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(Updates with makeup of BMI fleet in 15th paragraph, closing share prices in sixth and 12th.)
Nov. 4 (Bloomberg) -- British Airways parent IAG closed in on a deal to buy Deutsche Lufthansa AG’s U.K.-based BMI unit as it seeks a bigger share of the lucrative business-travel market at London Heathrow airport after third-quarter profit slumped.
IAG reached an agreement in principle for the purchase, with the closing of the transaction subject to due diligence and gaining regulatory clearances, it said today in a statement, without disclosing a price. The whole of BMI may be worth 248 million pounds ($397 million), Citigroup Inc. has estimated.
Buying BMI would bring access to the 8.5 percent of takeoff and landing slots that IAG controls at capacity-constrained Heathrow. Adding flights at Europe’s busiest airport will boost the number of corporate passengers, lifting margins after fuel costs and slowing demand cut quarterly earnings by 31 percent.
“The Heathrow slots are the fundamental attraction of BMI,” said John Strickland, an aviation analyst at JLS Consulting in London. “This is a one-shot chance and will give British Airways room for growth in the short and medium terms.”
IAG, as International Consolidated Airlines Group SA is know, said third quarter operating profit dropped to 363 million euros ($502 million) from 528 million euros a year earlier. Analysts had expected a figure of 424 million euros.
Shares of the London-based company closed 6.8 percent lower at 156.90 pence in London, valuing the company at 2.9 billion pounds. IAG has slumped 44 percent since its formation on Jan. 24, the second-worst performance over that period in the six- member Bloomberg EMEA Airlines Index, which is down 333 percent.
Chief Executive Officer Willie Walsh said IAG wants Castle Donington, England-based BMI for its mainline operations at Heathrow, and will use the purchase to expand its own long-haul network, particularly on routes to Asia and Latin America.
“It’s a great story for IAG, a fantastic story for the U.K. economy and great for consumers because it’s clear BMI in its current form is unsustainable,” Walsh said on a conference call. “The losses encountered in recent years have been massive.”
IAG will consider what to do with the bmibaby discount unit, but isn’t interested in a regional division which is based in Aberdeen, Scotland, and provides flights between secondary cities using smaller planes, spokeswoman Lorena Monsalves said.
Cologne-based Lufthansa said Oct. 28 it was in “advanced” talks to sell BMI Regional to investors previously associated with that part of the airline industry.
Citigroup analyst Andrew Light said in a note on Sept. 21 that BMI’s Heathrow slots could fetch between 264 million pounds and 396 million pounds. London-based Light said the regional division was worth as much as 100 million pounds and that bmibaby had zero value, while BMI also had 50 million pounds of net debt and a 180 million-pound pension deficit.
Lufthansa, which fell 3.1 percent to 10.1 euros today in Frankfurt trading, said the European Union has already been approached regarding regulatory clearance and that approval is anticipated in the first quarter of next year. IAG offered the “best deal” for BMI and regulatory clearance for the transaction is expected in the first quarter of next year, it added.
“We have been analyzing various strategic options,” spokesman Klaus Walther said on a press call. “A sale is the most promising solution for all parties involved. It gives new future prospects for BMI and its employees.”
The British Airline Pilots’ Association said today that news of an IAG takeover of BMI was “encouraging” in terms of safeguarding the jobs, careers and pension of flight crew, and that the union generally favors a deal involving a U.K. carrier.
BMI has 60 planes, spokeswoman Jo Tabberer said in an e- mail, comprising 25 Airbus SAS A320-series narrowbodies and two widebody A330s at the main airline, 14 Boeing Co. 737 at the discount division and 19 Embraer SA jets at the regional unit.
The GMB, which represents other staff, said it has had talks with BMI CEO in recent weeks, though it has some concerns.
U.K. billionaire Richard Branson’s Virgin Atlantic Airways Ltd. also made an offer for BMI and remains committed to an acquisition, it said in a statement today, adding that British Airways is “already too dominant” at Heathrow and that competition authorities should be concerned.
Walsh said regulatory rules “are not set by Mr. Branson,” and that he’s confident the deal will clear antitrust hurdles, since IAG will still control a smaller proportion of slots at Heathrow than its rivals do at their main bases.
No Other Bids
The purchase will give IAG 53 percent of takeoff and landing positions at its hub, compared with Lufthansa’s 56 percent of slots in Frankfurt and Air France-KLM Group’s holdings of 59 percent in Paris and 57 percent in Amsterdam.
IAG is currently “not active” in pursuing bids other than for BMI, Walsh told analysts on a conference. A planned sale of TAP SGPS SA by the Portuguese government, in which he has expressed an interest, is “unlikely to start anytime soon.”
Full-year earnings will be “around double” last year’s number, IAG said today. BA and Iberia had a pro forma operating profit of 6 million euros in the fourth quarter -- or 196 million euros excluding items -- and a 12-month figure of 225 million euros, according to figures released after their merger.
Walsh had said Oct. 18 he was expecting “significant growth” in annual earnings.
“High fuel costs continue to have a significant impact on our business,” Walsh said in the statement. “The main challenge for 2012 will be to offset increased fuel costs as our hedges unwind against a background of potentially weaker demand.”
Fuel prices have risen 25 percent since the start of 2011, and carriers lack the pricing power to recover the full impact, the International Air Transport Association has said.
IAG’s October traffic gained 1.9 percent as the carrier added 2.7 percent more capacity, it said today. Growth in premium bookings tumbled to 1.9 percent from 9.3 percent in September, while coach-class travel rose 1.8 percent, slowing from a 3.5 percent increase a month earlier.
Still, IAG is gaining market share in the long-haul premium market and its trans-Atlantic joint venture with AMR Corp.’s American Airlines is performing “better than we thought,” Walsh said, while the Japanese market is staging a faster-than- expected recovery from the earthquake and tsunami. The carrier is also looking at resuming services to Libya, he said.
Operating profit at Lufthansa dropped 27 percent in the third quarter to 575 million euros, Europe’s second-biggest airline said Oct. 27, while reiterating that it’s seeking annual earnings in “the upper three-figure million euro range.”
Air France-KLM, the region’s largest airline, reduced its annual earnings target in July, saying it aims to break even versus a year-earlier operating profit of 28 million euros. The Paris-based carrier reports third-quarter numbers on Nov. 9.
Industrywide profit will drop by more than half this year and 40 percent in 2012, with a downside risk, IATA says.
Carriers have put the brake on capacity increases this winter, with Lufthansa slowing expansion first from 12 percent versus a year earlier to 6 percent and finally 4 percent. Air France-KLM will add only 3.4 percent more seats after cutting long-haul growth by almost half to 2.6 percent.
IAG has said it’s cutting back on so-called “flexible capacity” in the final three months of this year, reducing the overall increase by one-quarter to 6 percent.
--Editors: Chris Jasper, Chad Thomas.
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