Aer Lingus’s strong trans-atlantic links and Heathrow slots make it an attractive proposition for IAG which had an initial offer rebuffed on Thursday.
The board of the former state carrier rejected IAG’s offer on the grounds that it did not, in their opinion, accurately reflect the value of the airline and its “attractive prospects”.
With Heathrow full, the majority of IAG’s growth in the coming five to six years is likely to come through its Spanish airlines, Iberia and Vueling, rather than from its flagship carrier, British Airways (BA).
Aer Lingus’s Dublin base could help IAG increase its growth, however, and its Heathrow slots could also offer significant flexibility, making a further bid likely in the coming months.
According to analysts at Davy Stockbrokers, IAG has strict criteria regarding inorganic growth around its core six strategic objectives, including: Leadership in its main cities and across the Atlantic; a stronger Europe-to-Asia position in critical markets; and growing its share of Europe-to-Africa routes.
The Irish carrier fits some of these criteria, particularly on the Atlantic front, according to Davy airlines analyst, Stephen Furlong.
“Dublin — now Europe’s seventh-largest transatlantic hub — provides [IAG] a growth option,” he said.
“Aer Lingus also has circa 3.5% of the slots and aircraft movements at Heathrow, providing valuable flexibility for IAG; however, we would expect that, similar to Madrid, a full Dublin-London shuttle service would be maintained or enhanced. We believe a further IAG bid is likely.”
Aer Lingus currently controls 42% of the London to Dublin route followed by Ryanair with 38% and BA on 13%. The potential overlap would be minimal, according to Mr Furlong who expects that any potential deal would be passed by regulatory authorities with some limited remedies.
Aer Lingus has been growing its long-haul capacity by double-digit rates of 12% and 20% in the past two years with similar levels of expansion expected again in 2015.
Mr Furlong is predicting a 2015 operating margin of 5.5% which falls well below that of IAG’s 10% to 14% target for the period 2016 to 2020, meaning that both revenue and cost synergies would be needed to boost Aer Lingus’s margin.
Aer Lingus is also likely to enter another capital expenditure cycle at the back end of the decade for its long-haul fleet which could challenge its free cash flow generation without a substantial improvement in operating performance, Mr Furlong added.
Last month, staff at Aer Lingus voted in favour of the airline’s funding plan while it has also upgraded its 2014 earnings guidance with profits expected to surpass last year’s levels.
On Thursday, its share price surged 14% on the back of speculation over an approach by IAG before falling back following IAG’s confirmation that it had submitted a takeover proposal which was subsequently rejected.
Mr Furlong said Aer Lingus had successfully managed the financial crisis in positioning itself as an independent value carrier and added that combining with IAG would likely bring revenue and cost synergies.
A price in the region of €2.50 per share is possible, he added.
The board has previously rejected three takeover offers from Ryanair at €1, €1.40 and €2.80 per share.
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