Business

The Counterattack

There is finally a fight among equals as Air Canada parries Onex’s bid

Kimberley Noble November 1 1999
Business

The Counterattack

There is finally a fight among equals as Air Canada parries Onex’s bid

Kimberley Noble November 1 1999

The Counterattack

There is finally a fight among equals as Air Canada parries Onex’s bid

Business

Kimberley Noble

It was 1995, and then-Air Canada boss Hollis Harris had it all figured out. Now that Canada and the United States had signed the “open skies” deal to free up North American air travel, he could deliver on the airline's perennial promise to investors: he would blow rival Canadian Airlines out of the skies. All he needed was $500 million in ammunition—and stockbroker Nesbitt Burns Inc., the Bank of Montreal’s brokerage arm, stood ready to load the guns. Nesbitt offered a quick deal in which it would buy a huge block of Air Canada stock, and resell it to investors.

Air Canada shareholders hated the idea. Such a huge share issue would slash the market price of the stock they already owned. Harris didn’t care. Like every Air Canada CEO before and since, he was convinced that all his sins would be forgiven after he showed he could strip Canadian for parts. The rest is Bay Street legend: the shares were hard to sell; Canadian Airlines International Ltd. stayed aloft, while Air Canada’s stock price crashed. It only bounced back after Toronto-based buyout specialist Onex Corp. tabled its $1.8billion bid to buy and merge the two airlines in August.

This week, Air Canada and Nesbitt finally got their chance to redeem themselves. They came up with a complicated but clever counterattack to the Onex bid that could satisfy disgruntled shareholders without contravening 1988 legislation limiting each Air Canada investor to 10 per cent of the company’s voting stock. (Air Canada is asking Quebec’s Superior Court of Justice to declare in a court case that starts this week that the Onex deal is illegal because it would violate this law.)

Air Canada’s latest CEO, Harris protege Robert Milton, calls his company’s $930-million package of shares, warrants and airplane leases—accompanied by a buyback of 35 per cent of the company’s shares and the purchase of Canadian for $92 million—“bold, sensible and innovative.” The stock market is not so sure; Air Canadas share price has barely budged since the announcement. If one thing emerged from last week’s events, however, it is the sense that this is finally a fight among equals.

This is where Air Canada’s marketing partners—UAL Corp., the U.S. parent of United Airlines, and Germany’s Deutsche Lufthansa AG—enter the fray. They are putting their own money on the line to beat back Onex’s financial backer, American Airline’s parent, AMR Corp. of Fort Worth, Tex. At last, the air war has evolved into what so many industry experts have called it all along: a serious showdown of international giants that pits UALs mighty Star Alliance against AMR’s Oneworld organization.

What makes Air Canada’s idea clever is the way it is structured. It is set up, in the words of one of its strategists, so the airline can now “be bought by anybody who chooses to buy it.” But there is a big hitch: no buyer can any longer deliver Air Canada to AMR’s Oneworld. That potential alliance was a big reason the giant U.S. airline has been willing to put up 62.5 per cent of the money for the Onex deal, in exchange for only 14.9 per cent of the equity. Without Air Canada, its insiders say, the Onex-AMR arrangement is grounded. “They say they are the only ones who can deliver,” an Air Canada strategist says through clenched teeth. “Well, we say, ‘Screw them.’ ”

Have they blocked the Onex deal? It’s possible. The linchpin of Air Canada’s proposal is a series of 10-year commercial

agreements with its Star Alliance partners, which management says do not require shareholder approval and could prove prohibitively expensive to break or fight. (Air Canada will not disclose any of the terms on which it can back out.)

Onex officials expected to spend at least a week exploring their options. At issue is how much more money they can put on the table, as well as ways in which they might mount a legal challenge to the flurry of new marketing and supplier deals. “There are enough poison pills to fill a dispensary here,” complains Onex spokesman Nigel Wright. “We are considering whether Air Canada has done something to interfere with the shareholders ability to consider the better offer.”

What is Air Canada worth to the Star Alliance? Its a complex, multilayered deal.

UAL and Lufthansa are kicking in $730 million, although $310 million of that is a line of credit from a German bank that the two foreign airlines have guaranteed, but that Air Canada, should it borrow this money, is expected to repay. UAL and Lufthansa are paying $230 million to buy preferred shares, convertible into seven per cent of Air Canada, in non-voting stock.

On top of that, UAL is buying three new Airbus A-330 planes from Air Canada for $190 million, which the Montreal carrier will then lease back over 25 years. For now, this is all cheap money: Air Canada pays no interest or dividends to the foreign airlines unless it starts paying dividends to the rest of its shareholders (something it has never done).

The remaining $200 million comes from a source closer to home. To protect one of its most valuable franchises, the CIBC Aerogold Visa card, Canadian Imperial Bank of Commerce is paying Air Canada in exchange for extending the current agreement and for warrants that can be used to buy three per cent of Air Canadas non-voting stock.

They prefer not to be quoted as saying this, but Air Canada

officials acknowledge that they have Onex chairman Gerry Schwartz to thank. Putting a price tag on the value of the alliance partnership “is something we have been trying to accomplish for a long time,” one says. Air Canada would never have been able to persuade the foreigners to pony up the cash without the threat that it would leave the Star Alliance.

Air Canada plans to use the proceeds, plus some of its own cash, to make a $2-a-share bid for Canadian—which depends on the capitulation of AMR, Canadians largest shareholder— and set up a stand-alone, low-cost airline. A “streamlined” Canadian would continue to exist as a Calgary-based domestic carrier—albeit, Air Canada says, with 2,500 fewer jobs. (Under Air Canadas plan, none of its own employees will face job losses. Onex, on the other hand, plans to cut 5,000 jobs in the merged airline.) Finally, instead of feeding AMR’s U.S. system, Canadian would be teamed up with Delta Air Lines Inc. of Adanta, which is not part of either I Star or Oneworld. By Friday, however, Air f Canada indicated it would be willing to al§ low Canadian to stay within the Oneworld « system.

To get those long-suffering shareholders onside, Air Canada is willing to pay $800 million, or $12 a share, for 35 per cent of their stock. Unlike the Onex deal, this offer does not require shareholder approval. Share buybacks, commonly seen as a way to increase a company’s stock price, are made at the discretion of the board of directors. Will this money be enough to make them vote, en masse, against the Onex offer on Nov. 8? Or, as most observers believe, will Onex sweeten the deal this week so shareholders will back their plan? “That question will be addressed by shareholders when they decide to tender,” says Ian Joseph of Altamira Management Ltd. Regardless of who has the artillery in this air war, in other words,

Air Canada’s owners will ultimately call their own shots.