Real test of IAG’s Aer Lin­gus takeover will come in bad times – not just good

Irish Independent - Business Week - - Richard Curran -

LAST week I was for­tu­nate enough to fly home to Ire­land after a very en­joy­able sum­mer hol­i­day. The Aer Lin­gus flight from Geneva to Dublin was like many oth­ers I had taken with the air­line over sev­eral decades. It is al­ways nice to see that Aer Lin­gus logo, the sound of Ir­ish ac­cents and the fa­mil­iar tones of a re­as­sur­ing Aer Lin­gus flight cap­tain (prob­a­bly from Clon­tarf ) that the weather in Dublin “isn’t quite as good as here in Geneva”.

Per­haps the most re­as­sur­ing part of the whole cus­tomer ex­pe­ri­ence is how lit­tle has changed three years after the takeover of Aer Lin­gus by British Air­ways’ par­ent group IAG.

The brand re­mains the same, as does the pres­ence of a Dublin-based se­nior man­age­ment team, the po­si­tion­ing of the air­line for con­sumers and the gen­eral feel of it.

Yet, an enor­mous amount has changed at Aer Lin­gus in the last three years. This week in 2015 share­hold­ers voted over­whelm­ingly (over 95pc) to ap­prove the takeover of the air­line by IAG.

The buy­out was fa­cil­i­tated by the Govern­ment’s de­ci­sion to back the €1.5bn takeover which en­sured a €335m pay­day for the State’s 25.1pc share­hold­ing.

After spurn­ing two lower of­fers for the stake, the Govern­ment backed the €2.50 per share cash of­fer put on the ta­ble by IAG chief ex­ec­u­tive Wil­lie Walsh.

Since then, the fi­nan­cial po­si­tion of the group has changed dra­mat­i­cally. Aer Lin­gus had re­ported rev­enues of €468m for the first six months of 2015 as the air­line was in the throes of the takeover bid.

In the first six months of 2018, rev­enues were €899m, an in­crease of 92pc in three years. The first half of 2015 saw the air­line reach an op­er­at­ing profit of €34.5m. It was €104m for the same pe­riod this year.

Bear in mind, Aer Lin­gus also had north of €640m in net cash on its bal­ance sheet at the time of the bid.

Such has been the rapid growth in rev­enues and prof­its, that it raises the ob­vi­ous ques­tion – did the govern­ment sell too cheaply?

The an­swer is spec­u­la­tive and would need to es­ti­mate how much of the air­line’s growth in the last three years would have come with­out the IAG takeover. Equally, the value of some­thing is the price some­body is will­ing to pay for it at the time.

Be­fore Wil­lie Walsh came knock­ing on the Aer Lin­gus’s door, the com­pany’s shares were trad­ing at €1.50 each, valu­ing the busi­ness at €900m. IAG paid a full €1 a share more in the takeover.

And of course there is the ques­tion of what would have hap­pened if the air­line had in­sisted on go­ing it alone. It would not have been able to catch the in­dus­try cy­cle to the same ex­tent in the last three years and might have seen its share price suf­fer even more.

The air­line’s op­er­at­ing prof­its in the first half of 2015 were not only one-third what they are now, but had de­clined by 10pc on the 2014 per­for­mance.

The key to Aer Lin­gus’s ex­tra­or­di­nary growth un­der IAG has been its ex­pan­sion into new transat­lantic routes while devel­op­ing Dublin as a trans­fer lo­ca­tion.

Not much had changed on my Geneva to Dublin flight last week ex­cept the num­ber of trav­ellers who weren’t Swiss or Ir­ish and who were fly­ing on from Dublin to North Amer­ica.

Since the takeover, Aer Lin­gus has added routes from Dublin to Philadel­phia, Seat­tle, Ne­wark, Los An­ge­les, Con­necti­cut, and Mi­ami.

There are two more routes due to be an­nounced in the com­ing weeks. The air­line has also or­dered four new long-range Air­bus A321 air­craft. These should help its reach even fur­ther.

Aer Lin­gus CEO Stephen Ka­vanagh has said the air­line has run a scop­ing ex­er­cise on dozens of US cities, ex­am­in­ing pas­sen­ger de­mand and cor­re­lat­ing it with cities that might do a deal on land­ing charges.

In an in­ter­view at the week­end he said it is not ab­surd to imag­ine Aer Lin­gus more than dou­bling its cur­rent transat­lantic daily loads dur­ing his term in the job, while also in­vest­ing fur­ther in the Euro­pean net­work.

One of the draw­backs of an in­ter­na­tional takeover, for an Ir­ish firm, is that lo­cal man­age­ment has to make an in­vest­ment case to HQ for the re­sources to ex­pand and grow.

We see it with US multi­na­tion­als with big op­er­a­tions in Ire­land, such as Mi­crosoft, Ap­ple or In­tel.

How­ever, in Mr Ka­vanagh’s case, he is mak­ing the case for in­vest­ment cap­i­tal for Ire­land, to a chief ex­ec­u­tive who used to do his job. It prob­a­bly has pros and cons, but on bal­ance is a far bet­ter sit­u­a­tion.

And Mr Ka­vanagh is prob­a­bly push­ing an open door right now with IAG. Aer Lin­gus has been the star per­former within the wider IAG group.

Between March and June for ex­am­ple, its op­er­at­ing mar­gin was 20.8pc. Ibe­ria’s was 10.4pc, while British Air­ways man­aged 15.4pc. Vuel­ing’s op­er­at­ing mar­gin was 9.3pc.

But it is re­ally on the score­card of re­turn on in­vested cap­i­tal that Aer Lin­gus shines for IAG. Its RoIC in the last four quar­ters was a mas­sive 27.8pc. This dwarfed other air­lines in the group, with Ibe­ria at 12.2pc, Vuel­ing at 13.1pc, British Air­ways at 16.9pc and the over­all group fig­ure run­ning at 16.2pc.

It sug­gests that IAG is man­ag­ing to milk very sig­nif­i­cant re­turns rel­a­tive to the cap­i­tal it has had to in­vest to achieve them. The ques­tion of get­ting it on the cheap rears its head a lit­tle again. The Govern­ment didn’t snatch the of­fer out of Wil­lie Walsh’s hand three years ago, but in­stead spurned two lower of­fers and ne­go­ti­ated hard se­cur­ing key com­mit­ments.

The whole coun­try was ob­sessed with re­tain­ing Heathrow slots after a takeover three years ago. The Govern­ment re­ceived a com­mit­ment the slots would be held by Aer Lin­gus. They were stronger as­sur­ances than what ex­isted be­fore but are not nec­es­sar­ily legally bind­ing.

Aer Lin­gus also com­mit­ted to con­tinue op­er­at­ing its daily win­ter and sum­mer sched­uled fre­quen­cies between Lon­don Heathrow and Dublin, Cork and Shan­non for at least five years and a fur­ther two if air­port charges do not in­crease above cer­tain lev­els.

At the time, IAG said it be­lieved Aer Lin­gus could de­liver up to 2.4 mil­lion more pas­sen­gers by 2020 and the air­line would have a net 150 new em­ploy­ees ris­ing to 635 new jobs by 2020.

The State put the €335m pro­ceeds of the sale into a spe­cial con­nec­tiv­ity fund within the Ir­ish Strate­gic In­vest­ment Fund (ISIF), of which €93m has been in­vested so far. Given that ISIF has around €7bn to in­vest, the ad­di­tional €335m doesn’t seem too sig­nif­i­cant, but it could be use­ful post-Brexit when it comes to in­vest­ing in new ship­ping in­fras­truc­ture and ex­port routes to Europe which need to by­pass Bri­tain. Dublin Air­port has this week an­nounced a new €16m pas­sen­ger trans­fer fa­cil­ity which ties in well with the Aer Lin­gus ex­pan­sion plan. The num­ber of pas­sen­gers us­ing Dublin to trans­fer from one flight to an­other has grown from 550,000 to nearly 1.6 mil­lion since 2013.

The Aer Lin­gus takeover has so far de­liv­ered what IAG promised and more. Yet it is ob­vi­ous Wil­lie Walsh bought it at the right time and for the right money.

But there are pos­si­ble clouds on the hori­zon. If other Euro­pean air­ports se­cure US im­mi­gra­tion clear­ance rights, Dublin’s ex­pan­sion could face fresh com­pe­ti­tion. US pres­i­dent Don­ald Trump’s de-sta­bil­is­ing trade wars could se­ri­ously im­pact transat­lantic pas­sen­ger growth. Brexit re­mains a very un­cer­tain is­sue. As fuel prices con­tinue to tick up, air­line man­age­ment are al­ways aware of the cy­cle in their in­dus­try.

Per­haps the real test of the value of the takeover to Ire­land Inc could emerge in tough times rather than in good ones. If there is a down­turn, how quickly might Dublin’s place within the wider group be truly tested?

But three years after the sale of Aer Lin­gus as a stand­alone Ir­ish com­pany, the out­look is pos­i­tive. Wil­lie Walsh may have got a bar­gain, but Ire­land Inc stands to do well out of it too.

IAG CEO Wil­lie Walsh with Aer Lin­gus CEO Stephen Ka­vanagh who is eye­ing the prospect of fur­ther ex­pan­sion in the US. Photo: Ja­son Clarke

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