Airline Group Selection: A Comparative Analysis Of British Airways And Iberia Airlines Merger

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Various long-term finances. The possible considerations are evaluated through weighted average cost of capital has been done for the purpose of extensive analysis of the report (In.finance.yahoo.com. 2016).

 The two airline group selected for the purpose of evaluation is Iberia Airlines and British Airways. An Iberia airline is based in Madrid and it has international flight operations from Madrid to Barajas. The aircraft is responsible for carrying out maintenance and handling in airport and management of various types of IT services. The airlines have its operations over 109 destinations and 39 countries. In terms of sharing agreements the airlines have its operations in more than 109 destinations. The British Airways is known for being the largest airline group in the United Kingdom in terms of the fleet size. The main airport of this airline is based in London Heathrow Airport. The airplane it has accommodation capacity of more than 280 passengers. This particular airline began its operations in the year 1972 with merging its operation in the two nationalized airlines carrier namely British Overseas Airways Corporation and British European Airways (Britishairway.com, 2016). The main Airline carrier operated by the company includes Airbus A320 which was a family aircraft launched in the year 1998. (Ustaömer et al. 2015).

 In the year 2010 both the airlines signed an agreement to merge between each other. Due to this merger of both the airlines a third largest commercial airline group was formed. The merged company is known as International airlines Group (IAG). Even after merger of the companies both will continue to operate with the same brand name, the International consolidates airlines group is based in Spain. In the recent times mergers of the various airlines has become a popular trend. After 2010 the merger activities has been seen between pinnacle airlines and Mesaba airlines, United Airlines and continental airlines, SkyWest and Atlantic Southeast Airlines, US Airways and America West Airlines, Pinnacle Airline and Colgan Airlines, Southwest Airlines and Air tran Airways.   The various types of mergers activities discussed have been considered after the 2010 and 2013  (Fageda  2016).

The rationale for the merger and activity was mainly due to the provide an improved customer service of the customers through better availability and coverage of the routes from Europe, North America, Australia, America and South America.  In this way the airlines can cover more number of airport routes and destinations. The enhanced customer service has been observed in dedicated lounges in more than 120 dedicated Iberia and British airport lounges which a flyer can enjoy while availing of the service. This has also ensured that the customers are able to book the tickets with greater ease through a single website and thereby more number of flights to choose from across the extended network of both the airlines carrier. Moreover it had been observed that an Iberia airline was losing its share of profit by more than 1.7 m pounds every day. The company was responsible for job cuts and attrition within the company before the merger and formation of IAG (Narangajavana et al. 2014).

British Airlines was one of the most popular airlines in all over the world. But in the end of the last decade, the company began to suffer from various financial problems. The company even had to face ownership issues over the state. It has also suffered due to recession in the global airlines industry. To solve the issues, the British Airlines management took decision to reduce the total numbers of cabin crews as well as cut down the salaries of the employees. Such strategy had been applied by most of the airlines companies in the recession period, which had become one of the major factors in the overall economic crisis in the airlines industry (Kaps et al. 2011). Being a part of the industry, British Airlines was also affected by the industry crisis, especially, its primary operation activities had suffered significantly. The decreasing rate of employee retention and salary deductions, caused many strikes within in the company, which, in turn, created negative impact on the passengers’ decision. The preferences of the passengers converted to other airlines services. It results into reduction in the company’s overall revenue. Moreover, it has been observed that the business class travel to North America had greatly fallen in this crisis period. It was also one of the issues for generation of lesser profits. Along with such internal & external problems, the company had to face tough competitions from the low-cost airtravel service providers (Belobaba et al. 2015).

In Spain, Iberia Airlines, had also faced same kind of issues. The major problem of the company was rising popularity of low-cost airlines, which caused significant fall in the revenue of the company. The rate of revenue earning had reduced so much that the company had decided to stop the payment of the employees for savings funds to exist in the market.

In such condition, both, British Airways and Iberia Airways decided to merge the companies for reducing the air fare to pull over more passengers and ultimately to increase the revenue generations. It was the primary object of the companies. The secondary objective of the merger was to expand its route. The ultimate goal of both companies was to get rid of the common financial issues, which was troubling both the organizations and also to avoid the impact of the world wide economic recession. Therefore, both the companies joined hands and formed International Airlines Group.

The advantages of merger activities can be measured by evaluating the pre merger and post merger financial performances of the companies. The merger process can be described as successful, if the post merger performances excel in every aspects in comparison to the pre merger economic activities. Hence, it is quite necessary to evaluate the performance of the newly formed company and compare it with that of the older companies.

The most effective tool of measuring and analyzing the pre merger and post merger activities, is financial ratio analysis. Amongst the various ratios, the appropriate ratios for such anlaysis are liquidity ratios, asset turnover ratios, profitability ratios and growth investment ratios (Healy and Palepu 2012).

In 2010, British Airways had generated loss of $425 million after tax and incurred $8225 million in terms of operating cost. Such high operating cost and huge loss, resulted to a net profit ratio of -5.32 and operating ratio of 102.89   (britishairways 2016). It indicates the company had to spent higher amount for its operating cost, but it was completely unable to generate enough revenue to meet the expenses. The financial records of Iberia also exhibits same scenario. It had generated a total revenue of $4582 million, whereas, its total operating cost for 2010 was $4608 million. The amount of net loss of the company was $273 million (britishairways 2016). The net profit margin & operating ratio were -5.96 and 100.57 respectively. After the formation of International Airlines Group on 2011, the newly formed company had earned $16339, which was more than the aggregate total revenues of the two companies, earned in 2010. The net profit margin of the new company was 3.39 and the operating margin was 97.03 (Iairgroup.com, 2016). Though the operating margin was on higher side, it should be noted that the company was formed in a recession period, when all the companies in airline industry were suffering from high operating costs. In such scenario, the merger activity had not only helped to decrease the cost but had generated profits for the two companies, who were suffering from loss over consecutive periods (Brigham and Ehrhardt 2013).

As per the liquidity aspect is concerned, Iberia was in a better position than British Airways. The current ratio of the company prior to merger was 1.53 and the super quick ratio was 0.46. From the balance sheet of British Airways in 2010, it can be stated that the company had been running out of liquid assets before the merger. The current ratio of British Airways was only 0.44 and the super quick ratio was 0.12. It indicates that on 2010, the company has taken huge debts from market for running its operation due to shortage of revenue generation. The current assets were not enough to cover the debts. Moreover, its liquid cash position was also at stake. In such condition, the merger was proved o be very beneficiary for British Airways to increase the revenue generation and cover its debt. The newly formed company was able to maintain a current ratio at 0.90, which was not a perfect ratio level, but at that point of time, it was quite satisfactory for any airlines company (Ledgerwood 2014).

The total asset turnover of both the companies was at par more or less on 2010. The turnover rate of British Airways was 0.75 and for Iberia, it was 0.76. The Fixed asset turnover rate of British Airways was 0.26, which was higher than Iberia, which was maintaining a rate of 0.14. The total asset of Iberia was higher than British Airways, but it had generated much lesser revenue on 2010 in comparison to British Airways. From the turnover rates, it is quite cleared that both the companies were not able to utilize its assets efficiently in that period. After merger, the total asset turnover and fixed asset turnover rate of the new company, IAG, has increased to 0.83 and 1.18 respectively. It denotes that the merge decision was very much effective for both of the company. By merging, the companies were able to utilize its assets more effectively for revenue generation. The capital turnover ratio had also increased to 1.49 in comparison to the individual capital turnover ratios of both the companies (Wahlen et al. 2014).

Iberia Airlines was a sole shareholder company. It is a form of private limited company, where the overall ownership in terms of equity shares is controlled by an sole shareholder. Therefore, the company was not very much concerned about its stock market price. British Airways is a corporate company, who use to maintain a favorable position in the stock market. In 2010, due to the loss, the company was unable to pay any dividend. Therefore, its market price had fallen drastically. The downward fall was amplified by the global economic depression. The return on equity rate of British Airways had become – 1.13 and the return on invested capital had gone down drastically to 0.55. The payout ratio was zero and the book value of shares was had fallen from 2.05 to 1.3. After the merger, It was able to increase the return on assets rate to 21.20 and return on invested capital to 14.37. In terms of payout ratio, the shareholders had experienced a constant growth (Brealey et al. 2012).

Therefore, by the ratio analysis of the pre merger and post merger financial activities of British Airways and Iberia Airways , it is quite evident that the merger was a successful venture for both the companies. Both the companies were suffering from high operating costs, lower revenue generation and tough competition from low cost airlines companies. The merger had provided the scope to cope up with the adverse issues and turn the market into their favor once again. Through merger, both the companies were able to utilize each other’s resources. It helped them to use their assets more effectively. Moreover, both the companies were able to lower the ticket fares and attract the passengers, who had switched their favor to low cost airlines, towards the new company. Due to international collaboration, the new company is able to enjoy various tax benefits from both the countries of Britain and Spain. Moreover, it can utilize various airport facilities and other cost benefits from both the countries. Thus, the new company was able to lower the operating and other non-operating costs and also to increase the revenue generation, which, in turn, increased the profit volume (Hüschelrath and Müller 2014).

The distribution of the company’s profit according to present condition is based on private distribution policy as per IAG shareholder policy. The present share price  of the company stands at 478.30 Great Britain pounds and the recent trends in the share prices has shown an increase of 0.72%. The key statistics of IAG shows market capital of 9.69 B and enterprise value of 968.88B. The total marginal cash flows of the company have been observed as 6.62 billion and total cash per share has been 3.12. The individual analysis of the share prices of the company has been explained below as follows (Fu and Oum 2015).

The company has a market capital of 83.13 B, the enterprise value of the company stands at 84.78B. The profit equity turnover ratio of the company stands at 17.64 and the price sale ratio has been observed as 0.86. The company is also associated in various types of research and development activities related to production of the spare parts and making modification in the planned and unplanned activities. The airlines has a tie up with the global services related to supply chain management which further provides the company with the option to transfer its services in the supply chain division. The financing activities are therefore divided into two broad sections, one dealing with the general passenger carrying airlines and other being the cargo division of the airline (Grundy and Moxon 2013).

The external sources of the finances of the company includes from hiring activities of the various partners of the company. In a similar way the other external agents adding to the total; finances of the company includes debentures, venture capital, overdraft equity capital and revenues received from factoring services. The company also takes loans during the financial downturn in this case the company is able to suffice its financial requirements through bank loan. These are the main source of the company’s long term finances (Wakefield 2013).

The Iberia Airlines had faced a loss of more than 2.17 million before the merger and formation of IAG. The share in the IAG was up by 168.8 percent after the merger of both the companies. The nine month of operating loss of 262 pounds was recovered by the profits of the British Airways. The job loss in the Spain due to and unemployment rate was also reduced significantly. The airline is operated by a single ownership; this allows the airlines to operate with greater amount of working capital. The sole operator of the business also deals with lower distribution of dividends among the share holders, this further allows the company to retain greater amount of liquid cash flow into the system (Ustaömer et al. 2015).

According to Madden, Madden and Strickling (2014), merger is corporate combination of two or more independent commercial corporations into a single enterprise, generally the absorption of one or more firms by a dominant one. The entire merger operations is considered to be accomplished when one firm purchasing the assets of other with cash or its securities or by purchasing shares or stocks of one firm by another an d issuing its stock to the stockholder’s of the other firm in exchange for their shares in the acquired firm.  According to the theories of merger, there are various types of mergers: horizontal, if both firms offer same service or commodity for same market. This concept is completely different in the case of market extensional which is referred when both participated firms are produce the same service and commodities for distinct markets. However, if a firm acquires either a customer or a supplier then this strategic alliance is called vertical. This current merger between Iberia and British Airways which was completed on 24^th January 2011, upon the listing of the shares in the International Airlines Group (IAG), can be considered as a market extensional merger types because both the companies are renowned participator in the airline industry (Cooper and Finkelstein 2014). Basically there are many corporate reasons for which the merger is being taken. Here, Iberia airline and British Airways both the companies made this align to expand the scope of their carrier. The corporate objective of this deal is to more airlines – but importantly right airlines- to join the group. Both the company considered this merger a foundation step towards establishing a multinational multi-brand airline group. 

According to the purpose of a theory of mergers, both the company combines motives of the managerial merger. With an industry level regime shift that may be the cause of value-increasing merger opportunities (Ishii and Xuan 2014). To analyze the corporate strategy of both the companies, the researcher needs to explain the theory of merger. According to the efficiency theory of merger, companies initiated mergers in the expectation to generate enough realizable synergies to make to make the corporate deal beneficial to both the parties.  Based on this concepts the literature of the merger suggests different theories such as “Differential efficiency theory”, “Inefficient management theory”, “Synergy”, “Pure diversification”, “Strategic realignment to changing environment” and “undervaluation”. According to the differential efficiency, if one company is more efficient than the other one and if the initial firm acquires the later one, then the efficiency of the later company is likely to be brought up to the level of the initial firm. The theory defines that some firms operate below their potential and s a result have below average efficiency (Fröhlich et al. 2016). This theory is quite rationale as per the given case scenario. Due to the impact of the continued operational loss, Iberia Airline was majorly looking for financial stability during the pre-merger phase. Additionally, this Spanish airline company faced corporate inabilities due to the cause of rising fuel price and gradually increased cost of the employees.  On the other hand, British Airlines faced challenges due to slowdown of the global economy, primarily caused by the Euro zone crisis, financial and strategic investors have become cautious and risk-adverse about the company’s portfolio investments (Fageda and Perdiguero 2014). Though the company faced several challenges, this British airline was strategically insights for broader market capitalization and increases the growth opportunities for the future period.  After this merger, valued at 5.3 billion pound, IAG raised effectively their market share by 2.3 percent.  This refers that the both the company had distinct vision and different corporate objectives but interested in this strategic alliance for generated greater efficiency in the both the national airline market. However, this merger case study also ensures that the global corporate strategy made for global dominance in this sector.

Based on examining the above mentioned corporate strategy, there are many potential impacts of this deal o the corporate objectives of the merged company. Previously, the corporate objective of Iberia airline was to provide the best airline service at the most competitive price. However this was not possible due to operational deficiencies and functional inabilities. After this merger, IAG initially estimated £349 million of annual cost savings by the fifth year after the merger. Here this merger may impacts of the corporate objectives of the company and IAG may change their potential objectives like as follows:

• Getting listed in both the stock exchange: Madrid and London stock exchanges and generate global dominant position in the international airline industry.
• Provide a higher operational efficiency
• Acquire more airlines and generate more revenue
• Better corporate service and ensure a higher customer satisfaction.
• IAG’s brand strategy has intrinsic strength
• Faster progress with labor restructuring

On the contrary, this merger may have the negative impact of the corporate objectives of IAG airlines. For instance, IAG not yet achieving sufficient ROIC and strategically the company is now is at aim to achieve 12 percent or more return on investment capital in 2016-2020 for both the group and for the individual operating companies (Dobson and Piga 2013). Therefore, insufficient level of productivity may reduce the group potentiality in the long run. In that context the company also equates to an operating margin target within the range of 10 percent to 14 percent. Secondly, British airways still has a relatively high CASK. This is indeed a serious concern for this airline. In spite of the enhanced labor productivity and its reduction in unit costs, the name of this company remains the highest cost European airlines as per the measured costs per available seat kilometer. This has been found that BA sits are further above the trend line for European complete service carriers compare than does Iberia( Barbot et al. 2013). In means there are still have operational differences and thus the deal may impacts on corporate objectives. Moreover, the company is considered as small in Asia Pacific because Iberia failed to operate to the region at all. However, BA has successfully increased their share of seats between Asia Pacific and Europe by 5 per cent (Budd et al. 2014). Therefore, IAG needs to improve their international network in the Asia pacific region and this may be a potential consideration to make this deal more impactful.

There are mainly three primary challenges that are faced by the company International Airlines Group (IAG) following the merger took place between the Iberia and the British Airways. Firstly, the particular company IAG is facing trouble due to the rise in the fuel price (Ross et al. 2015). This hike in the fuel price leads to hike in the price of the air tickets of the company. This fact is considered as the key issue that is decreasing the numbers of customers of the air travel. Simultaneously, if the company intends to keep the price of the air ticket constant then it might lead to a condition called Beak-even point situation, where no profit and no loss situation will prevail or the organization might run under loss. Secondly, the issue or the challenge faced by the firm IAG after merger is the change in the behavior of the customers. It has been found that the demand of the air tickets or the numbers of people having demand for leisure have declined due to sudden believes and shocks. These include – terrorist attack, hike in price of air tickets and many more. This has resulted into change in growth strategy of the organization International Airlines Group (IAG). The particular organization has even decided to lower the numbers of seats within each aircraft as the demand of the leisure travel has been weakened to a greater extent, especially after the attacks of Brussels. Thirdly, the news of cancellation of flights in the recent days has also affected the share prices of the whole airline industry. Therefore, the stock prices of the particular company International Airlines Group (IAG) have also been affected (Fletcher 2016). This has reduced both the earnings and revenues of the particular firm. In addition to these, it can also be said that this merger took place between two companies British Airways and Iberia of various countries. Thus, the newly formed company IAG has to face various challenges regarding managing employees, work culture and organizational culture of the firm.   

Conclusion

Thus, it can be said that the fact of merger between the organizations, the Iberian airways and the British Airways has resulted into positive outcome that has resulted into the formation of the new company named International Airlines Group (IAG). This specified merger is quite successful as it has been found that the earnings per share of the particular firm IAG has spontaneously improved after the merger that occurred in the year 2011. In addition to this, it has also been found that the values of the financial ratios, efficiency ratios, profitability ratios and the liquidity ratios increased continuously over the period of time (the period of post-merger). According to the analysis, the price of the share increased to a wider extent during the period of post-merger in comparison to the period of pre-merger. It has been noted that presently the firm IAG is facing various troubles due to various reasons though the increasing trend of the earnings per share puts a positive view on the wealth of the shareholders.  

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