The Sky's the Limit

Ross Laver September 27 1999

The Sky's the Limit

Ross Laver September 27 1999

The Sky's the Limit

As Air Canada goes on the offensive against Onex’s bid, the horizon fills with a flock of alternatives


Ross Laver

For a man whose company’s future is on the line, Air Canada CEO Robert Milton seems to be in an awfully good mood these days. On the surface, it’s hard to see why: two months after taking the top job at the Montreal-based carrier, the 39-year-old Wunderkind is being forced to defend his company against Onex Corp.’s hostile bid to merge it with archrival Canadian Airlines International Ltd. Yet colleagues insist that Milton is in high spirits. “Whenever I see him these days, he’s smiling,” says one. “He gets a terrific adrenaline charge from this.” It’s not just the cut and thrust of corporate batde that Milton appears to enjoy. Privately, Air Canada executives say Onex chairman Gerry Schwartz has, in one sense at least, done the airline a favour. “One of the best things that’s happened in this process,” says a senior Air Canada official, “is that Gerry Schwartz has sold the country on

why we need one major national and international carrier.”

Around Air Canada, that has been the view for years. In fact, Macleans has learned that the company approached Canadian Airlines with its own merger proposal last winter, well before Schwartz decided to bid. The existence of the offer was never made public, but sources say Air Canada was ready to buy the Calgary-based company provided that Canadian first took steps to reduce its $ 1 -billion debt, if necessary by going into receivership. “Our position was that the combined debts of the two firms would sink the new entity and that we, Air Canada, already had enough debt,” an Air Canada representative says. “What we didn’t need were Canadians problems.”

Canadian swiftly rebuffed Air Canada’s offer, in part because its 33-per-cent equity shareholder, AMR Corp., the parent of American Airlines, refused to surrender effective control of the Calgary company. This summer, Air Canada

publicly floated another proposal, which would have entailed buying Canadian’s international routes and leaving the smaller carrier to carry on as a purely domestic operation. Again Canadian and AMR said no, but by then they were secretly preparing to turn the tables on Air Canada by throwing their support behind Onex.

This week, Air Canada’s board of directors will issue an official appeal to the airline’s shareholders to reject the Onex deal, expanding on the reasons it believes the offer is unacceptable. The directors will also review several possible counterproposals, one of which may be an Air Canada-led merger involving one or more of its international partners, such as Lufthansa and United Airlines. “In situations like this, the first thing you do is concentrate on your defence, and I think we’ve done that,” a high-level Air Canada official says. “Then you work on your offensive strategy and take a look at the various alternatives.”

Milton and his team are not ruling anything out. But few people believe the status quo is an option. Even many Air Canada supporters agree that, regardless of who prevails, the airline sector is destined for a wholesale restructuring. Based on interviews with airline representatives and industry analysts, there appear to be at least four possible outcomes:

1. Onex wins

Even the cleverest defensive strategy could fail if, in the end, Schwartz is prepared to pay more for Air Canada shares than any other bidder. But in that event, says David Gillen, a business professor and aviation expert at Wilfrid Laurier University in Waterloo, Ont., it’s likely that Ottawa will impose limits on the merged airline’s monopoly power. “The government,” he says, “would have to go out of its way to protect the regional carriers and any potential new entrants that came into the market.” (Already, there are rumours that a business group is putting together plans for a new discount airline focused on the heavily travelled Toronto-OttawaMontreal triangle.) An Onex victory, Gillen says, might also prompt Ottawa to ease the current restrictions on airline foreign ownership so as to encourage more competition.

2. Air Canada remains independent

One of the most potent weapons in the Montreal-based airline’s arsenal is an existing federal law that prevents any single shareholder from owning more than 10 per cent of Air Canada. The Onex bid cannot go forward unless that rule is rescinded. A key part of Air Canada’s strategy, one supporter said, will likely be to urge the federal Liberals to stand firm on the 10-per-cent limit, on the grounds that eliminating it would effectively allow U.S. investors to take control of Canada’s major national carrier. If the tactic succeeds,

Schwartz will almost certainly have to abandon his bid.

But Air Canada might pay a heavy price for victory. Ottawa has repeatedly signalled its determination not to allow Canadian to fail. To ensure its survival, some analysts say, the government could intervene—for example, by transferring Air Canada’s Asian routes to the smaller carrier and strengthening Canadian’s hold over its Vancouver hub.

3. Air Canada buys Canadian

Under this scenario, Air Canada would probably take over all international routes and operate Canadian through a holding company as a purely domestic carrier. Air Canada would endeavour to sell this as a made-in-Canada solution to the industry’s problems, although it would still have to find some way of accommodating American Airlines, perhaps by joining American’s OneWorld marketing alliance. “Would American end up with a piece of Air Canada?” an Air Canada official asked rhetorically. “Who knows? There are many ways of making it work.” As with an Onex victory, the resulting merger of Canada’s two national carriers would invite some degree of additional government regulation to protea consumers and ensure the monopoly airline did not engage in predatory tactics to drive smaller, regionally based carriers out of the market.

4. AMR buys Canadian Airlines

Despite holding only a quarter of the voting shares, AMR’s agreement with Canadian allows it to veto any change in ownership. There is also a requirement in the Onex deal that any purchaser of Canadian honour its marketing alliances and long-term service contracts with AMR. The Onex bid would allow AMR to leverage that position into a significant stake in a monopoly national carrier, but that outcome might not find favour with many Canadians. A better solution, says Tae Oum, a professor of air transportation at the University of British Columbia, would be for the government to allow AMR to take full control of Canadian. “That way, consumers will continue to benefit from competition and American would be free to run the company very efficiendy,” Oum says. The biggest obstacle to that outcome is that Ottawa, like other governments, negotiates landing rights with other countries, but only on behalf of domestically owned carriers.

How will it all play out? Until Air Canada makes public its own preferred solution, most observers will hedge their bets.

One Montreal-based analyst rates Onex’s chances of victory at 40 per cent—less if Lufthansa and United get behind an Air Canada counterbid, but more if Onex and AMR put more money on the table. The poker game has just begun. EI3