LONDON/MADRID (Reuters) - British Airways’ BAY.L widening pension deficit could become a stumbling block in its merger talks with Iberia IBLA.MC, as the Spanish airline’s shareholders use it to gain a bigger stake in the new group.
The British carrier announced last month that trustees at its biggest pension scheme had calculated its deficit on March 31 at 1.5 billion pounds ($2.65 billion) — a bigger-than-expected hole that spooked the market.
It compared to just 357 million pounds quoted in BA’s most recent annual report — although a company spokesman said the two figures had been calculated using different methods.
Analysts in both London and Madrid said they expected Iberia to use the deficit as a negotiating tool to gain a greater slice of a merged entity than the one third many analysts estimated it would receive when the pair announced merger talks in July.
“I don’t think the merger is in danger, (but) what could change is the swap — British Airways has a very big liability there .. I don’t see Iberia carrying much dead weight,” said Manuel Zayas, airlines analyst at Fortis in Madrid.
“I don’t think there will be delays, it is purely a problem of valuation,” he added, suggesting that Caja Madrid, the regional savings bank that is Iberia’s biggest shareholder with a 23 percent stake, would be pushing to take advantage.
Caja Madrid Chairman Miguel Blesa said on Monday Iberia investors were likely to receive 40 percent of the combined group although a BA spokeswoman said ongoing talks would determine the ratio.
His comment — the first time a shareholder from either side has publicly mentioned the split — was part of the cut and thrust of negotiations, analysts said.
British Airways’ deficit has spiked as markets take a beating and money in the pension fund falls short of its obligations to 70,000 current and former employees belonging to its final salary pension scheme.
In contrast Iberia has no pension deficit, no final salary scheme, and last year had a pension bill of just 22 million euros ($29.90 million).
Industry magazine Aviation Week ranked the Spanish carrier as the world’s third-best performing carrier in a recent report, marked on liquidity, fuel costs, financial health, earnings and use of assets. It has 1.57 billion euros of cash reserves.
“Both sides are building a case and this will definitely be a factor. The pension deficit is one that is BA specific,” said Collins Stewart transport analyst Andrew Fitchie.
Based on their stock prices on Tuesday morning, British Airways — down 8 percent — would receive less than 60 percent of what would be world’s third biggest airline in terms of revenue.
A BA spokeswoman said ongoing talks would decide the ratio, adding: “Talks about the proposed merger between the companies cover all issues, including the pension deficit.”
BA’s shares have plummeted nearly 50 percent since the pension snapshot on Sept 18 — due to an uncertain outlook for the airline industry, volatile markets, but also because of uncertainty surrounding the deficit.
British Airways last conducted an actuarial review in 2006, which resulted in a deficit of 2.1 billion pounds. It subsequently agreed to pay two one-off sums of a combined 850 million pounds to plug the deficit, plus annual payments of 131 million pounds until 2016.
One major BA shareholder said it was not clear how much the merger discussions would depend on a triennial pension review due to start next March — the same month BA estimates the merger should be wrapped up.
BA spokespeople have said the result of the review to determine the actuarial value of the pension fund will not be known until autumn.
Some analysts predict that when the full extent of the deficit is known, BA may be forced to go back to the negotiating table with the pension trustees to agree a new plan — all of which will have an impact on any future BA-Iberia combine.
“We believe the shares have further to fall, and estimate it is entirely possible that the deficit could exceed BA’s current market cap at the next full actuarial valuation. This raises the very real prospect that BA will have to put more cash into the schemes,” said Societe Generale analyst Jonathan Wober.
“The BA pension fund trustees will be concerned about what effect the merger will have on the covenant — a company’s ability and willingness to finance the scheme,” said Andy Scott, Principle of pensions consultant Punter Southall.
Iberia and BA are being advised by Morgan Stanley and UBS respectively.
Additional reporting by Cecilia Valente; Editing by Chris Wickham