British Airways' pension fund deficit could yet scupper its planned merger with Spain's Iberia, as the UK airline still has to agree the size of the multi-billion pound shortfall with the fund's trustees.
Iberia, which on Friday posted a bigger than expected nine-month operating loss, agreed with BA on Thursday to create a group with a combined market value of $7 billion as they continue to battle the worst industry downturn in decades.
But BA's pension deficit was one of the main stumbling blocks in the 16-month merger talks and was a key negotiating point for Iberia, which is reserving the right to back out of the deal if the funding hole turns out to be bigger than the Ł3 billion ($5 billion) which analysts have forecast.
BA pension trustees undertook a triennial review of the pension scheme earlier this year but the results have yet to be announced, with BA saying it expects to agree a figure with the trustees in the next two to three months.
“The market will be looking at the discount rate used by BA's trustees to calculate its pension liabilities. You'd expect them to use a favorable one to help push the deal through though, especially since the deficit is bigger than its market value right now” a London-based analyst said.
“There's still a risk that the deal will fall through. It's all hanging on BA's negotiating weight with the trustees over its pension,” a Madrid-based equities sales trader said.
Some analysts said they were surprised that the terms of a deal had even been announced before the pension issue has been resolved.
Analysts believe BA could insure all or part of its liabilities through a buy-out deal with a specialized insurer or hedge specific risks such as the longevity of pensioners through a swap deal or pledge contingent assets such as its real estate.
The new company will combine British Airways' strong position in Europe-to-North America traffic with Iberia's Latin American business, and will potentially be reinforced by a planned alliance with AMR Corp's American Airlines.
So far the deal looks set to give BA shareholders 55% of the new company, effectively giving it control, but the balance of power remains in question and could shift in Iberia's favor depending on the outcome of BA's talks with trustees over its pension deficit.
The BA-Iberia format mirrors the ground-breaking 2004 merger of Air France and KLM, which airline industry executives describe as a back-office merger designed mainly to slash costs.
Under this model, the airlines would maintain their own fleets and networks, which operate under the banner of national traffic rights, but would be owned by a common holding company.
“This is a five-year plan to get through the crisis and generate cash, and then BA will firmly take the driving seat,” said Enrique Quemanda, Chief Executive of boutique investment firm ONEtoONE.
The pair, who have targeted annual synergies of about €400 million by the end of the fifth year, will combine BA's strong position in north Atlantic traffic with Iberia's Latin American business, which will potentially be reinforced by a planned alliance with American Airlines.
Britain's Unite union said on Friday it would not back the merger unless commitments are given to avoid significant job losses as both airlines seek to streamline shared functions.
“We need assurances from the outset from British Airways and Iberia that compulsory redundancies will be avoided. Our continued support for this project is dependent upon a satisfactory agreement being reached between us and both companies,” said Steve Turner, Unite's national officer for civil aviation.
BA's merger ambitions have historically been frustrated by its dominant position at London Heathrow, the world's busiest international airport, and the European Commission could still force the carrier to give up or sell take-off and landing slots there to allow a transatlantic alliance with American Airlines to go ahead.
“I'd expect the pensions issue to be more of an obstacle than getting competition clearance. I would expect Europe to welcome the creation of another big player,” said Astaire analyst Douglas McNeill.
Iberia said its loss before interest and taxes widened to €331 million, and was bigger than analysts' average forecast for a €320 million loss, as aggressive cost-cutting was not enough to compensate for a 20% fall in revenues.
“Iberia has done some aggressive campaigning to fill its planes, even at cheap fares, and margins have suffered as a result,” an analyst in Spain who asked not to be named said.
The airline swung to a net loss of €181.9 million from a €51.1 million profit a year ago as the economic crisis continued to dent passenger numbers, Iberia said on Friday.
“The airline industry in Spain is facing exceptionally difficult circumstances,” Iberia said.
Iberia carried 5.1% fewer passengers in October, while its load factor - a measure of how full its planes fly - improved to 80.6%.
British Airways posted last week posted a Ł292 million pretax loss and said predicted revenue would slump by Ł1 billion this year.
The International Air Transport Association expects airlines to lose $11 billion in 2009. (Reuters)