British Airways PLC's estimated £2.7 billion pension deficit could still become a hurdle in the merger talks with Iberia Líneas Aereas de Espana SA, but it probably won't be an insurmountable one.
Consultants and analysts following the talks believe officials with Madrid-based Iberia will ultimately put the firm's survival ahead of concerns about future BA pension liabilities, despite the potential risk the massive deficit might have on the combined company's balance sheet.
“It still is a difficult issue conceptually in as far as Iberia is concerned,” said Nicholas Cunningham, analyst at Evolution Securities Ltd. in London, who covers the airline industry. Company officials realize that the value of the deficit “will affect the joint company's share price,” he said.
Iberia needs to complete the deal for its own economic sake. Iberia is “too small to remain independent,” Mr. Cunningham added, “and if they look around at the potential partners that can bring scale, BA is just about the only game in town.”
As of Sept. 30, London-based BA had about £12.2 ($20.2 billion) in pension assets globally.
Its pension deficit is valued around £2.7 billion while the company's market capitalization is about £2.4 billion, leading one competitor to dub BA as “a pension deficit with wings.” Iberia's pension obligations fall under Spain's public pension system, which is funded by contributions from employers and employees nationwide; therefore, the airline has no pension liabilities on its balance sheet.
On Nov. 12, BA and Iberia announced plans to merge. If completed, the transaction would create a new company called TopCo, with BA shareholders likely to take a 55% stake.
According to a clause in the agreement, “Iberia will be entitled to terminate the merger agreement if the outcome of the discussion between British Airways and its pension trustees is not, in Iberia's reasonable opinion, satisfactory because it is materially detrimental to the economic premises of the proposed merger.”
Iberia has appointed Mercer LLC, London, to advise on the pension issues. BA officials are prepared to assuage Iberia shareholders, according to consultants who spoke on the condition that they not be identified. The BA proposals might include:
• TopCo “will not provide any guarantee or use any cash or credit facilities to fund the BA pension schemes,” according to the announced agreement. The consultants said one way of accomplishing that goal is to “ring-fence,” or separate, the pension liabilities from the combined company's liabilities for a period of five years.
• BA officials might also propose extending its annual contributions of about £280 million for longer than the 10-year period initially agreed with U.K. regulators in 2007 to improve pension funding levels.
• Another option, albeit more politically challenging, is to freeze the BA fund, according to one consultant. “Any scheme that is closed to new members eventually will be closed to new accruals ... and BA is no exception,” the consultant said. BA closed its two defined benefit plans — the £7.3 New Airways Pension Scheme and the £6.2 Airways Pension Scheme, both of London — to new members in 2003.