Air Canada talks up a proposal with its partners, while the big banks choose sides in the airline war
A new bid on the tarmac?
Air Canada talks up a proposal with its partners, while the big banks choose sides in the airline war
For almost 24 hours, it looked like this might be the bid everyone had been waiting for. On Oct. 3, a Chicago newspaper reported that Air Canadas U.S. and German marketing partners were on the verge of announcing an offer to buy part of the Montreal-based air carrier. UAL Corp., owner of United Airlines and Deutsche Lufthansa AG were in talks with Air Canada. The report said they planned to team up with the Bank of Montreal to acquire a 35-percent stake, and that the move could be made public as early as Monday morning. Finally, it looked as if Air Canada and the Star Alliance partnership would give archrival Canadian Airlines International Ltd. of Calgary and its would-
be financiers a run for their money.
Then: squat. Monday morning dawned without a concrete counteroffer. It turned out there would be no announcement last week. Instead, Air Canada officials made vague statements about talks with “several third parties.” Air Canada president and chief executive Robert Milton finished the week still vowing to unveil a counterproposal that will top Toronto-based Onex Corp.’s offer to merge it and Canadian. This new bid, Milton said, would not violate restrictions on foreign and individual ownership of Air Canada.
How Air Canada would pull this off, no one seems to know. “I’ve had no success in ascertaining what they’re planning to do,” says Ross Healy of Torontobased Strategic Analysis Corp. “But
then, I’m not sure that they have either.” Last week’s intimations mean that either Air Canada’s management has something dazzling to unveil and is waiting to pull the rug out from under Onex president Gerry Schwartz, or that it is stalling in the hope that something will materialize before its shareholders vote on the Onex merger offer at a Nov. 8 meeting.
Schwartz did some of his own rugpulling late in the week, attaching “ironclad” commitments on jobs, regional services and ticket prices to Onex’s proposal. He promised the federal government that a merged airline would: limit price increases for five years to the rate of inflation and uncontrollable costs (such as fuel); maintain service to small communities for the same length of time; use layoffs only as a final resort; and continue to hold seat sales and honour frequent-flyer points.
This is what Ottawa has been waiting to hear. But what about shareholders? The so-called phantom Air Canada of-
fer provides a glimpse of how the airline batde is dividing the Canadian investment community. By now, just about every significant financial or legal firm is involved, either working for Onex or Air Canada—or inadvertently for both. Heading towards a potential faceoff are two financial powerhouses—the Royal Bank of Canada and the Bank of Montreal. The intriguing dynamic is that these two wanted to unite and create a mammoth Canadian bank in last year’s hotly contested, and ultimately unsuccessful, bank merger debate.
Until last week, the Royal was the most closely scrutinized of the major financial players in the airline debate—because it is the biggest domestic commercial lender to cash-strapped Canadian. The Royal has a lot to lose if the airline goes belly-up. The exact amount of its exposure is confidential, but it is said to be in the hundreds of millions of dollars.
The bank came under fire in early September over a potential conflict when Royal Bank Investment Management Inc., the arm that handles private money management including mutual funds, joined Onex in asking an Ontario court to move the date of the Air Canada shareholders meeting to November from January. But RBIM officials insist their actions were not influenced by the bank. Mike Edwards, RBIM’s chairman, told Macleans that Air Canada shareholders should be able to vote on any offer during the time frame Ottawa has provided. “This in no way indicates support for or against the Onex bid,” he says.
RBC Dominion Securities Inc., the bank’s investment brokerage arm, is also working as strategic adviser to Canadian. Ironically, RBC-DS started out as Air Canada’s lead underwriter when shares in the Crown corporation were first sold to public investors in 1988 and still handles some of its financing. But Air Canada has grown close to the Bank of Montreal’s Nesbitt Burns Inc.—its strategic adviser—ever since the investment house underwrote $500 million worth of the company’s shares and debentures in 1995. The airline spreads its banking business around as much as possible. On the commercial side, Air
Canada relies mostly on the Bank of Nova Scotia and the Canadian Imperial Bank of Commerce—the former a bit of a problem because Schwartz, a close friend of Scotiabank chairman Peter Godsoe, is on the bank’s board.
Other than through Nesbitt, the Bank of Montreal has not been a major player in the airline business—despite
the fact that Air Canada chairman Jack Fraser is on the bank’s board. BMO’s potential involvement in a new bid would change that. Sources close to the negotiations are cautious, but point out that the Bank of Montreal is determined to expand its almost invisible merchant banking operation—and that this unit is capable of buying a large
Connecting flight paths
On the face of it, Air Canada and its backers are in a heated batde to thwart Onex Corp.’s proposal to merge the carrier with Canadian Airlines. But in the small worlds of the airline industry and Canadian finance, archrivals may not be as far apart as they seem. A program on some of the players:
Sources say the Bank of Montreal may be prepared to join forces with Air Canada, Lufthansa and United Airlines in a bid to merge the carrier with Canadian Airlines.
The Bank of Montreal’s Nesbitt Burns is Air Canada’s strategic adviser.
Air Canada recently announced it is pulling its employee shareownership plan away from the Royal Bank’s trust division.
The Bank of Nova Scotia is one of Air Canada’s two main banks.
^ Onex sold 47 per cent of Sky Chefs, its inflight catering service, to Lufthansa.
Onex president Gerry Schwartz is an acp quaintance of Bank of Montreal chairman Tony Comper and a friend of Jack Fraser, chairman of Air Canada’s board.
Schwartz and his wife, Heather Reisman, are close friends of Sherry Cooper, Nesbitt Burns’ II chief economist. Reisman recently hosted a book launch for Cooper.
The Royal Bank is the biggest domestic commercial lender to Canadian Airlines.
Royal Bank Investment Management’s mutual fund investors own a big piece of Air ^‘Canada’s equity. RBIM supported Onex’s call for Air Canada shareholders to vote on its merger proposal.
Peter Godsoe, Scotiabank chairman, is a good friend of Schwartz, who sits on the bank’s board.
equity stake in Air Canada. If that were to happen, BMO would make Canadian banking history—and might prevent the rival Royal Bank from recouping the money lent to Canadian.
From the outside, the “phantom” bid appears to involve Air Canada’s Class A non-voting shares, which could be issued or sold to United, Lufthansa and the bank without violating ownership rules. This makes analysts question whether a serious counteroffer is in the works. “Are they buying shares?” asks Healy. “From whom? Existing shareholders? Treasury? Is this a refinancing? Or an injection of new capital? If that’s all they are doing,” he says, “it really amounts to nothing except a big underwriting.”
But, from the Bank of Montreal’s point of view, even if the proposal will be no more than a refinancing or buyback of the Class A non-voting shares, it would still involve an ouday of $100 million—huge by the chartered banks’ standards. A potential political factor is that pension fund manager Caisse de dépôt et placements du Québec owns just under 20 per cent of these shares, which it could sell to Air Canadas allies to help block an Onex deal.
Money managers say that what such shareholders really want is a better deal than what’s on the table. The investment community has come to accept Onex’s argument that its offer is not worth only $8.25 an Air Canada share, but between $10 and $12, after taking into consideration that most shareholders would opt for a package of cash and stock. From the purely financial point of view, analysts say a deal could be done tomorrow for a combined offer that was the equivalent of $ 15 per Air Canada share.
With the Bank of Montreal in its camp, Air Canada may have finally found a source of money. Or the Nesbitt team may just have pitched in temporarily to stop Onex and its partner AMR Corp., the Texas-based parent of American Airlines, from getting control of Canada’s biggest airline. What happens next still depends on United and Lufthansa, observers say. “It’s inevitable that they will get a bid from these people,” predicts an industry insider. “I just don’t know what’s taking them so long.” Milton and the Air Canada board may be keeping their powder dry until just before the court-ordered Nov. 8 vote on the Onex deal. Or Air Canada, the insider says, “will sell some stock and solidify its position—and Onex will be left out in the cold and Canadian will be back in the soup.” E3
Carty: Don’t ‘disarm’ Canada
At 53, Montreal-born American Airlines CEO Don Carty is a veteran of air wars on both sides of the border, with experience at both Air Canada and Canadian Pacific Air Lines, the forerunner of Canadian Airlines. During a business trip to his home toivn last week, he talked with National Affairs Columnist Anthony Wilson-Smith about air wars, his airlines role and the industry. Excerpts:
Macleans: American Airlines is investing a great deal of time and money in its partnership with Canadian Airlines. What are the attractions?
Carty: First, Canada itself. There is an enormous and growing amount of cross-border traffic. Second, the access we gain to Vancouver: it is the ideal West Coast gateway from North America to Asia. As well, we don’t really have a hub for traffic to Europe east of Chicago, and Toronto gives us that.
Macleans: Does there come a point at which American Airlines might decide the Canadian air wars have become too problematic to justify putting in any further energy and money?
Carty: Of course, you can come to an economic point where another alternative to present ef-
forts makes more sense, or else you simply do nothing more. Maclean’s: How close are you to that?
Carty: I have a lot of faith in [Onex Corp. president] Gerry [Schwartz] and the solutions he proposes. We have been friends for many years and our trust is implicit. You don’t get involved in a proposal of this magnitude unless that kind of trust exists. Macleans: Hostile takeovers are nasty and often expensive. How can that be avoided, even if the Onex bid is succes fid?
Carty: It wasn’t intended to be unfriendly, and I still believe Air Canada would do well to reflect more carefully on the offer as good for both sides. I have a great deal of respect for [Air Canada CEO] Robert Milton, and in earlier talks some months ago, I felt the potential existed for things to move amicably. Macleans: Gerry Schwartz has suggested American carriers should be given access to the Canadian domestic market, so long as the same is done in reverse. Is that a viable option? Carty: There’s no momentum in the United States for that idea right now. And given that, it would be naïve for Canada to unilaterally disarm itself. Macleans: Is Canada big enough to support two national airlines in their presentform?
Carty: I would not always have said this—especially since I have worked for both Air Canada and Canadian—but the answer is no. The choice has now made itself clear. Canada can have two money-losing international airlines functioning at far below capacity, or it is capable of producing one truly great carrier. Both are losing money. Air Canadas stock was about $8 a share in 1988, when it was privatized. When Onex began its play, the stock was at about $5. You would have been better offburying your money in a sock 11 years ago.
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