Aviation: The battle for BEE

Over the weekend it was reported that International Airlines Group (IAG, parent of British Airways) was entering the fray, increasing the possibility that the fight to acquire Flybe (flight code BEE) might involve IAG's CEO Willy Walsh sparring with his arch-rival at Virgin Group, Sir Richard Branson. Such could become the stuff of airline legend as both men have big egos, but each now have their ambitions fettered by wider interests. In fact IAG has not even formally declared that it is throwing its hat into the ring yet, although some pundits see it as favourite to win the battle. Whatever unfolds over the days ahead, the possibility of a bidding war has already sent Flybe’s share price soaring – by lunchtime on Monday November 26 it was trading just over £0.22 while at its nadir ten days earlier the price was just under £0.09.

So the obvious question is: are these two potential suitors serious, and what could Flybe bring to either of them?

FlyAG?

Firstly IAG. It is a multi-airline conglomerate that already owns British Airways, Ireland’s Aer Lingus, Spain’s Iberia and several smaller carriers including some in the budget and regional sectors. The group’s British Airways (BA) and BA Cityflyer operations are already well entrenched at London Heathrow, London Gatwick and London City, at each of which Flybe also holds slots. British Airways and its partners get very little domestic feed from Flybe, which prefers to channel its passengers onto BA’s rivals.

It seems almost inevitable that an IAG takeover of Flybe would face an investigation by the Competition and Markets Authority (CMA), much as its acquisition of bmi did six years ago. The likely outcome would be the surrender of another tranche of slots at BA’s key hubs, potentially opening the door to alternative and maybe stronger competition. Meanwhile, British Airways has largely forsaken the UK regional airports such as Belfast, Birmingham, Manchester and Glasgow, the only exception being links to London. So it’s difficult to see what positive impact acquiring of Flybe would have on IAG’s existing businesses. On the other hand IAG may see an underlying potential in Flybe – the latest accounts do point to some light at the end of the tunnel if it was rid of costly leases and onerous finance charges, while it could also gain from the better dollar-based fuel purchase rates that can be achieved by a much larger group. So if it could be turned around, Flybe might become a valuable stand-alone member of the group.

Flyve?

Virgin Atlantic on the other hand is only a long haul carrier with routes radiating out from London Heathrow, London Gatwick, Manchester, and to a lesser extent Glasgow and Belfast. It already has codeshare agreements with Flybe that channel passengers from some smaller UK airports through Manchester in particular and Heathrow to a lesser extent, onto its transatlantic services. Acquisition of Flybe would undoubtedly strengthen those connections, while losing to IAG could weaken them. Furthermore, Virgin is part-owned by Delta Air Lines of the USA (49%) and [soon] Air France / KLM (31%). Air France / KLM in particular is locked in a battle with IAG for European market share using links from its bases in Paris and Amsterdam to UK regional airports. It just happens that Flybe has a large at slot holding at both European hubs, through which it has the potential to carry passengers travelling between Exeter, Norwich, Southampton or East Midlands (to name just a few) and Asia, Africa or the Americas.

But Virgin and Flybe are geographically separated with headquarters in Crawley and Exeter respectively. They also have somewhat different business models and cultures. Has Virgin got the strength to take on Flybe? Sir RIchard doesn't rule the roost quite as much these days, so are his partners European and American partners prepared to bankroll Virgin through what would undoubtedly be a complex and time consuming acquisition?

What next?

Clearly Virgin Atlantic - along with its partners - has the most to gain from acquiring Flybe. But Virgin hasn’t been overly successful itself when it comes to profits over the last few years. Taking over another airline which carries more passengers and has a much more complex network, turning it around and making the sum of the two successful, could be risky. So Virgin has more to gain from Flybe – but also more to lose, especially financially, if merging two diverse organisations proves to be challenging.

Wild-card Stobart Air made a bid for Flybe earlier in the year and still has to decide whether it will make another approach. It is much smaller than IAG or Virgin and could find an acquisition on the scale of Flybe very challenging. On the other hand IAG has experience within to turn Flybe around even if that means stripping out the profitable core and dumping the rest – assuming the CMA didn’t impose too many onerous conditions. But does IAG really need Flybe? Perhaps it is just making mischief in the hope that will increase the price another suitor has to pay? Maybe it sees the acquisition of Flybe as a chance to block any expansionist aims in its rivals?

No money has changed hands yet, and indeed two of the parties involved – Flybe and Virgin – have gone on record as saying there is no guarantee a deal will be done. The Aviation Oracle thinks this one is too difficult to call right now. The winners so far are the Flybe shareholders, who have seen their investments more than double in less than two weeks. The Flybe share price is still a long way from its peak of £1.46 almost four and a half years ago, but at least its heading in the right direction.