IAG and Norwegian: perfect marriage or hostile takeover?

Why does IAG want Norwegian? The answer isn’t simple, but there are some approaches that may help to explain it.

The big surprise

The markets were taken by surprise when Bloomberg broke the news on Thursday April 12 at 11:24. IAG had acquired 4.61% of the shares in Norwegian Air Shuttle (NAS, the parent company listed on the Oslo Stock Exchange). Just a few minutes later, IAG distributed a press release confirming the purchase and stating it considered Norwegian to be an attractive investment. The intention of the minority investment is for IAG to establish a position to initiate discussions with Norwegian, including the possibility of a full offer. IAG stresses that no prior discussions with Norwegian have taken place and no decision has been made on an offer at this time and there is no certainty that any such decision will be made.

Norwegian has been closely monitored by IAG and its financial advisors over the last three or four months and IAG CEO Willie Walsh was planning to lock in the asset before any rival airlines or financial institutions emerged on the scene. On April 12, he placed his bet.This took the markets and Norwegian off guard. Very few or none had seen IAG emerging to acquire shares and indicate intentions for a full takeover of Europe’s third-largest low-cost carrier.

IAG already has two-and-a-half low-cost carriers under its umbrella, Vueling (low-cost short and medium haul, operating out of Spain), LEVEL (established in 2017 as a low-cost long-haul carrier, operating out of Spain) and Aer Lingus (hybrid carrier operating short, medium and long haul out of Ireland). British Airways also has plans to start up low-cost long-haul flights between London Gatwick and points in the US by using “high density configuration” Boeing 777s to compete head-on with Norwegian.

So why does IAG want Norwegian? The answer is not simple, but there are some approaches that may be a reliable guide.

The most obvious approach

Most mainline airlines did not foresee the impact that the new low-cost carriers would have on the markets and on airline business models, when the fact that low-cost travel on short and medium haul was revealed to be sustainable and become the driving force behind passenger volume growth. It was almost too late to take evasive business actions. Norwegian’s business model on low-cost long-haul has already disrupted the mainline airlines’ business and Norwegian has partly proved that low-cost long-haul is sustainable, though its CEO Bj?rn Kjos still has work to do before its low-cost long-haul business model is green-stamped.

IAG does not want to be late for boarding on the low-cost long-haul flight and plans to acquire Norwegian to bypassing and saving time on organic growth within IAG. Level’s limited number of A330s operating from Spain to cities in the Americas and British Airways’ plans of “high density” Boeing 777s between Gatwick and the US, together with Aer Lingus’ hybrid flights between Ireland and North America are not enough. More aircraft, pilots, crew and maintenance staff are needed – which is exactly what Norwegian can offer. If Norwegian ends under the wings of IAG, it is most likely that the Level brand will be parked in the hangar and swapped with Norwegian.

Not only is low-cost long-haul targeted by the Willie Walsh radar, IAG has not been too successful in growing its LCC Vueling and hybrid Aer Lingus at the same speed as their peers Ryanair, easyJet, Wizz Air and Eurowings (including Brussels Airlines). Norwegian would be a game changer, with its extensive route network and bases across Europe not to mention the orders for 200 Airbus and Boeing aircraft it has placed and starting to receive from 2019. Nor to disregard the 7 million members of the loyalty program Norwegian Reward.

Finally, the small and shining diamond in an IAG-Norwegian deal: a stronghold in the lucrative Scandinavian markets. Neither British Airways, Aer Lingus nor Vueling have a strong position in Scandinavia, where the main players are SAS and Norwegian, which jointly control around 60% of the market (including domestic and international). SAS rules in the corporate segment, something IAG obviously wants to challenge by joining forces with Norwegian. This can put SAS into a two-front war, with oneworld member Finnair invading from the east and IAG (Norwegian and British Airways), also oneworld members, invading from the west, all targeting corporations and SMEs in the Nordic countries. SAS and Star Alliance will, however, put up a tough fight.

Maybe Lufthansa Group will have to go another round with their excel spreadsheets on a SAS takeover business case; in 2008 it was literally hours away for Lufthansa signing a deal on SAS but it was jeopardized by the October 2008 global financial meltdown.

The not-so-obvious approach

IAG is not able to speed up its organic growth on the low-cost segment to keep pace with its peers, particularly on long-haul. How can IAG slow down or knock out the low-cost long-haul competition? One way is to buy up major disrupter Norwegian and get control of its inventory to use in IAG’s best interests. The lucrative market between the UK and North America is under threat by Norwegian and its smaller contemporaries Primera Air and Iceland’s Wow, forcing the oneworld North Atlantic joint venture partners, American Airlines, British Airways and Finnair to follow suit and offer low-cost long-haul products on their routes, typically with unbundled Light fares allowing one cabin bag and other services such as seats and checked-in luggage to be paid for.

Looking at Iberia and the market between Spain and South America, Norwegian is likely to boost its network and turn out to be a challenger for Iberia, the dominate airline. A ramp-up by Norwegian will drive the fares down, as already experienced in the North Atlantic. This will probably also open up the space for more low-cost long-haul carriers, resulting in fierce competition over the South Atlantic.

This can be a costly and dangerous flight path. Already speculations run the numbers of Norwegian’s value, including underlying values, to surpass €4 billion, including a current net debt of approximately €2.25 billion, not to mention the turbulence and resistance from Norwegian’s shareholders if such a plan was leaked or known in any way.

Regardless of IAG’s almost unlimited access to capital, via its shareholder the state of Qatar which holds 20% of the shares, a hostile takeover attempt of Norwegian does not seems realistic on the cards.

Any more bidders?

Ryanair has often been mentioned as the most likely company to acquire Norwegian, particularly to get into a position to launch large-scale low-cost long-haul. The Irish low-cost giant recently acquired a 24.9% stake in Niki Lauda’s airline Laudamotion, with the option rising the stake to 75%. Ryanair has its hands full implementing Laudamotion to be its spearhead in Germany and Central Europe against the fast-growing easyJet and Eurowings. CEO Michael O’Leary and his skilled management team will focus on the battle of Germany and disregard any bids on Norwegian.

easyJet is occupied setting up new operations in Germany, after acquiring 25 former Air Berlin aircraft in 2017. The leading UK low-cost carrier has also teamed up with US-based investment fund Cerberus to bid on the bankrupt Italian stallion Alitalia. easyJet has ambitions, but IAG’s timing of a bid on Norwegian is bad news for easyJet and it is not likely it will join in a bid on Norwegian.

Lufthansa Group is also busy after acquiring 85 former Air Berlin aircraft in 2017, where the major part will be assigned to Eurowings. Lufthansa is also looking at Alitalia and has submitted its interest to Alitalia’s bankruptcy administrators. It is not likely Lufthansa will shift focus and bid for Norwegian. But it may have a second look at SAS, to protect the markets in Scandinavia against a IAG and oneworld invasion. If a realistic bid on SAS is launched by Lufthansa, the majority owners of SAS, the Danish, Swedish and Norwegian governments, are likely to sell their shares to the German giant.

Wizz, the Hungarian low-cost carrier, is growing at 25% a year, making it Central and Eastern Europe’s leading airline. This growth pattern is set to continue in 2018 and it requires hands-on control to manage such fast growth, leaving no time for its management to use any resources in a bid and take over of Norwegian.

As for KLM-Air France, both airlines have their own low-cost carrier brands, HOP and Transavia, while in 2017 Air France also launched JOON. KLM already has a good market position in Scandinavia, it being the second most important market in Europe for the Dutch carrier. For Air France, the Scandinavian markets are less important in a European perspective. These two carriers are not involved in any large-scale business operations for the time being, leaving resources available for top management to investigate a business case on Norwegian. Looking back in time, KLM and Air France failed with Alitalia and they have not been visible in grabbing parts of airlines that went bankrupt in 2017, Air Berlin or Monarch Airlines. Nor have the Dutch and French shown any interest in Alitalia today. These facts leave little chance for KLM and Air France to bid on Norwegian.

After all, would Norwegian’s major shareholders, Bj?rn Kjos and Bj?rn Kiese, who jointly hold 25%, sell their shares? Norwegian is the masterpiece of its CEO Kjos, who on several occasions has stated that he wants to run and own the airline to push forward the business plan to be the leading low-cost long-haul carrier in the world. There is still a way to go before this goal is reached. Kjos is 71 years old but that doesn’t stop him from working and travelling all over the world to drive the carrier forward.

Due to heavy deficits in 2017 and a declining stock value, the company’s equity capital has come under pressure, something that is being closely monitored by the financial institutions that have provided the €2.25 billion in loans to Norwegian. The equity and capital situation has somewhat improved for Norwegian in 2018, despite the company came with a profit warning for its Q1 (January-March) period. The bulk of investments in long-haul aircraft, new routes, pilots and crew will level off in mid-2018, enabling Norwegian to focus on efficiency, revenue optimization and cost reductions.

The situation is that Kjos does not have to sell to IAG or anyone else, but in a press conference on April 13 he was clear that IAG is good company with very competent management. If Norwegian gets a solid owner like IAG, the business plan and moving forward for Norwegian will be in safe hands.

However, it will be mandatory that Norwegian remains a separate brand under the IAG umbrella and maintains its DNA. As for Norwegian’s passengers, the expression “Kjosfast”, meaning stuck somewhere in the world due to a Norwegian flight being cancelled or delayed, will be a thing of the past. Oneworld alliance partners will assist in transporting passengers to their destinations, just as SAS uses its Star Alliance network to cope with irregularities.

All in all, Norwegian and Bj?rn Kjos could hardly get a better owner than IAG, and if the transaction “package” for all of Norwegian’s shareholders includes a fair pricing for the company’s assets and its underlying values, the chances for a deal to come through are good.

But IAG should act fast, and if the process gets into motion, maybe a deal can be concluded by Q3 2018.

This article was first published by Hans Joergen Elnaes on April 16th in www.standbynordic.com