Proposed merger between BA and Iberia

In today's FT (30 July 2008) there is discussion about the possible merger between British Airways and Spain's Iberia. From a corporate finance point of view this is potentially a great case study as it brings the theory behind mergers and acquisitions very much to life. So what are the attractions of such a possible deal?

The primary motivation seems to be the desire to create a much larger company that would be able to compete more effectively against the other large global players in the airline market. A merged BA and Iberia would immediately take it into the top three European airlines.

According to Kevin Done in the FT's Companies and Markets section (page 17) a second attraction of this merger would be that the larger entity would be in a better position to take advantage of the next wave of rationalisations in the airline industry which will inevitably follow the ending of some "international regulatory obstacles". As an example the FT cites the US rule that foreign entities can only own a 25% voting stake in a domestic carrier. When such restrictions are removed the BA/Iberia combination will be in a stronger position to make a play to become a truly global airline.

A third advantage is that the merger would be useful for diversification as BA is currently overly reliant on the North American routes especially in terms of their long haul market.

The final argument in favour of this deal is a classic example of corporate financial theory in practice. If you read any good textbook it will argue that most mergers come about in order for the companies involved to make financial gains due to the synergies that exist between the two companies. This comes down to the hope that the sum of the value of the two businesses will be more than their individual parts. As an example, the FT article quotes the case of Air France-KLM and Lufthansa which "created much larger than expected revenue synergies from their enlarged groups."

The biggest obstacle to the merger might be the usual problem of trying to integrate the two sets of employees. This will be a particularly severe problem in what remains a highly unionised industry. It will be fascinating to see this story develop in coming weeks.