Desire for Aer Lingus clear from O'Leary's bid

Ryanair’s latest package of remedies submitted over the weekend to the European Commission in relation to its €694 million offer for Aer Lingus is unprecedented in terms of aviation takeovers.

It also clearly illustrates the strategic long-term value that Michael O’Leary places on acquiring Aer Lingus.

Ryanair has offered to provide a €100 million, no-strings-attached, cash payment to UK regional carrier Flybe to capitalise a new business in Ireland that would take over 43 of Aer Lingus’s 90 short-haul routes.

Ryanair has also guaranteed Flybe that the piece of Aer Lingus that it takes over would come with a cost base that would result in a profit of €20 million a year. Ryanair has agreed to hand over the Gatwick-Ireland routes to British Airways rather than the Heathrow slots.

The Government has a near-veto on the use of the Heathrow slots and was not keen on Ryanair’s initial remedy that they be transferred to BA, which already flies the route.

BA would retain an option on the Heathrow slots in the event that Ryanair can persuade the Government and others to allow them be transferred. Either way, whether it is Gatwick or Heathrow, Ryanair is effectively giving away another chunk of Aer Lingus’s profits.

These remedies mean that the cost of buying Aer Lingus in its entirety would top €1 billion.

It has already spent €407.2 million on acquiring its 29.8 per cent stake.

Buying the remaining shares would cost it €487 million. To that, you can add in the €100 million payment to Flybe and the profits forgone by giving away half of Aer Lingus’s short-haul routes.

It’s not clear what level of profitability the other half of the business throws off but some analysts suggest it is probably about €30 million.

This would suggest a multiple of 33 times, which is off the radar.

These are rough calculations and Ryanair could get management control of Aer Lingus – it would increase its shareholding to 50.1 per cent – without buying out all of the remaining equity.

That would cost it €108.4 million rather than €487 million and reduce the multiple to 21.2 times, which is still very high. The chunky multiples might suggest why some Ryanair board members and institutional shareholders are said to be questioning whether this deal is now worth doing.

Why is O’Leary prepared to spend all this money to effectively buy half of Aer Lingus’s business?

Sturdy balance sheet

Aer Lingus has net cash of €390 million, giving it one of the strongest airline balance sheets in Europe. But that could be significantly reduced to resolve the deficits in the workers’ pension schemes. It has a profitable long-haul business that O’Leary probably feels he can grow successfully.

There is also undoubtedly a significant brand value in Aer Lingus and O’Leary has spoken confidently of growing its operations across Europe.

You can be sure that O’Leary will also be ruthless in eliminating costs from Aer Lingus while leveraging synergies from joint aircraft orders and delivering other procurement savings.

Perhaps more importantly, acquiring Aer Lingus would give him greater leverage with the Dublin Airport Authority and significant control over Irish skies.

Some wonder whether Flybe has the market power and stamina to be a viable long-term competitor of Ryanair in Ireland, as Aer Lingus is now. Its market cap yesterday was just £34.25 million and its share price has declined by 15 per cent over the past three months.

Last month it announced plans to lay off 10 per cent of its staff and review its entire network to help achieve cost savings of £35 million by 2015. Brokers estimate its full 2013 losses at anything up to £20 million. It’s no EasyJet.

Who’s to say that Flybe would make a success of flying 43 routes from Ireland? Or that Ryanair wouldn’t simply swat it away after a few years of polite rivalry?

Ryanair could clean up in this market by taking out Aer Lingus. Having failed with two previous offers for Aer Lingus, O’Leary knows this is his last chance to acquire his local rival. The weight of money is still on the commission saying no but O’Leary’s daring remedies have shortened the odds and made the outcome on March 6th less predictable.