Insight: The future of bmi

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UK carrier bmi is sitting on a much sought-after pile of slots at London Heathrow and its future ownership - which could change as a set of buy and sell options near their expiry date - is drawing interest from a number of players

As US carriers finally secure their long-awaited access to London Heathrow, a second key capacity battle is brewing amid uncertainty over the future ­ownership of the airport's second largest slot holder, bmi.

While prospects of capacity-boosting measures at Heathrow - such as mixed-mode operations and a third runway - remain uncertain and distant, the UK Star Alliance carrier and its envied slot pool could potentially be under new ownership by June next year.

Bmi Timeline

November 1999

Bmi, Lufthansa and SAS enter into European Co-operation Agreement

July 2000

Bmi joins Star Alliance

February 2001

British Midland rebrands itself as bmi

April 2001

Bmi returns to long-haul services with the launch of flights from Manchester to Washington Dulles. Lufthansa cleared to acquire 20% stake in bmi from SAS

November 2002

Lufthansa increases bmi stake to 30% minus one share

February 2007

Bmi acquires BMed

June 2007

SAS confirms plan to sell its 20% stake in bmi

In a note published earlier this year, ABN Amro analyst Andrew Lobbenberg identified bmi's future as one of 2008's most intriguing European aviation issues, saying: "Although a mid-size, unquoted business, we see [bmi's] future having major strategic ­consequences for the industry."

Virgin Atlantic chief operating officer Lyell Strambi labels bmi's future as "very important", adding it is the most interesting development coming into play at Heathrow in the near-term. British Airways chief executive Willie Walsh says bmi is "clearly of interest". Meanwhile, Lufthansa chief executive Wolfgang Mayrhuber says it has set aside funds to increase its stake.

This heavyweight interest is hardly surprising as this summer bmi will hold just over 11% of the airport's total slot pool (see chart), second only to BA's 41%, making it a desirable acquisition target.

But a set of put and call options is central to any major ownership change at bmi (see box p33). If neither Bishop nor Lufthansa act on them, instead electing to ­extend or renegotiate the deal, the status quo will be maintained.

Bishop is remaining silent on his plans for the airline and declined an interview request from Airline Business, but his official spokesman says: "One of the likely options is that nothing will happen at all. They will write a new shareholder agreement and go forward from there. There is no compelling reason for Sir Michael to do anything at all."

Lufthansa is remaining ­­tight-lipped about the agreement and its plans, but Mayrhuber says the airline has set aside some financial reserves should Bishop decide to sell his 50% stake. Mayrhuber's acquisition strategy centres on friendly transactions which satisfy three key criteria: an interesting market, cost synergies and a unique selling point. Lufthansa says bmi definitely meets these criteria, through its strong Heathrow presence, and similar cost synergy potential to Swiss International Air Lines, which was acquired by the ­German carrier.

But it adds: "It is definitely too early to say how [bmi] would be run. If we look at Swiss, it shows that we are able to develop a scenario where a company retains its brand, is allowed to grow and make decisions. It would be the same scenario for any company joining Lufthansa Group."

If Bishop chose to action only his 10% put option, Lufthansa could still potentially secure a controlling stake in bmi by acquiring the 20% stake SAS holds in bmi giving it a combined shareholding of 60% minus one share.

The SAS stake

SAS head of investor relations Sture Stolen says: "We are in discussions [with Lufthansa] over various issues and it's natural that bmi is part of that. One option could be to sell to Lufthansa this year. That depends on getting a reasonable price, but it could be an option."

Lufthansa has previously identified the acquisition of the stake SAS holds in bmi as an option for the future, but says: "There are no talks with SAS yet, but it is possible that we will talk to them. That could be of interest to us. On the other hand we are also ­looking at Sir Michael's stake."

Bmi's executives continue to distance themselves from the impending ownership changes, ­instead focusing on day-to-day business. Deputy chief executive Tim Bye says: "We are not focusing on changes in ownership. We are focusing on delivering the strategy that all of the shareholders signed up to, of expanding the mid- and long-haul business from Heathrow and delivering a successful and profitable performance for all of the shareholders."

But others - particularly Virgin Atlantic - are keen to track any developments. In the past Virgin has openly courted bmi over a potential merger deal as, joined together, the two carriers would deliver synergies forming a strong rival to Heathrow incumbent BA. But bmi has been keen to play down any potential tie-up ­between the carriers.

Virgin's Strambi welcomes bmi's strategic decisions to acquire BA franchise carrier BMed and not go ahead with transatlantic operations from Heathrow, saying the two moves "certainly didn't hurt" Virgin's aspiration of bringing the two businesses together. Outlining some of the possibilities, Strambi says: "Bmi could remain as an independent organisation, but maybe under Lufthansa's wing. It could be sold, it could be broken up. It's not for me to speculate.

"In any of those scenarios we'd be very clearly looking for what role we could play, to see how we could do something for our organisation. At the right time we'd be in a position to play a role in it, one way or another. It could be very interesting."

Virgin interest

But despite Virgin's vocal expressions of interest, the airline's president Sir Richard Branson says it is not in talks to acquire SAS' 20% stake. Strambi qualifies the comment, saying: "It is only a small stake and what can you do with a 20% stake?"

He adds that Virgin remains interested in talking with bmi's current or future owners, but says it is not in direct contact with Lufthansa. This does not rule out potential talks between Lufthansa and Virgin shareholder Singapore Airlines, which says it is still ­reviewing and considering all ­options for its 49% Virgin stake.

By acquiring stakes in both ­Virgin and bmi, Lufthansa could join forces with Branson and merge the two UK carriers to create a strong long-, medium- and short-haul player at Heathrow. This transaction would unite Heathrow's second, third and fourth largest slot holders - bmi, Lufthansa and Virgin, respectively - representing 20% of the total portfolio. It would build Star's Heathrow foothold and safeguard against bmi, and its slots, going to a rival alliance.

Lobbenberg's note identifies a Lufthansa-led combination of bmi with Virgin as the most likely scenario, but Lufthansa says: "We are not involved in anything with Virgin or Singapore Airlines. That is definitely speculation."

The oneworld alliance, mainly through BA's membership, holds 49% of the slots at Heathrow. Star Alliance members hold 27% and SkyTeam has 7%, while unaligned carriers hold roughly 17%. But BA's Walsh is also on the lookout for potential strategic ­targets. "We are very interested in the future of bmi. It has to be of significance to us because of the position it has at Heathrow. Anything that gives us the opportunity to pursue further growth or accelerate our growth plans at Heathrow is of interest to us," he says. "But clearly we are conscious of the position at bmi where Sir Michael Bishop has said he is not selling and we are all aware of the fact that there are put and call options in place. But that is something that is clearly of interest to us."

Strambi is certain that BA could secure regulatory clearance to acquire bmi, albeit with a hefty regulatory price tag. He says Virgin would be looking to benefit from any conditions imposed and get its fair share. "It's about being ready to have those arguments," says Strambi. But he believes that BA should not be allowed to ­acquire bmi: "There's a golden opportunity here to create two very big carriers. Heathrow's a big enough market to have two home-based carriers and it would be a bit disappointing if that was ­sacrificed to suit a monopoly.

"You can see the world consolidating down to a certain number of carriers and it would be very disappointing if each carrier had their own little turf which they control. It would be a very boring world, a very controlled world. I don't think it is remotely desirable. I think it would be very bad for UK aviation it would be quite sad."

In the near-term BA could only gain control of bmi if Lufthansa were to acquire the carrier and sell it on, but Lufthansa says: "Our idea is not to sell off companies. We are interested in long-term relations with other airlines. We are not an investment house, selling off something for ­­­short-term profit."

While SAS would ideally like to see its 20% bmi stake pass to another Star Alliance member, rather than a oneworld rival, its main interest is in securing the highest possible price for its 20% stake. Stolen of SAS says: "If we get a good price, we'll sell tomorrow. If we have a very strong bid from a Star Alliance competitor, it would definitely be considered. It won't stop the transaction."

But bmi says SAS cannot sell its shares to another airline without Bishop's approval, as dictated by the terms of its shareholder agreement.

Heavy losses

Both SAS and Lufthansa have incurred years of heavy losses through a risk sharing joint venture with bmi known as the European Co-operation Agreement, which began in 2000 and ended at the close of 2007.

Lobbenberg makes the following point in his note: "We think the economic performance of bmi will be severely challenged in 2008 by the recent termination of the ECA. While bmi's financial security does not appear to be at risk given its rich portfolio of Heathrow slots, we think the ECA termination could expedite a deal to determine bmi's future."

Stolen estimates that SAS lost over SKr2.5 billion ($408 million) over the course of the ECA's life, which effectively prevented the carrier from disposing of its bmi shares any earlier. He says: "We are extremely happy [to be out of it]. It's been a sad story. We are just glad it's over. Now it's all about getting as good a face price as possible for the remaining shares that we have."

Although SAS is keen to exit bmi, Stolen concedes that its minority shareholder status makes things tricky and may involve a waiting game to get the best price. "We can say we'll put it on hold. There's no urgency as we have a sufficient cash position, sufficient funds. We could wait until next year when the put and call ­options are in place," he says.

Should Bishop or Lufthansa decide to take up their respective options, Stolen says SAS will not be left exposed: "In the agreement we have some sort of protection in our shareholding. We are not completely on our own. There are some arrangements, but I can't go into details." He says SAS is comfortable with the level of response stirred up by the planned sale, adding that several parties have expressed an interest.

Any significant change to bmi's ownership and the price which SAS can demand will be heavily dependent on whether Bishop or Lufthansa action their options. But an unpredictable element of the airline's future ownership is Bishop's personal attachment to the airline. Bishop, aged 66, is a very private individual. He ­declines to comment, maintaining a characteristic silence on the future of his bmi shares.

Unlike many senior figures in the aviation industry, Bishop has worked his way up to the top, beginning his aviation career in 1963 with Manchester-based regional carrier Mercury Airlines.

When Mercury was liquidated in October 1964, some of its UK routes, along with Manchester station manager Bishop, were taken on by British Midland Airways, which was rebranded bmi in February 2001. Bishop became general manager in 1969, managing director in 1972 and in 1978 became chairman after leading a management buy-out.

His spokesman says: "His commitment to the well-being of the airline is absolute, so he would do nothing which would damage bmi. The well-being and future of the airline is the most important factor in his considerations. There is no compulsion for ­anything to happen."

Bmi chairman Sir Michael Bishop holds the key to the carrier's future, but is characteristically playing his cards close to his chest


BMI's ownership Options

The future ownership of bmi is coming to a head via two separate channels.

Disgruntled minority shareholder SAS is selling its 20% stake and claims to be in talks over the disposal with Lufthansa, which already holds just under 30% of bmi.

The remaining 50% plus one share is held by bmi chairman Sir Michael Bishop. Under a 1999 shareholder agreement Bishop and Lufthansa have a set of put and call options, which are fast-approaching their June 2009 expiry date.

Through this confidential agreement Bishop has the option of forcing Lufthansa to buy either his entire stake or 10% of bmi through a fixed-price put option, which has been active for some time and expires in June next year.

In turn, Lufthansa has a fixed-price call option, which it can use to force the sale of Bishop's stake. This call starts in December 2008 and runs until June 2009.

Bishop's official spokesman points out that Lufthansa has no 10% option its call applies only to the entire shareholding.

He confirms that the options are absolute, but adds: "Nobody is going to force anyone to do anything. Lufthansa and Sir Michael have a close and constructive working relationship.

"It is highly unlikely that ­anything will be done without agreement between the two.The relationship is very friendly. This is not a confrontational ­situation."