Airline Mergers and the Case Between BMI and Lufthansa

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Table of Contents

Introduction
Point of View of BMI
Point of View of Lufthansa
Lufthansa’s Move
Lufthansa and Sir M. Bishop
Conclusion
References

Introduction

There are various kinds of businesses around the world. There is the manufacturing business or the buying and selling type of businesses. One could also make money, not by producing or selling a product but by providing a particular type of service. The transport business allows for the movement of goods and people. And it can be argued that in this particular type of business, there is none more glamorous than the airline industry.

This is probably the reason why it is a highly competitive industry and it is very hard to make money through buying planes, maintaining them and then transporting passengers from location to the next. One business strategy that allows a company to survive is through airline mergers. In the case of BMI and Lufthansa airlines, the German firm wanted to acquire the British owned BMI. It was a logical thing to do for both companies but the “put option” exercised by a majority owner of BMI almost derailed the acquisition and it went as far as going to the court of law to resolve their problems. The following is an in-depth analysis of what transpired and how Lufthansa and BMI were able to get what they both wanted out of the deal.

This is an interesting case study because an airline merger and acquisition does not guarantee success. This is true in any type of industry but according to experts there is a reason why it would be doubly hard to make an airline merger work. First of all how can two companies merged when both had been developed using different sets of corporate values and strategies? There is a difference in corporate culture for both companies. There are also two different systems of accomplishing a particular task.

How can two become one? In one example – the merger of PSA and USAir – the employees of PSA believed that they have a better airline (Kaplan, 2000). This also means that employees of the acquired company must relearn or undergo training to learn a new mode of doing things (Kaplan, 2000). This can be the cause of a rough start and can be the cause of a small rift that will prove to be difficult to deal with at the end.

Aside from the corporate leadership point view there is also the problem of profitability. A group of researchers, who followed airline mergers, compiled their research findings and concluded that mergers can be disastrous for both companies and added, “It shows highly negative returns several years beyond the acquisition. Cumulative returns are negative three years after the acquisition for eleven of the fifteen surviving acquirers (three did not survive, three years postmerger) and twelve of fourteen acquirers had negative cumulative returns five years after the acquisition – four acquirers failed within five years of the acquisition (Kaplan, 2000). In the case of BMI and Lufthansa the acquisition was not even able to take off the ground.

There are two major problems and can be traced to a) a “put option” that came from a deal made ten years ago; and b) the global economic crisis that is affecting airlines around the world (Ebrahimi & Osborne, 2009). An option is the right and not the obligation to either buy or sell (Siegel, 1998). A “put option” on the other hand allows the holder of stock to sell it at a set price for predetermined period of time (Siegel, 1998). In the case of BMI, the majority owner Sir Michael Bishop was able to secure a deal ten years ago allowing him to have a “put option” for 50.1% of BMI shares.

The decision to have a “put option” could have been easily reached ten years ago because of the level of revenue that BMI was enjoying. In order to understand the bargaining power of BMI, a look back at their productivity level a mere four years ago will reveal that BMI operates 1,700 flights a week to destinations across Europe (Clark, 2006). Aside from that it has a handful of intercontinental routes from Manchester (Clark, 2006). This allowed BMI to carry 10.5 million passengers in 2005 alone (Clark, 2006). It would be easy to be impressed with those numbers and therefore gave BMI the leverage to command a fair price for its shares at the time when the “put option” was made.

Now, the underlying principle for a “put option” is “set price for a predetermined period” meaning the owner of stock has a guaranteed price even if the buyer sees that the market has declined. No one can claim clairvoyance when it comes to the stock market and those who entered into agreement with BMI allowing it to have a “put option” knows the risks and the rewards of such an arrangement. If the buyer can purchase the said share at a set price even if the value has gone up; that investor will make a great deal of money but if the same investor was forced to buy the same price when the value has gone down significantly then that will not be good for him or her. This is the root cause of the legal wrangling between BMI and Lufthansa.

Lufthansa tried to extricate itself out of the deal by explaining to authorities that BMI is no longer a cash cow and its value has declined in recent years. This would not be fair for any buyer. Lufthansa made it very clear that it will not agree to the original price set by BMI a long time ago. In order to force Bishop to reconsider his demands, Lufthansa countered by saying that BMI had to infuse new capital in order to increase the value of the company so it can justify its price tag.

Point of View of BMI

One has to understand that Sir Michael Bishop had to protect what he believes to be rightfully his. In order to put it into perspective it has to be pointed out that Bishop started at the very bottom of the BMI corporate ladder. He started as a baggage handler at the age of 16 (Clark, 2006). After working hard for a very long time he became the managing director of BMI (Clark, 2006). Then by a stroke of genius he borrowed 1.8 million pounds from an American dentist in order to take control of the airline with two business partners (Clark, 2006). Three men began to build British Midland Airways into one of the most highly respected airline in the country.

It all started with the BBW Partnership. It was an investment company that stands for Sir Michael Bishop, Stuart Balmforth, and John Wolfe. The trio took control of BMI when it was still known as the British Midland Airways, in 1978 (Clark, 2006).

When the took over BMI they secured a 50.1% ownership of the airline. But John Wolfe and Stuart Balmforth served as minority partners. There are many who questioned the motive behind the swift consolidation of shares. But a spokesman of Bishop downplayed the event by saying that it was all done on friendly terms and added that, “Sir Michael wants to tidy up the shareholding situation and I suppose it’s also quite convenient for their own purposes to take the cash” (Clark, 2006). Irregardless of the real reason behind the quick change in the ownership structure of BMI, it is safe to say that after the deal, BMI immediately went under the control of one man. Afterwards, Bishop exercised his authority by forcing Lufthansa into a corner.

With the decisive move to acquire the rest of the shares under the BBW Partnership and with Sir Michael as the sole owner of the said company, with 50.1% of the airline, Lufthansa had to respond to their challenge. The rest of the shares are held by Lufthansa and the Scandinavian airline SAS (Clark, 2006). This business relationship and the fact that Sir Michael Bishop has control can help explain why Sir Michael Bishop was able to secure the “put option”, the bone of contention in the 21^st century between Lufthansa and Bishop

It would be impossible to go into the details of how shareholders and the part-owners of an airline go about their business. Suffice it to say that the “put option” when it was agreed upon ten years ago, it was a deal that seemed to be advantageous for all the major shareholders such as Lufthansa and SAS. From the point of view of Bishop and BMI it is a good deal because he is assured of getting a fair price up until 2009 if he so choose to sell. The only negative consequence of agreeing into a “put option” is the possibility that if BMI’s stock will soar ten years later, the BBW Partnership and Bishop will not be able to make more money out of it.

From the point of view of Lufthansa ten years ago, the “put option” is also a good deal because if the German firm will decide to acquire it then it is only required to pay the set price as dictated by the “put option” rule. Still, it was very advantageous for Bishop because he can be assured that he will not lose money. The worst thing that can happen to him is not to be able to get a windfall in case the airline industry will experience a breakthrough and the value of its share skyrocket overnight. But on the other extreme, if the economy tumbles then Bishop is protected. Moreover, the “put option” is not an obligation to sell, therefore Bishop can delay as long as he wants and stretch the waiting period up to the last minute of the deadline. Bishop seems to have covered all the bases because he also had the right not to sell it.

It has to be reiterated that when BMI agreed to the idea of a “put option” BMI and the rest of the airline industry could not foresee a future where low demand and high fuel prices can easily force airline companies to declare bankruptcy. A few decades ago the airline industry was booming. At the height of the airline boom in Europe and America, people were excited to travel. During that period in human history people had the ability to travel long distances and can even cross the Atlantic in relative comfort and speed.

So it can be said that by agreeing to a set price, Bishop was limiting his capability to earn more. On the other hand if the price of the stock goes below the projected price then Bishop is still assured of a fair compensation for all his efforts the moment he decided to sell. This is a calculated risk for all parties involve. The price of the shares can go either way. If it goes up then the buyers will also be protected. Their bases are covered because they will not be caught by surprise the moment Bishop is ready to sell. In other words Lufthansa will know what is coming and so the corporate leaders as well as the shareholders will have plenty of time to make the right decision.

Bishop is very well aware of the strategic importance of BMI. The said company controls 11 percent of the landing and take-off slots at London’s Heathrow airport (Ernstein, 2009). BMI is only second to British Airways which controls 44% of landing and take-off slots. Bishop knew that many airline companies would like that kind of resource that they can leverage in order to increase revenue. Bishop knew that Lufthansa and other airlines are salivating to acquire BMI because they have to deal with a perennial airport problem – congestion.

Saturated airports are a recurrent problem that has to be dealt with in order to sustain a competitive advantage. An airliner that has the ability to lower its prices and offer hard-to-turn-down promos will see their competitive advantage go up in smoke because customers will be fuming mad if their flights are cancelled or delayed. It is common knowledge what delayed flights can do to the senses and how it can stress out a paying customer. If they can find a better airline, one that can assure them of timely flights then they will not hesitate to avail of their service even if it is slightly more expensive.

The right to take off and landing slots at Heathrow is made more attractive from possible suitors because of a recent development. In 2008 the “Open Skies Agreement” will be in effect and this means that there will no longer be any restricted access from the United States to Heathrow and vice versa. This restriction came in the wake of the September 11 terrorist attacks and the limited access is presumably a security measure to monitor European travelers going to the U.S. mainland. Since the restriction will be lifted this will mean more airliners and more passengers will be passing through Heathrow. Any airline company who is committed to improving their service and brand name would love nothing more than having more access to more landing and take-off slots in the busiest airport in Europe (Ernstein, 2009).

Sir Michael Bishop and BMI executives have an ace up their sleeves and they are willing to go to the trenches and fight for what to them is the right thing to do. With the “put option” as part of their arsenal BMI can go to war, so to speak, with Lufthansa and expect to come up on top. But there is a chink in their armor; the “put option” will expire after 2009. If they will fail to reach an agreement with Lufthansa or any other airline company then they too can expect to lose a ton of money. This problem has been dragging on since last quarter of 2008. So much has been wasted with unnecessary legal battles, when what is needed is to combine forces. BMI and Lufthansa must come to terms so that both firms can make more money. They can do better than when both companies are operating separately.

The preceding discussion was all about protecting the interest of BMI and why they have a legal basis to bring Lufthansa to court. This time, there is a need to look at the issue from the business point of view and why Bishop has to let go of BMI. Based on the current state of the global economy and the rising fuel prices, BMI will be hard-pressed to earn money in 2009. Bishop and BMI are in a precarious situation because as of this moment there is nothing in sight that can assure their shareholders that the airline industry will suddenly turn around and experience once again the high-profit margin of yesteryears.

In a very conservative estimation of where the industry is going it would be hard to be optimistic. In this regard Lufthansa can swoop in and pressure BMI to give in to their demands. In addition, BMI had no answer to the challenge of Lufthansa to infuse more capital into the embattled company. Bishop will have no way of producing that kind of money based on the financial loses the company had endured in recent years. This simply means that Bishop will be forced to accept a compromise deal.

Point of View of Lufthansa

A merger is not a guarantee for financial success. It has been made clear earlier how problems from personnel and operations can be a major stumbling block, preventing two companies to be merged as one. On the other hand there will come a time when there is no other choice but to consolidate by acquiring the competition. There is no sense going head-to-head with each other and in the process two companies will go down and lose everything. This is the reason why shareholders can easily agree to a takeover if this means that they can protect their investments.

In the case of Lufthansa trying to acquire BMI they needed the slots controlled by the British Firm. They also needed the other things that BMI can offer such as their loyal customer base as well as their pilots, efficient staff and various types of resources ranging from aircraft to technicians who are already well-trained to handle major airports like London’s Heathrow airport. If Lufthansa has the resources to take over another company then there is no better choice than Bishop’s BMI.

Aside from the fact that BMI has much to offer to Lufthansa, there is also the added incentive of having to only spend less because Lufthansa is already a part owner of BMI. By having 100% control of BMI, Lufthansa will be able to utilize its resources and then incorporate it to their existing operations. This is like having another set of arms to be able to accomplish another set of tasks but using only the same amount of effort.

They can manage their resources and become even more cost-efficient as compared to the time when they were merely part owners and cannot dictate BMI to adjust to their needs. One hundred percent ownership of BMI also means that they can make use of an additional 11% of landing and take-off slots in one of the busiest airports in Europe and probably the world. By acquiring BMI, Lufthansa will be able to fully develop a system that will help them achieve competitive advantage over other airline companies in Europe.

This deal will not be a walk in the park for Lufthansa. They have to be ready to go to war and then after winning it they have to take a long hard look at what they had achieved and then begin the long and arduous journey of merging two companies, using the best that BMI can offer and then discarding the rest. In these tough times Lufthansa can either increase their revenue and strengthen their position or become the laughingstock of the industry. There are many reasons why they must proceed with caution.

Lufthansa need not look far in order to understand the kind of problems that they may face in the aftermath of acquiring BMI. In the beginning of 2007 cabin-crew employees at British Airways (“BA”) complained about pay and working conditions (Smith, 2007). This resulted in flight cancellations that cost BA $150 million. One hundred and fifty million dollars is not something that one can pick up in the streets. The company had to expend a great deal of resources in order to earn that kind of money and with just one episode of misunderstanding what could have been money in the bank was lost unceremoniously.

Even if Lufthansa is committed to make things work for BMI employees there are still many obstacles ahead that needed to be cleared up before they can proceed. The first major roadblock is the “put option” that Bishop is dangling in court. Sir Bishop claims that he can force Lufthansa to buy the 50% plus one share stake of BMI to the German firm which is also another major owner of BMI. There is no need to go into the nuts and bolts of the airline business but suffice it to say that Bishop exercised the “put option” to ensure that he will not end up a loser.

On the other hand Lufthansa agreed to the deal ten years ago knowing that BMI has something to offer major airlines raring to acquire it. But with the current global financial crisis and the reluctance of travelers to take on that much needed vacation and fly using services of BMI, tough times are ahead and this can affect the bargaining power of BMI.

Even if Lufthansa can persuade Sir Michael to acquiesce they still have to make a lot of adjustments before they can say that the acquisition was a successful business move. Everyone, from employees to executives on both sides must be in agreement. Lufthansa can be easily dragged down with employee bickering and there could even be labor strikes that can be very counterproductive. If BMI employees cannot see that their lives are improving under new management they might resort to this kind of tactics. Lufthansa had to deal with these problems and not simply focus on making money. The company had to make a decision whether it is worth it to invest in BMI or not.

Lufthansa had to take one step at a time on the other hand it must also be revealed that Lufthansa already made a commitment a long time ago that there is nothing as important as acquiring BMI. If this is not the case then why is it that Bishop was able to compel them to honor the agreement made ten years ago? Lufthansa is saying that it has no obligation to honor an agreement because the “item” sold to them is not what they have expected when they agree on purchasing it after a certain period of time.

One way to understand the position of Lufthansa is from the point of view of a company who wanted to become a major player in the global airline industry. But it also be argued that Lufthansa’s back is against the wall so to speak. This is simply because Lufthansa is not an outsider looking in. Lufthansa is one of the major shareholders of BMI. It does not have control of the company but it is heavily invested into it.

This means that Lufthansa will have to answer to its shareholders if ever the BMI deal is dead on the water or if BMI continues to lose moneya and the German firm cannot do anything about it. In other words if BMI will lose money then Lufthansa will also lose money. This acquisition is not only about making money in the long-term but it is also about saving money in the short-term. If one can see BMI as about to implode due to anemic performance in the past couple years then from this perspective one can also say that Lufthansa is now forced into a position where it must be save the ailing company from sinking even deeper.

Lufthansa’s Move

The first major move is to finalize an out-of-court settlement with Sir Michael and BMI. There is no sense in engaging with a protracted legal battle with Bishop. Based on information made available regarding “put option” and the strategic value of BMI there is no need to go into a lengthy court procedure to determine that Lufthansa is more than willing to buy BMI while on the other hand, it is in the best interest of Bishop to sell a wobbling company. Bishop does not have the clout and the market share of Lufthansa to re-engineer his company and make it one of the “big boys” in the European airline industry. He had to sell because the “put option” will expire soon and he could end up with nothing.

Lufthansa must go to the authorities to make them understand that when the deal was made ten years ago, the status and profitability of BMI was never in doubt. In fact, based on old data they had nothing but praise for BMI and its potential to make more money for its shareholders. This is no longer true in 2009. Thus, Lufthansa can argue that since the value of BMI was radically altered then it follows that the German firm is no longer bound to any agreement made in the past. In order for the previous agreement to be enforced then both buyer and seller must be looking at the same product as it was offered ten years ago. It is like buying a car in advance. The seller has provided the specifications and what can be generally expected from the seller.

In the case of BMI the product that was on sale was not really something as tangible as a car or a piece of equipment. It was a company whose value fluctuates on a daily basis. In other words BMI promised to deliver a particular “product” and now when the delivery date is near the buyer was surprised to find out that what will be delivered is something entirely different from what was agree upon years ago. Thus, Lufthansa must be released from a supposedly binding agreement.

Anticipating the legal quagmire it has brought unto itself, Lufthansa must convince Bishop that they can both emerge winners by agreeing to a compromise. Time is of the essence and further delay will lead both companies to increasing pressure from their investors and various stakeholders. They have to act fast before other companies can crash into their party. Since Lufthansa is a part-owner of BMI it needed only to deal with the “put option” and the rest of the shares that it has to acquire to have 100 percent control. It must reduce the asking price of Sir Michael so that it will have enough cash reserves to buy every share of BMI in order to have full ownership and control.

Lufthansa and Sir M. Bishop

When Sir Michael and Lufthansa agreed on a compromise deal and an out-of-court settlement they were merely doing what is right. For both parties the bottom line is the most important and both are well aware that they needed to merge the two companies. It was all a matter of agreeing on the right price and when that was settled both parties were eager to sign on the dotted line. The much anticipated deal was formally announced by Lufthansa in June of 2009. Interestingly though, it is not the only announcement they made. The German airline company also confirmed that they are going to enter into a partnership with Brussels Airlines (Ernstein, 2009).

This suggests that Lufthansa is not merely looking at acquiring BMI to strengthen their position in Europe but they are already thinking a few steps ahead in order to capitalize on their new acquisition. From different angles, BMI’s exclusive access to 11% of take-off and landing slots at Heathrow is a very important factor to be considered in order to understand the mindset of Lufthansa.

Compromise is needed so both parties can move forward. There is no sense in waiting for the next best deal to come. Lufthansa will lose money in the long run while Bishop also cannot improve the efficiency of the company due to the lack of necessary funds for doing so. Bishop could not even afford the initial demand of Lufthansa that it should inject fresh capital into the ailing British airliner. Both parties were able to determine where the middle line is and the amount of money needed to transfer hands so that they can proceed to the next step of the process.

Lufthansa knew early on that the legal battle is merely the beginning and that even if they already paid their dues they will still have to wait for all the necessary rules and regulations are followed and observed before the airline can be fully-owned by the German firm. There is therefore no time to lose and if the deal is expected to happen then there is no better time than today.

In the said compromise deal Sir Michael agreed to let go of his “put option” and will no longer badger Lufthansa for paying him the exact amount stipulated on that deal. Bishop will not bother Lufthansa with his demand for a fresh infusion of capital to troubled BMI. For his troubles, Lufthansa paid him 175 million pounds (Ernstein, 2009). On top of that Lufthansa will acquire the entire stake held by Bishop for approximately 48 million pounds as of July 1, 2009 (Ernstein, 2009). This money is not something that can be taken lightly. With his fortune and the money he has made with the BMI deal, Sir Michael Bishop can easily acquire another small firm and turn it around just like what he did with British Midland Airways.

Without a doubt the deal will create a ripple effect in the European Union and in the whole European airline industry. Lufthansa has never been a small player but with the acquisition of BMI the competitive advantage of the German firm has multiplied if one will consider two major factors. Firstly, Lufthansa was very aggressive in making it known that it will buyout SAS in order to have 100% ownership of BMI. Then afterwards it has also made known its intention to partner with Brussels Airlines. This means that whatever Lufthansa gained from buying up BMI can be multiplied because of its ability to cover more routes as well as access to one of the busiest airports in the world, London’s Heathrow.

By having full control of BMI, this will enable Lufthansa full discretion on how to properly utilize the access to 11 percent of the landing and take-off slots at Heathrow airport. With its partnership with other airlines as well as other valuable acquisitions, Lufthansa can leverage the resources under its control so that it can become a more cost-efficient airline company. With the resources mentioned earlier it can be argued that Lufthansa will be able to deal with one of the perennial problems faced by major airlines traversing through very busy airports.

Conclusion

The legal wrangling between Lufthansa and BMI can be traced to a “put option” that both companies agreed upon ten years ago. The unique deal was made possible by two factors first, the long history of success of BMI as one of the major British airline company in Europe. Secondly, Lufthansa is also a major shareholder in BMI. When Sir Michael Bishop made a move to acquire control of BMI he exercised his right to sell the shares of BMI to Lufthansa. When the German firm balked then Bishop had no choice but to sue Lufthansa in order to protect his interest. But upon closer examination both companies cannot afford to engage in a protracted legal battle.

The corporate leaders of both BMI and Lufthansa must answer to their investors and various stakeholders as to why they cannot reduce the amount of money lost on an annual basis. By acquiring BMI, both companies will strengthen their position. On the part of BMI it will be under the control of Lufthansa one of the most capable and respected airline company in the world. On the part of Lufthansa the acquisition of BMI is like acquiring an extra set of tools that can help in creating a more cost-efficient airline company.

References

Clark, Andrew. (2006) Bishop Strengthens his Grip on Wobbling BMI. Web.

Ebrahimi, Helia & Alistair Osborne. (2009) BMI chairman Sir Michael Bishop goes to court to force Lufthansa to buy his stake. Web.

Ernstein, Burt. Lufthansa Reach Deal with BMI’s Bishop. Web.

Kaplan, Steven. (2000) Mergers and Productivity. IL: University of Chicago Press.

Maxon, Terry. (2009) Lufthansa Works Deal to Eventually Acquire BMI. Web.

Siegel, Joel. (1998) Schaum’s Quick Guide to Business Formulas. New York: McGraw-Hill.

Smith, Adam. (2007) Cabin Pressure. Time. Web.

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