Why does International Airlines Group want to buy Norwegian?

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As has been widely reported today, Thursday 12 April 2018, International Airlines Group (“IAG”) has acquired a 4.61% stake in Norwegian Air Shuttle ASA (“Norwegian”).

This was first reported by Bloomberg. IAG confirmed in a statement to the Stock Exchange that this was done to initiate discussions with Norwegian with a view to making a full offer for the airline. Norwegian was not aware of IAG’s activity and no discussions have taken place to date.

According to the Financial Times, Norwegian’s co-founders Bjørn Kjos and Bjørn H. Kise own a joint 27% stake in the airline. It is axiomatic that no takeover bid could go ahead without their consent.

British Airways is not buying Norwegian

First, let’s get one thing out of the way. Many outlets have reported this story as BA buying or merging with Norwegian. This is not the case. BA has no involvement in IAG’s activity. Whilst Norwegian is a significant competitor to BA, any decisions around buying Norwegian and its subsequent integration rest solely with BA’s parent company IAG.

IAG and Norwegian have been pursuing opposing strategies

For the entirety of IAG’s seven year existence, it has preached that the airline industry must pursue rational, disciplined growth. All IAG airlines (Aer Lingus, BA, Iberia and Vueling) must meet IAG’s target Return On Invested Capital of 15%.

They guide our decisions to pursue growth, either organic or inorganic. They guide our investments in products, they guide our investments in aircraft. They guide pretty much everything we do.

(IAG CEO Willie Walsh, November 2017)

Norwegian has not done that. It has pursued very aggressive growth. Much of this has been in IAG’s home markets, most notably at London Gatwick where it is now the 3rd largest airline with 4.6 million passengers, but also Ireland and Spain.

This year, Norwegian plans to expand capacity by 40%. This compares to just 6.7% for IAG. This is despite the fact that it lost money last year. A consequence of this is that Norwegian has a weak balance sheet. It has net debt of NKr22.3bn (approximately £2bn). It has already pursued a refinancing this year and is contemplating selling off its frequent flyer programme.

IAG has long had its sights on Norwegian

IAG has been very transparent that it has been actively monitoring Norwegian, particularly its activity on long-haul, for some time.

Witness the following comments from IAG CEO Willie Walsh in 2016:

I do not mind admitting that we looked at some things Norwegian did, and I said this publicly and I said, ‘Wow, that is interesting.’ They have actually demonstrated that consumers will accept some things that people questioned whether they would work on long-haul.

IAG group airlines have made a number of competitive responses to Norwegian:

– BA has started to densify Gatwick based Boeing 777s. BA claims these have a lower seat cost than Norwegian.

– BA has matched Norwegian on a number of routes at Gatwick, such as New York JFK, Fort Lauderdale, and Oakland.

– Aer Lingus, BA and Iberia have launched unbundled “basic economy” long-haul fares

– IAG has launched a new airline brand LEVEL which currently operates from Barcelona and will launch new routes from Paris Orly later this year. LEVEL has operated Airbus A330s at launch, but has not ruled out operating the Boing 787. Strictly speaking, LEVEL does not exist an airline. It is simply a brand operated through other airlines in the IAG group.

What would IAG gain from buying Norwegian?

First of all, IAG gets to manage a competitor that has been targeting all of its major markets. In light of IAG’s financial targets, it is inevitable that IAG would immediately put the brakes on Norwegian’s growth. There would also be a rationalisation of routes. Further deliveries of new aircraft could be allocated to other IAG group airlines.

IAG would gain approximately 40 daily pairs of take-off and landing slots at Gatwick which would radically transform its presence at the airport. Of equal importance is that IAG would prevent another airline gaining these slots. easyJet gaining these slots at Gatwick in any alternative situation would be very bad for BA in London.

IAG also gains a significant presence in Northern Europe where it is relatively weak. Not just in Oslo, but also Copenhagen and Helsinki. It is likely that IAG would commit to retain the Norwegian brand. The only IAG brand at risk of disappearing is LEVEL.

Whilst Norwegian would retain a Head Office in Oslo, a lot of back office functions such as finance and IT would be merged into IAG’s “Global Business Services” platform. In addition, all future decisions about growth and aircraft orders would rest with IAG.

What would Norwegian gain from being part of IAG?

If Norwegian’s founders and its major shareholders are willing to sell it allows them a dignified and orderly exit from their investment and Norwegian would gain a financially strong parent.

From an operational perspective, Norwegian would also have the support of IAG group airlines during disruption. Whilst Norwegian is often praised for its service, there are equally loud complaints about the lack of support during disruption.

It is likely that Norwegian would join the transatlantic joint-business of American Airlines, BA, Finnair and Iberia (though Aer Lingus has not still joined) and therefore benefit from access to their distribution networks.

Its frequent flyer programme “Norwegian Reward” would adopt IAG’s “Avios” frequent flyer currency and the ability to earn and redeem Avios on other IAG airlines would increase the attractiveness of the programme.

A bid for Norwegian is not certain and does carry risk

Not only is Norwegian heavily indebted, it also has a complex operating structure. At London Gatwick Norwegian operates through three different airlines in order to secure traffic rights. Even to just bid for Norwegian, IAG would be required to carry out due diligence on all three airlines.

Norwegian and IAG group airlines currently overlap on a significant number of city pairs, notably long-haul routes from Gatwick. In order to satisfy the competition authorities, IAG would be required to offer slots at London airports to new entrants on overlapping routes. This was the case when IAG purchased bmi and Aer Lingus.

There may be local opposition in Norway to Norwegian joining IAG. However, IAG has navigated delicate issues around national interests before. When IAG bid for Aer Lingus it managed to assuage concerns about Aer Lingus and gain the support of the Irish Government by making certain commitments to protect its central management in Dublin, its routes and London Heathrow slots.

What happens next?

In its seven year history, IAG has not pursued minority stakes in airlines. It has bought stakes in airlines to acquire full ownership and control.

There may well be further market activity by IAG and possible spoiler activity by rival airlines. That said, IAG has shown before that it will act patiently to do the job properly. IAG will no doubt be asked questions by its investors when it announces its first quarter results on Friday 4 May 2018.