BA owner IAG's push on Norwegian a smart move

With Norwegian's large level of debt, UK firm may move to split up the airline in order to derisk it, such as seeking a buyer for the short-haul operations

A Norwegian Air Boeing 737-800 at Ezeiza airport in Buenos Aires, Argentina. The carrier has become a target for IAG. Marcos Brindicci/Reuters

IAG's move on budget carrier Norwegian Air Shuttle may prove a shrewd one for the group led by Willie Walsh ahead of expected further turbulence in the European aviation industry.

Norwegian's plan to bring the low-cost model that has proven so successful on short-haul routes in Europe to flights across the Atlantic has affected IAG's British Airways more than other carriers in Europe because Norwegian has targeted flying from Britain in particular.

Analysts estimate British Airways makes the majority of its profit on North Atlantic routes and alliances between established carriers on both sides of the Atlantic have for years helped to protect prices more than in other regions.

In response to the low-cost threat, and mindful of how it was slow to react to short-haul budget carriers in Europe, BA parent IAG has set up budget long-haul unit Level, cut costs and moved to offer stripped back fares on North Atlantic routes.

On Thursday IAG, which also owns Iberia, Vueling, Aer Lingus, went a step further, saying it had bought 4.6 per cent of Norwegian with a view to starting takeover discussions.

While Norwegian has shaken up the market, and given others such as Icelandic Wow, Lufthansa's Eurowings, Level and Primera the confidence to try out low-cost long-haul, its rapid expansion has put it under financial strain.

It had net debt of 22.3 billion Norwegian kroner (Dh10.5bn) at the end of 2017, while its cash liquidity reduced by 27 per cent to 4.04bn kroner in the final three months of 2017. This year it has raised 1.3bn kroner in a share sale to ease its balance sheet.

Ryanair boss Michael O'Leary has often predicted Norwegian's demise while others are still unsure whether long-haul can work without high paying business-class passengers up front.

"Norwegian is in need of execution and capital, frankly, and maybe IAG can give that so it definitely on the face of it makes strategic sense for IAG," Davy analyst Stephen Furlong said.

One industry source who has advised on major European airline deals in the past said Mr Walsh would be unlikely to make a quick move, but would be more interested in the long-haul operation and the Norwegian brand.

With Norwegian's large level of debt, Mr Walsh may move to split up the airline in order to derisk it, such as seeking a buyer for the short-haul operations.

"The ideal outcome here is that Willie buys it and carves it up and O'Leary buys the short-haul business off them," he said.

Ryanair declined to comment when asked whether it was interested in Norwegian.

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Seasoned deal-maker Mr Walsh was much quicker than rival full-service airlines Air France-KLM and Lufthansa to embrace budget flying, buying short-haul carrier Vueling in 2015 and setting up IAG's own long-haul low-cost carrier Level last year.

"Willie Walsh has long been interested in the low-cost long haul concept, long before the creation of Level. This may be an attempt to accelerate its development, while also adding to the scale and reach of Vueling in the intra-European market," Liberum analyst Gerald Khoo said.

The move on Norwegian continues a wave of consolidation that began last year, with Alitalia entering insolvency and the failures of Britain's Monarch and Germany's Air Berlin.

Airline CEOs have repeatedly said more consolidation will come, whether via takeovers or failures, and easyJet and Lufthansa are currently jostling for Alitalia.

The assets of collapsed Monarch and Air Berlin, such as take-off and landing slots, planes and crews were keenly fought over last year by Lufthansa and easyJet, as well as IAG and Ryanair.

However, a bidding battle is not expected for Norwegian, because of its shaky finances and because it may be hard to buy without paying a premium given that founder and CEO Bjorn Kjos controls almost 24 percent of the shares.

The airline failures last year already helped to ease pressure on ticket prices and the adviser said IAG buying Norwegian would be good for other airlines in Europe because it would remove a rival that was growing at a loss.

"If Norwegian was part of IAG it would curb the growth rate that they are on because they are not making any money the way they are growing," he said.

Bernstein analysts said a full takeover could be expensive but suggested a partnership deal would benefit both parties.

"A partnership that looks to maximise the synergies of the two networks, minimise duplications of capacity and investment on key routes, and use IAG's travel management capabilities to improve Norwegian's expertise in this area could all provide some of the benefits of consolidation without the likely high cost of a deal," they said.