Flying high or wings clipped? Analysts brace for airline merger

SHARES in the new British Airways/Iberia airline giant will taxi down the stock market runway tomorrow, but the City jury remains stubbornly out on whether it will fly high or hit turbulence.

Supporters say International Airlines Group (IAG) will get a twin-engined boost from the 339m of synergies in the airline marriage, and from a more benign sector backdrop.

The stock market bulls say the merger of two big and basically well-run European flag carriers was the logical response to a prolonged and painful economic downturn.

BA, for instance, only recently swung back into the black after two years of losses, partly triggered by the 2008-9 recession that hit both business and leisure travel.

The new business combination is also seen in many quarters as being better able to repel rising competition from budget airlines such as Ryanair and EasyJet.

Analysts with buy recommendations on the stock also point out that IAG will surely benefit from its joint venture with American Airlines on money-spinning transatlantic routes.

Consumer groups, meanwhile, have been generally supportive of the merger between BA and Iberia, suggesting it won't push up prices and therefore will be unlikely to have passengers flocking to rivals.

But optimism about the merger is not universal. Critics say there are headwinds for IAG in 2011 and beyond. According to this camp, it would be shrewder for investors to keep their safety belts fastened until the view from the British/Spanish cockpit is clearer.

The bears point to the uncertainty that surrounds the execution of any big merger.

The case for steering clear of IAG's shares points to a still difficult economic backdrop. Fears of a double-dip recession in both the US and Europe are impossible to completely rule out.

Meanwhile, experts say the price of oil is expected to hover about $100 a barrel, or go significantly higher, which is hardly good news for airlines. It is estimated that 30 per cent of an airline's cost base is fuel, and doubters say the current vertiginous prices are an unhelpful environment for a new airline player such as IAG to launch.

They also point to the saga of the BA cabin crew strike being far from resolved. Will that industrial action, commercially hurtful and debilitating for morale, be like a lead weight on the new entity?

Douglas McNeill, transport analyst with Charles Stanley, has put a "reduce" recommendation on the shares, which are expected to start trading tomorrow at 282.5p, the price at which BA's were suspended last Thursday.

"We think IAG's management is good and the strategy is right, and the stock market shares that view," says McNeill. "But we believe the market is getting carried away in the assessment of the benefits of the tie-up.

"They are taking an optimistic view of the revenue synergies that can be achieved in both the initial merger and then with the joint venture with American Airlines."

McNeill says it is possible bulls will be vindicated but he is concerned "they are pricing in plain selling in which everything [in the integration of the British and American flag carriers] goes well."

He adds: "Mergers can be difficult things to pull off. There's execution risk at IAG, but the market is currently discounting that risk."

Others are more sanguine about the new group's prospects. One analyst says: "The airline industry started recovering last year, but a lot of it was lost because of special one-off factors such as the volcanic ash that closed airports and really hit bottom lines.

"In BA's case it also took a big hit from the strike action by cabin crews and lost days of income. We are now further out of recession, though, and so you could argue that IAG is launching on the front foot, particularly if BA can sort out its cabin crew problems.

"It will get substantial synergies from the merger at just the time there is also something of an industry-led recovery, and we are unlikely to have the wild card of volcanic ash disrupting everything again."

One fly in the ointment, however, is that sorting out that cabin crew strike, which has so far cost BA 150m, may be harder than thought. The Unite union voted in favour of industrial action again on Friday for the fourth time in 13 months.