AIR Gerry

Kimberley Noble September 6 1999

AIR Gerry

Kimberley Noble September 6 1999

AIR Gerry


Financier Gerry Schwartz unveils an aucous proposal for one national airline

Kimberley Noble

Gerry Schwartz adores cars. As a frizzy-haired 15-yearold in Winnipeg, Schwartz took apart and rebuilt a 1938 Plymouth—although, the story goes, he discarded the body and just drove the frame through the city’s back laneways. The next year, 1958, he bought a silver-blue Austin-Healey. By the 1990s, a decade into his stint as Canada’s leveraged buyout king, Schwartz had nine cars in his Rosedale garage. Planes, on the other hand, he can take or leave. Before he left Winnipeg, Schwartz did get his pilot’s licence. And he does own a jet, a Gulfstream II, and spends much time in the air, travelling between corporate investments in Toronto, New York City and Los Angeles. But unlike the chief executive officers of Air Canada and Canadian Airlines—the carriers that Schwartz proposes to buy and merge—he is not a plane nut. “I have not flown a plane for years and years. Flying,” he says, “is not a passion.”

Schwartz speaks plainly. The founder and chief executive ofToronto-based Onex Corp. told Macleans that he’s in it for the money. As Canadian Airlines International Ltd. announced it was running out of cash and the federal government called for made-in-Canada solutions, Schwartz weighed in last week with his stunning proposal to create a single merged carrier—to be called Air Canada and to be based in Montreal. In doing so, Schwartz has thrust himself

into the middle of one of the most contentious corporate squabbles in recent business history—one that involves not only duelling airlines but also those fiercest of regional rivals, Quebec and Alberta. He’s doing this, he insists, because it makes economic sense for his shareholders. And, Schwartz says: “I am very excited by this transaction because of the opportunity to make a paradigm shift in an unbelievably important industry that has been limping or broken for probably 25 years.”

Friends, foes and financiers all agree: if anybody in Canada can pull it off—it’s Gerry. After all, the man is not simply rich, he has more connections than an airport hub. He’s a powerful Liberal fund-raiser and has served as a key member of the federal party’s executive committee, a man who has entertained Prime Minister Jean Chrétien in his Toronto home and has shown himself to be a strong supporter of Finance Minister Paul Martin’s leadership aspirations. He is also one of the most respected financiers on Bay Street, with an unparalleled talent for scooping up undervalued companies, restructuring and expanding them. Just as important, Schwartz, at 57, is at that point in his life and career where he has not only the means but the energy and appetite to take on such a formidable challenge.

Not that everyone wants him to take it on. Schwartz’s audacious $ 1.8-billion bid has sparked complaints and a flurry of behind-the-scenes manoeuvring. The Canadian

Auto Workers union lambasted Schwartz’s suggestion that I this deal—which evolved after Calgary-based Canadian I Airlines approached Onex for funds last spring—would I eliminate 5,000 airline jobs. Consumer groups expressed concern about reduced competition and the potential for higher plane fares.

Executives of Montreal-based Air Canada, meanwhile, scrambled to come up with a counter-attack, reminding observers, including the federal government, that it was Canadian, not Air Canada, that was on the ropes. Analysts expect that Air Canada’s key partners in the Star Alliance—United Airlines of Chicago and Germany’s Lufthansa—will be suggesting alternatives to the Onex solution. (Star Alliance is a marketing partnership that provides passengers with benefits, including the use of mileage points on any affiliated airline.)

Schwartz and Air Canada’s chief executive Robert Milton have chatted cordially by phone, but publicly the carrier dismissed the Onex proposal as an unsolicited move that holds nothing for its shareholders. Onex proposes to buy all the shares of the parent company, Canadian Airlines Corp., for $2 each, and all the shares of Air Canada for $8.25 apiece, and merge the two companies into a $5.7-billion airline. Air Canada has a point about its shares—they rose on the news of the merger proposal to close the week at $9.10. But Schwartz says that, of course, price is negotiable.

In the deal on the table, Onex says it plans to put in $250 million of its own cash. Another $500 million is slated to come from Canadian’s largest investor, American Airlines parent AMR Corp. of Fort Worth, Tex. Together, the two companies would borrow another $250 million from Onex’s Toronto bankers. In total, they would pump $1 billion of new capital into the combined airline. Onex would take a 31 -per-cent stake of the new entity, while AMR would get 14.9 per cent. Investors would hold the rest of the shares.

All last week, Schwartz took flak about the proposed merger. Opposition MPs accused him of using his connections with Chretien, Martin and Transport Minister David Collenette to help cinch the deal. Schwartz said Onex had no direct contact with the government, and defended his right to take part in the political process.

Most insulting to the financier is the suggestion that he’s merely a slick front man for American Airlines, whose parent company, like all foreign firms, is limited under federal rules to a 25-per-cent voting stake in a Canadian airline.

“The Onex bid is being cooked by American,” charges Tae Oum, a professor of air transportation at the University of British Columbia in Vancouver. He sees the creation of a monopoly, that American Airlines would control, as the objective. “Absolutely not,” Schwartz snaps. “We [Onex] are the dominant shareholder. We will elect a majority of the board of directors and we will drive this proposition for-

ward. It’s in our complete control and in no way is this even remotely characterizable as an American takeover of a Canadian business.”

What American wants from the deal is a way to convert Air Canadas $1.5 billion a year in cross-border sales to Americans Sabre reservation system and a means of selling its investment in the Canadian airline industry over time. Most important in the short-term, the deal would not violate a key provision in Americans contract with its pilots, who must approve investments in other airlines above 15 per cent as a means of ensuring that its staff does not lose work.

As Schwartz argues the merits of his case, Bay Street is keeping a close eye on how many Air Canada shares change f hands. It is not the price as much as the volume that matI ters, says investment banker Tony Hine, head of the transI portation finance department of the National Bank of I Canadas brokerage. When a deal like this hits the street, “investors sell and arbitrageurs buy” with a view to making the highest possible short-term profit. At mid-week, Hine predicted that once 30 million of the company’s 190 million shares trade, arbitrageurs would own enough stock to make a deal fly. “At that point, anybody who comes in 10 per cent above market will be able to buy it all,” he said. From Schwartz’s Aug. 24 announcement to the close last Friday, 31.3 million Air Canada shares had traded on the Toronto and Montreal stock exchanges.

Last week’s bold proposal starts with a beleaguered president and CEO—Canadian’s Kevin Benson. Onex had looked at investing in that airline several years ago. It rejected the possibility as uneconomical, but the two companies stayed in touch. Last March, Benson approached Onex vicepresident Anthony Melman about a cash infusion. Their talks quickly became a discussion about merging Canadian and Air Canada, with Onex spearheading such a deal. Melman spoke to Schwartz, who then called his old friend Don Carty, the chief executive of American Airlines, the company that bailed out Canadian in 1994. Schwartz has known Carty since the mid-80s, when Carty ran Canadian’s predecessor, Canadian Pacific Air Lines, and an Onex subsidiary wanted to buy CP Air’s catering operations. “I called Don Carty and said maybe we should pull out our old file and dust it off,” Schwartz says. Carty, who is originally from Montreal, thought it sounded like a good idea. “So some people here began to work with people at Canadian,” says Schwartz, and it just evolved into where we are today.”

What Schwartz and the Onex partners are counting on is that a consensus is building in favour of a dramatic change in Canada’s airline industry. They cite the federal government’s Aug. 13 decision to suspend competition rules for 90 days to allow Air Canada and Canadian to talk freely about a merger. “It allows a private-sector solution,” Schwartz says.

Ever since airline deregulation in 1988, airline analysts have argued that Canada cannot support two national carriers. Canadian has lost $552 million over the past five years and needs $500 million in new capital just to keep operating this winter. Air Canada is in better shape, but it still finished last year $16 million in the red.

Previous attempts to merge the two organizations have foundered. In 1992, when Air Canada wanted to take over cash-strapped Canadian, the Calgary airline’s board lobbied fiercely to prevent that from happening. That’s how Ameri-

Sizing up the competitors

Air Canada Canadian Airlines Employees 23 17000 Head office Montreal Calgary `heet size 155aircraft83~i~raft 1998 operating revenues $5.93 billion $3.17 billion 1998 $16 miii~ $137 .~~iiiion 1998 assets $6.4 billion $2.1 billion

Turbulent Rides Average monthly closing prices for shares in the two national airlines:

He unveiled the plan in Air Canada’s home base of Montreal, then rang an old pal—the airline’s chairman

can Airlines ended up with its stake. The U.S. airline was invited in to keep Canadian out of its rivals clutches. But this time, many westerners sound resigned to a merger. “It’s going to mean the loss ofWestern Canadas airline,” Alberta Premier Ralph Klein acknowledged. “Everyone has come to the conclusion that the two airlines were not sustainable, and it’s a lot better than Air Canada completely taking out Canadian.”

Whether the Schwartz proposal gets off the ground will depend on several factors: the willingness of the federal Liberals to change the rule limiting any one shareholder to 10 per cent of Air Canada, as well as to tolerate the creation of a new airline monopoly; how

much money the institutional shareholders who own the bulk of Air Canada are willing to accept in exchange for their stock; and how determined either American or United Airlines—the driving forces in the Oneworld (of which Canadian is a member) and Star marketing alliances—are to see their own lucrative reservation and route systems dominate the North American continent.

For his part, Transport Minister Collenette has taken a stand opposite the one Martin adopted during last year’s bank merger debate. Collenette wants the private companies to work out all the details first, and then submit a proposed solution to Ottawa for approval.

Schwartz says that neither he nor anyone at Onex has had direct contact with Collenette or Chrétien. But they are getting some firsthand information from Benson, who told the transport minister about his talks with Onex as early as the last week of June. Schwartz says Benson left Ottawa with the sense that the government is willing to see the two airlines merge—provided steps are taken to protect consumers.

This means the main opposition to Onex’s bid will come from Air Canada or its alliance partners. Schwartz, ever the schmoozer, has made what overtures he can to Air Canada’s management and shareholders. He called Air Canada chairman Jack Fraser (another longtime Winnipeg friend) soon after Onex unveiled its bid. And Schwartz has made statements that— should the companies find a way to come together—Air Canada’s Milton could be in the running for the top job of a merged airline.

“I really hope that when they [Air Canada officials] have had a chance to look at our offer and understand the nuances of it, they will say, this is the time, this is the opportunity, let’s put these airlines together,’ ” Schwartz enthuses. The next few weeks will show whether the dealmaker from Winnipeg can make this big bird fly.

With Brenda Branswell in Montreal, John Geddes in Ottawa and Patricia Treble in Toronto