Taking a brief look on the economic development in Europe up to the year 2008 reveals high GDP growth rates and reminds us about the times of prosperity that we almost all so nostalgically recall. But Austrian Airlines have never seen any boom in revenues, profits and the number of transported passengers. This alone is a reason for big concern as airlines have never been a counter-cyclical business. If the company is unable to sustain itself in the times of prosperity what loss will they carry in the books in the times of economic downswing?
Finding a powerful strategic partner seems like inevitable for the Austrian company. In 2008 Austrian Airlines was the 11th biggest airlines in Europe with 10,7 million passengers and 2,5€ billion in revenues. On the other side Lufthansa has 7 times more passengers and makes 10 times more money in revenues. Putting these two categories into relation shows how company? s size creates numerous benefits, particularly financial ones. In 2008 Austrian Airlines had revenue of 233€ per passenger while Lufthansa attained 357€ per passenger.
Now it is obvious how size matters and that synergies create great cost-cutting potential and increase profitability. If Lufthansa manages to bring Austrian Airlines to its own level of profitability they would have EBIT of 140€ million if the expenses and passenger number stay on 2008 levels. Not to mention the strategic benefits of this acquisition, and probable Lufthansa? s ability to make use of synergy effects i. e. to cut costs and sell even more flight tickets thanks to wide-spread sales offices all over the world.
Acquiring Austrian Airlines proves as lucrative for a Lufthansa if they transform the company and as a good deal for current shareholders who can count on even more losses if Austrian Airlines decide to pursue stand-alone strategy which means that they will eventually lose all the capital they put up . This simple analysis show why did consolidation wave in airlines industry pick up on speed. It really seems that main task for carriers is to get big as fast as they can or to face with a demise of their business.
Immediate recapitalization of Austrian Airlines in the amount of 500€ million just supports above statement as even the biggest European airline would be unable to cover such a huge accumulated loss if it weren? t for the help of the Austrian government and the European Union. Lufthansa plans to take advantage of the Austrian Airlines? geographic location and their know-how and expertise in CEE and Middle East. After the fall of communism in Europe Austria has played a crucial role as a gateway to Eastern and Southeastern Europe.
Austrian Airlines took its business one step further and established new core market in the Middle East. For an international company like Lufthansa Austrian Airlines represents a cornerstone in the expansion towards Middle Eastern and Asian markets. Austrian Airlines is a first mover in CEE and Middle East and a market leader with 61 destinations in the region whose expertise in the Eastern markets will be of a great use ones Lufthansa decides to go East more aggressively as Austrian Airlines will share their core competence with the group.
Cutting overlapping flights and optimization of its joint offer and sales activities will improve Austrian Airlines business activity right away. Further developing of Austrian? s successful hub system at Vienna airport will also bring positive effects in the long run. Since Lufthansa and Austrian Airlines are old partners within the framework of the Star Alliance and they know each other very well integration in the Lufthansa Group should play out without major obstacles.
Companies cooperated within the context of a bilateral joint venture for Austrian-German flight traffic as well as in the important foreign markets of Switzerland and Brussels. Even their technical services have been cooperating closely and that is also one of the reasons why Austrian executives have trust in Lufthansa and why did they choose exactly Lufthansa among 12 initial bidders. Companies expect to be able to exploit extensive synergies and assess these to amount to 40€ million in cost savings and additional revenues.
Apart from all this, Lufthansa has assured Austrian Airlines that they will be granted extensive autonomy within the group and that they will preserve their Austrian identity which stands for quality and Austrian hospitality. Vienna will remain the hub of all flight operations, so that Austria will continue to feature very good international flight connections. Its central position in the heart of Europe made it easier for Lufthansa to grant them autonomy. No major downsizing of the fleet is planned which would be unthinkable if they wanted to pursue stand-alone strategy.
On an organizational level, Austrian Airlines will operate as a profit center within the Lufthansa Group what represents a great incentive to get out of the red once and for all. As a part of Lufthansa Group Austrian Airlines will easier protect its position on the market if the recession hits the economy in 2009 because smaller carriers which are not supported by a strong corporate parent will struggle with insufficient resources and declining passenger numbers. As it will soon become apparent, Austrian Airlines shareholders, especially Republic of Austria, will sign a great deal if transaction proceeds.
Keeping independence among the group, operating under its distinguishing identity while improving quality and profitability of its services sounds almost incredible for the company which could declare bankruptcy if it weren? t for its strategic partner. Considering current situation both sides could profit from the transaction. Moreover, the integration in the Lufthansa Group will provide Austrian Airlines with access to new passenger flows and enable them to more effectively build up international brand awareness and be Austrian ambassador all over the world which will strengthen their business model.
Lufthansa? s worldwide presence, their size, lobbying power and relationship with gasoline sellers will be of great help to Austrian Airlines. In the light of the bleak economic prospect for 2009 Austrian Airlines can focus on their core business knowing that Lufthansa watches their back. This strategy could work well as Austrian Airlines received numerous awards in 2008 including the so-called “Oscars” of the industry and a first place ranking as the best airline in Europe according to a survey carried out by “Capital” magazine. Austrian Airlines have a reliability rate of over 99. % and is among top five most punctual carriers in Europe and could improve Lufthansa? s business model too by sharing their expertise.
A fully restructured Austrian Airlines will be forced to become a thriving member of the Lufthansa Group once the company is aware that the Republic of Austria will not back them up if anything goes down the drain. Concerning a history of mutual cooperation between Lufthansa and Austrian Airlines executives in charge need to be particularly careful to avoid accusations of conflicting self-interest as these may arise due to close ties between two companies.
Since there were 11 other bidders at the start and Lufthansa was chosen in the end both parties need to be adequately informed about all facts relevant to this transaction so that they can clearly explain why is this transaction undisputedly the best possible solution for both sides. Considering that Lufthansa is taking over a company which made huge losses in the past years and whose balance sheet reveals equity ratio of just 11% (which is appalling even for a bank) strategic rationale needs to be explained clearly and concisely together with all future advantages because otherwise someone could think acquisition is completely irrational.
Even after the restructuring aid Austrian Airlines will remain highly indebted and Lufthansa? s executives have to justify their reasoning by outlining benefits. Transaction Overview After signing initial agreements (CA;LOI) which provide a foundation for any further steps, Framework Agreement is often cited in the underlying Voluntary Public Offer. Basic arrangements between parties should be outlined in the letter of intent and then once more stipulated in the Framework Agreement.
The underlying Voluntary Public Takeover offer stipulates conditions precedent which are to be fulfilled before closing. From that reason they all represent potential deal-breakers since there is a possibility that some of them will not be fulfilled. According to Framework Agreement an extraordinary shareholders meeting will be called just before the closing of the Share Purchase Agreement so that recapitalization can be authorized, new supervisory board appointed and articles of association amended.
In order to mitigate any negative impact of information leakage on the transaction Lufthansa and Austrian Airlines had signed a confidentiality agreement. Both parties are obliged to use confidential information just for the purposes of the ongoing transaction and will not disclose any information to the third parties in order not to bring any company in an unfavorable position. Letter of intent is a second important document signed which outlines Lufthansa? intentions and give an overview of the basic transaction, purchase price, determines break-up fee and division of costs incurred as well as court under which jurisdiction any disputes will be solved. For Lufthansa it is of extreme importance to include an exclusive dealing clause so that Austrian Airlines obliges to negotiate just with Lufthansa and no one else at the time. Since Lufthansa plans to take over a company in an extremely bad shape it would be inappropriate of Austrian Airlines not to bring in all their energy and focus to close the deal.
Letter of intention needs to include details about a stake purchase and subsequent mandatory public offer. The details of the purchase price (maximum 4,49€ per share) should also be included i. e. the price paid for the 41,56 % of shares held by Osterreichische Industrieholding AG which includes the details on the earn-out option (under which conditions will Lufthansa pay an amount of up to 162€ million depending on Austrian Airlines? future economic performance and on the outperformance of the Lufthansa? s share price).
It should also stipulate the conditions of the offer given to a minor shareholders so that Lufthansa holds at least 75% of the permanent voting shares (without consideration of the treasury shares) in Austrian Airlines after the end of the initial acceptance period. Lufhansa? s intention to fully take over Austrian Airlines should be clearly pointed out particularly their wish to acquire 90% of all shares so that they can launch a squeeze-out. The important conditions precedent should be included in the Letter of Intent.
Approval by the competent antitrust authorities in the European Union and other countries should be right away designated as “conditio sine qua non”. Approval of the restructuring aid is also deemed as extremely important and it should be stipulated in the Letter of Intent as 500€ million granted by the state of Austria and the European Union are absolutely necessary to compensate for the negative shareholder value of Austrian Airlines and make Lufthansa willing to take them over. Recapitalization will also further dilute the free float shareholders making it easier for Lufthansa to launch a squeeze-out procedure.
Letter of intent should also arrange who bears the break-up cost in the case of a regulatory disapproval. This is seen as one of the major risk since Lufthansa and Austrian Airlines partly operate the same lines and consolidation would lead to a further concentration of power. Considering negative financial results of the Austrian Airlines letter of intent should already include frame of the future executive structure while definitive agreement should include exact top-management structure in the Austrian Airlines which will facilitate integration in the Lufthansa group and turn around the profitability.
Since Shareholders Agreement of Austrian Airlines syndicate had already dealt with issue it might be a bit cumbersome renegotiating it. Letter of intent should also state that Lufthansa has no intention whatsoever to dismantle Austrian Airlines i. e. that brand, headquarters and route network favoring Austrian national interests will be kept. Lufthansa should try to avoid the matter of employment until the very end (final agreement) so that they are not bound by pre-signed clauses once they negotiate the final contract because restructuring of the Austrian Airlines is necessary by all means.
Considering that Lufthansa is the biggest European airline company it the approval of antitrust authorities will not come smoothly. Second condition precedent, approval of 500€ million is not deemed as problematic as this pay-out coincides with Austrian national interests to preserve a national carrier which serves its interest. (Besides it wouldn? t make almost any sense for the European Union to grant the acquisition but rejects the aid. ) Acquiring Austrian Airlines will only increase Lufthansa? s size and market power.
Holding such a dominant position could incite abusing it e. g. by charging unfair prices or refusing to innovate. This horizontal agreement will put competition in an unfavorable position but on the other hand Lufthansa can argue that consolidation in the European airline industry is inevitable. However, only consolidation will ensure survival of the European airlines in the long run, fragmented market structure leaves them susceptible to either bankruptcy or takeover by Asian od American airlines who are fortunately by law not allowed to be major shareholders.
Since regulation is the real obstacle to consolidation alliances in Europe prevail. Unfavorable circumstance is also the fact that at the time of this pending transaction Lufthansa bought a big chunk of Brussels Air. The regulators will certainly not like that. Like in any deal representations and warranties play an important role as they typically make up the largest part of the share purchase agreement. They have an informational, protective and supportive role in the transaction . Austrian Airline? epresentations and warranties, coupled with the Lufthansa’s due diligence, enable Lufthansa to learn as much as possible about the business prior to signing the definitive acquisition agreement. Second, they are protective. This is crucial for Lufthansa who acquires highly indebted company which value without restructuring aid is negative. The seller’s representations and warranties provide mechanism for the Lufthansa to step back or possibly to renegotiate the terms of acquisition.
The second major feature of merger the agreement is the inclusion of various pre-closing covenants, or promises to do something or not do something during the period between the signing of the acquisition agreement and the closing. Generally, covenants should be absolute and Lufthansa? s goal is that none material changes take place until the closing and that business condition does not aggravate in any respect because if such events took place it would mean that they overpaid.
The reasoning behind the indemnification is the same. One should emphasize the importance of reps and warranties relating to financial statements (compliance with accounting standards) , taxes and employees (manager contracts, severance terms and compensations) and no pending litigations which breech would surely threaten the envisaged transaction. The role of all above named provisions is risk minimization and these provision should also act as an incentive for a fair dealing.
Courtney from Study Moose
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