Market outlook: Can mergers deliver real value?

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This story is sourced from Airline Business
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The latest outbreak of "merger fever" comes as little surprise, with the news that United, having broken off discussions with US Airways, has instead opted for a "merger of equals" with Continental. Unsurprisingly, the United news has focused attention on what American might do, as well as the "jilted" US Airways.

Elsewhere, Mexico's anti-trust regulator sees no impact on competition if Aeromexico and Mexicana were to merge. Meanwhile, in Europe, BA and Iberia have concluded their merger agreement and Aegean and Olympic are busy with their own tie-up.

However, despite the optimism expressed by a significant number of commentators, there is little reason to believe these latest - or indeed other proposed mergers - will deliver the benefits hoped for at the time of the announcement.

Size alone does not guarantee success. Even if two strong companies are put together, there is no guarantee it will result in an even stronger one. And a strong company is unlikely to arise from a tie-up of two weak players.

Without significant post merger actions - and perhaps significant cash costs - mergers are unlikely to act as a silver bullet for mature market players' woes. But most analysts still seem to take the view that consolidation is positive, even though there is a long hard road between the initial tie-up idea and realising the benefit.

Moving the pieces round the "chess board" and articulating the case for the merger are relatively straightforward, as is quantifying sufficient benefits to attract the attention of management and investors. More difficult is identifying where and how this will be delivered, and then delivering it.

In a mature industry, mergers should represent a route to get "more for less" - particularly more revenue for less cost. But how much of this translates into profit, increases the value of the business, or is realised, only to be to be competed away? No matter how many targets are set, the problem is measuring actual impact.

The reaction to the United announcement, as with others before it, has been to take the "identified" synergies, assume they flow straight to the bottom line, apply a valuation multiple to them and suggest that this represents the potential uplift to the combined market capitalisation.

In the case of United and Continental, the net cost savings have been estimated to be some $200-300 million from $1-1.2 billion in possible synergies which are forecast to be realised by 2013.

Some commentators have estimated that the cost savings could add some $2 billion to the combined market capitalisation. However, by 2013 we will be well on our way to the top of the cycle and it will be even harder to distinguish between cyclical and structural effects. Indeed, the real test will be in the next downturn.

Putting the synergies in context, the $200 million figure is less than 0.7% of United and Continental's combined costs for 2009, and the $800 million of other synergies is equivalent to 2.8% of revenues.

BA and Iberia are hoping to achieve €400 million in synergies (one third revenue and two thirds cost) by 2015, when we're likely to have passed the peak. In total this offers potential for a 2.8% margin improvement on 2009's revenues.

But, in both cases, the "planned benefits" are not significantly different to the margin for forecasting errors, given the size of the numbers and time horizons involved. Perhaps the rationale is to under promise and over deliver?

Mergers may deliver structural and cyclical benefits, but the Air France-KLM tie-up appears to have done little to strengthen its business against a downturn, as it is currently forecast to be the last European major to recover.

While announcing target synergies is important to get "buy in" from the offset, the probability is that, even if they can be credibly measured, that they will be forgotten by the time set for delivery.

Realising benefits more quickly would be a better way to proceed, but this is not only more difficult but certainly more costly. This means that airline management should closely focus their attention on the strategic rationale for any proposed combination.

This gives rise to a set of simple questions for management at the time an announcement is made. Why merge? What are the tangible benefits? What are the constraints to realising these quickly? And, how much will it cost to do the initial deal and then to get those synergies? At the end of the day, "me too" is not a good reason.