appendix3).
Approach and Methodology
Secondary research was conducted to address the issue and investigate and discuss the matter further. The Groups Airlines websites were thoroughly researched to access all the necessary information such as financial performances and reasons behind the acquisition and the disposal. Also in order to carry this report, the use of University's Electronic Library helped in accessing the academic journals and the textbooks which were recommended by the lecturer. However, recommended reading for the books dedicated to the topics of mergers and takeovers with UK focus and series of readable articles from the newspapers (using internet web pages) helped to understand the theory behind the practice.
Rationale for Acquisition
This report has been carried out with brief look into reasons for the previous acquisition whilst Lufthansa took over BMI in 2009 when bought 50% of firm owned by Sir Michael Bishop who actually forced the purchase under a long standing agreement. As for Lufthansa being already main shareholder of BMI, this acquisition has given the company more control in flights from London Heathrow airport. BMI's main hub was Heathrow airport where they controlled 11% of take-off and landing slots. Unfortunately, after the acquisition Lufthansa accumulated BMI had an operating loss of 154 million Euros in the first nine months, widening from 90 million Euros a year earlier, Lufthansa said Oct. 27, 2011, "adding that it's unlikely to match 2010's full-year sales and earnings." According to the Lufthansa, the rising fuel cost was primary driver that resulted in a fall in profit as well as tax burden incurred at the time of acquisition.
Rising fuel costs have led to number of carriers seeking closer ties with rivals or for some airlines to have had to cease their operations. Consequentially, in November 2011 BMI had been put up for sale. Announcement has been made by the IAS on 22 December 2011, that International Airlines Group (IAG) and Deutsche Lufthansa AG that they had reached "a binding agreement for IAG to acquire British Midland Limited (BMI) for BMI purchase." "The cost is £172.5 million in cash and the price is subject to significant reductions." However, Lufthansa decided not to sell the BMI subsidiary (BMIBABY) before the completion of the deal (Buyck, 2011).
Part of the agreement is for Lufthansa to take on BMI's defined pension benefit scheme. Other motives for the deal that provided a rationale behind the IAG's proposed acquisitions are landing and take-off slots times; which BMI holds and which, according to the IAG, increase their "slot portfolio by 56 additional slot pairs." BA currently has approx. 44% of Heathrow slots. The acquisition would take IAG slot share (BA + IB + BMI) to around 53% Transforming the Heathrow hub efficiently will significantly give room for unit cost reduction post acquisition eliminating duplicated overheads, utilising aircraft in size and sector length as well as in distribution and marketing synergies .
Also IAG seeks to expand their operations to Asia, deal may allow IAG to" boost services to China and offer new destinations including Korea, Vietnam and Indonesia" said chief executive Willie Walsh (Rahn & Baigorri, 2011).Overall, the BMI takeover will give British Airways (IAG's) an increase in revenue with greater range of destinations for customers and better network connection opportunities. On the other hand, Lufthansa's decision for sale has been made under comparatively harsh conditions by the current economic situation and fuel price increases the decision was final to" dissociate from sustainably loss making subsidiary."
Virgin Atlantic and Virgin Founder Sir Richard Branson are making efforts to block the takeover of BMI, claiming the impact of acquisition would create competition concerns for airline passengers creating local monopolies and drive up fares. UK takeovers are regulated under Competition Policy of the European Union set out in Articles81 of the Treaty of Rome. The sale of BMI to IAG has yet to be approved by European Union regulators. The European Commission on March 12 extended a deadline to rule on the deal to March 30.
There has been a vast increase in the number of acquisition and mergers over the last fifty years and as a result, whether or not these acquisitions and mergers create value for their shareholders has become one of the most extensively researched topics in all of finance (Sudarsanam & Mahate, 2003). The result of such research efforts is largely inconclusive and still being heavily debated. When two organizations are combined this represents a complex situation where there are many underlying factors that can be attributed to success and failure. Generally, the goal of such mergers and acquisitions is to create a level of synergy in which the combination of the two organizations provides greater value than the sum of the two separate organizations.
Yet, there seems to be a plethora of motives to consider in such a deal from both sides of the arrangement. For example, one study found that the target company's shareholders were prone to financial gain while the acquiring company's shareholders were less fortunate financially (Meeks & Meeks, 2001). Another study conducted with Spanish firms illustrates even a greater reward to the target company than found in the U.K. And U.S. (Ocana, et al., 1997). Some of this phenomenon can be attributed to the transaction costs which must be absorbed by the acquiring firm. However, there may also be some self-serving interests from the acquiring company's chief executives due to their personal financial incentives that are awarded in the form of bonus, stock options, etc. In the wake of an acquisition. Therefore it is reasonable to suspect that many mergers and acquisitions have taken place with little to no regard for the actual benefit of the company's shareholders.
Another dilemma that occurs when trying to construct model in which to analyse mergers and acquisitions is that it is difficult to effectively measure long run performance because markets are dynamic. If you could hold all factors constant then the models would be fairly easy to create. However, competition will react to the merger and create new pressures, other industries, horizontal or vertical, could change considerably, and investor information change quickly as well. Thus there is no model that can fully account a strong or semi-strong version of the efficient market hypothesis (EMH) (Limmack, 1997). Yet many attempts at studying the long-term shareholder value post-merger have found that there is a negative effect on value ranging from either slight to more severe…