Should British Airways be sacrificed to save IAG in Europe?

Under pressure from several airlines and EU member states, IAG may be forced to spin off British Airways to comply with Brexit rules. And, logically, the English don’t see it that way.

After the crisis, we’re back down to earth

The health crisis has pushed certain issues into the background, but now that the end of the tunnel is approaching we’re seeing the return of some backroom maneuvering, and in particular the application of the consequences of Brexit to IAG, parent company of British Airways, Iberia and Aer Lingus, among others.

Some countries, including France and Germany, are pushing for a strict application of the rules, which could lead to IAG having to spin off British Airways in order to comply with Brussels regulations.

What does the law say?

As we explained at the time when we discussed the possible consequences of Brexit on air transport, European regulations are clear: an airline operating flights between two EU countries must be majority-owned by Europeans. This is why Easyjet has set up a subsidiary in Austria.

The question therefore arises for Iberia, Aer Lingus, as well as Level and Vueling, which operate intra-European flights and are owned by IAG, if we assume that IAG is not a European business in the legal sense, i.e. with a majority of its capital held by Europeans.

Is IAG European?

Because that’s the real question: is IAG a European business? The answer to this seemingly simple question doesn’t seem to be so obvious. As we wrote at the time, IAG and the EU are not on the same page, and have radically different interpretations of the texts.

Let’s start by reminding everybody what IAG is. International Airlines Group, as it is called, was founded in 2011 as part of the merger between British Airways and Iberia. On this occasion, the shareholders of both airlines took a stake in IAG, which became their 100% shareholder, with the subsidiaries becoming co-owners of the holding company that owns them.

IAG is a Spanish-registered business, though headquartered in London, and, importantly, more than half of its directors are now European. And this is the group’s argument to justify its European status: “if our capital isn’t European, our directors are”.

Remember that the same technique was used for Iberia, and it was already the argument used before the Brexit. Thanks to a clever legal set-up designed at the time to avoid offending Iberian sensitivities, voting rights were separated from capital ownership. Iberia was owned by a business that is not majority European, but as the majority of voting rights are held by Spaniards, the business is run by Spaniards, and is therefore Spanish, and therefore European.

Which brings us to IAG’s capital. Ce dernier est détenu par une majorité d’investisseurs européens et britanniques mais le plus gros actionnaire se trouve être l’état du Qatar avec 20% des actions. Before the Brexit this wasn’t a problem, today now that British investors are no longer European, only 30 to 40% of its capital would be European today, which doesn’t comply with the legislation.

Hence the debate on voting rights and directors. If we consider a business to be European if it is majority owned and controlled by Europeans, then IAG can try to argue that it is indeed under European control. The question is whether ownership and control are cumulative or alternative conditions.

And finally, IAG even disputes the validity of these grievances. In her view, Europe validated its compliance before the Brexit and there’s no need to revisit the subject. According to Europe, there has just been a pause in its request for compliance due to the crisis and the desire to give IAG time to find a solution, but it has never abandoned its determination to ensure compliance with the regulations.

British Airways, collateral victim

And so the possibility of a split between IAG and British Airways resurfaces. Why British Airways? Honestly, after reading the explanations of certain French media, we didn’t really understand but it was the explanations that were wrong, not the solution.

We have indeed read things like “an airline operating between two European countries has to be European, so IAG is thinking of spinning off British Airways”. But British Airways does not operate any flights between two EU countries! This would have been true if it operated cabotage (for example, a London-Paris-Lisbon flight), but this is not the case. On the contrary, it is airlines like Iberia that are targeted here.

So why British Airways? Because, let’s not forget, when IAG was set up, the investors who owned the British airline became IAG shareholders, and they are mainly British themselves. If British Airways and IAG split up, the proportion of IAG capital held by non-Europeans will mechanically fall back below the fateful 50% threshold.

But it doesn’t seem quite that simple: it’s not just a question of turning British Airways into a spin-off, taking it public and selling off its capital. In our view, IAG’s British shareholders would have to sell their IAG shares to buy BA shares, and either IAG’s European shareholders or new European investors would have to buy their IAG shares. Because, in the final analysis, the problem is not that IAG owns BA, but that BA’s former shareholders own IAG. It might even be possible for BA to remain part of IAG, but its shareholders should leave.

So, contrary to what you may have read here and there, British Airways and its operations are not really the problem, but the solution. And when people talk about creating a European subsidiary for BA’s European activities, it makes no sense: it doesn’t have such operations!

What are the options for IAG?

Given that the EU clearly has no intention of giving up, and that Air France and Lufthansa, through their respective governments, have a strong interest in seeing their biggest competitor dismantled, let’s take a look at IAG’s options.

1°) Spin off British Airways.

We’ve just been talking about it.

2°) Make their case and show they’re in their own right.

IAG can also go to court and argue that it is not majority owned by Europeans, but controlled by Europeans. The procedure will be lengthy, which will save time, but the outcome is highly uncertain.

3°) Bringing in European investors

That would be the simplest option on paper…but not in reality. This would mean either convincing non-European shareholders to sell or increasing the capital.

There’s no reason why non-Europeans should want to sell their shares, especially the British if British Airways remains part of IAG. What’s more, given that the consequences of the crisis are far from over, no one will want to exit at a loss. The simplest thing would be for Qatar to sell its 20% stake to Europeans, but it’s doubtful they’d want to, and it’s hard to see who in Europe would be willing to take 20% of IAG in the current context.

As for increasing the capital, this presupposes that the increase is reserved for Europeans and that existing shareholders agree either to follow the increase or to be diluted. Once again, we can’t see Qatar agreeing to be diluted, and if it were to go along with the capital increase, given its weight, it would only exacerbate the problem.

But playing on the shareholding could make it possible to keep British Airways simply by changing the investors…if they agree to leave without their baby.

4°) Find a new set-up

Without being lawyers, we think it’s complicated and that everything possible has already been done. Indeed, mechanisms such as the “Dutch Sandwich” or the “Irish Double”, which have been very successful in terms of tax optimization, play on tax rules, but not on the nationality of businesses, which is the subject here.

5°) Negotiate with the EU

One solution would be to convince the EU to apply the rules less strictly, and some countries like Ireland and Spain (what a surprise!) are arguing for this. But with Germany and France arguing for strict enforcement, this seems complicated.

6°) Buy a European airline.

Remember that when IAG was created, Iberia and British Airways shareholders gave up their shares in exchange for IAG shares. Could the same operation be carried out today? Possible but highly unlikely.

One might have thought, for example, of the Air Europa takeover, initiated before the crisis but obviously abandoned in the current context. Globalia, which owns Air Europa, could have acquired a stake in IAG, thereby increasing the European share of the company’s capital. But is it worth 20%? We doubt it. And Globalia’s aim was to bring in cash, not to invest.

ITA also comes to mind, but here again the Italian government’s intention is to sell and keep only a minority stake, not to invest. And for the time being, unless the airline’s value is suspiciously overvalued, it will never be enough. And what’s more, Lufthansa seems to have the upper hand.

Bottom line

We can always criticize the fact that British Airways’ competitors are trying to win a competitive battle on the green carpet that they should be winning in the air, but the fact remains that there are regulations that have to be applied.

IAG is facing a challenge which is not operational, but concerns its shareholder base and governance, and could emerge transformed and weaker from this sequence, the outcome of which we cannot imagine being imminent.

Image : british Airways aircraft by Ondrej Zabransky via Shutterstock