The aviation sector has been one of the hardest hit by the coronavirus outbreak, with international travel off limits and fleets grounded.
Global deal value in the aviation industry fell 66% from Q4 2019 to Q1 2020, to a total of US$4.6 billion, according to Mergermarket data. Volume over the same period dropped 33% to 14 deals, as M&A has fallen down the priority list as industry valuations and earnings have declined. Air travel has dropped by up to 95% during the pandemic, pushing some leading airlines into losses for the first time in five years. The S&P 500 Airlines Industry index has almost halved in value since the start of the year.
In the face of these headwinds, airlines have focused on shoring up cash reserves. A Federal US$25 billion grant and loan bailout program for the major US airlines, and successful forays into the high yield bond market by the likes of Delta Airlines, have provided access to much needed liquidity. For now, all cash has been directed towards covering high fixed cost bases rather than pursuing M&A transactions.
Deals from distress
As the lockdowns are lifted, however, airlines are likely to require additional funds on top of the finance already secured from governments and bond markets. The International Air Transport Association (IATA) estimates that up to US$200 billion will be required to save the industry.
A large proportion of this total will have to come from equity, as balance sheets and credit lines are already extended to their maximum. This will see M&A come into play, as has been the case in the past when the airline industry has emerged from crisis.
In the years after the 9/11 terrorist attacks in 2001, the US airline industry went through a series of bankruptcies, restructurings and mergers as it recovered from the drop in demand. Several airlines, including US Airways, Continental and Northwest, were taken over, resulting in a far more concentrated market. The drop in air traffic because of COVID-19 is significantly deeper and more extreme than what the industry had to encounter after 2001, but the route to recovery could follow similar lines, with M&A playing its part.
In recognition of the severity of the situation airlines are facing, regulators are granting temporary exemptions from competition rules, as seen in Norway, where the state has relaxed controls and allowed competitors SAS and Norwegian Air to work together and coordinate routes in order to keep afloat.
Whether steps such as these lead to long-term competition exemptions that would allow M&A remains to be seen. Airline booking provider Sabre Corp, for example, won its antitrust case against the US government with regards to its purchase of Farelogix for US$360 million, but a proposed joint venture between Hawaiian Airlines and Japan Airlines was denied antitrust immunity by the US Department of Transportation.
If the distress across the industry continues to escalate, governments may wave through more deals that wouldn’t have progressed prior to COVID-19 in the interests of maintaining a functioning air industry when borders reopen and planes can take to the skies once more.
There has already been evidence of such pragmatism in some jurisdictions. South Korea’s competition authorities, for example, expedited HDC Hyundai Development’s acquisition of Asiana Airlines and the tie-up between budget carriers Jeju Air and Eastar Jet, citing the financial struggles airlines have faced because of the coronavirus. A Malaysian minister, meanwhile, has said a merger between Malaysia Airlines and AirAsia could be allowed if required to save the two airlines.
Early movers
Although most M&A and consolidation is likely to come through later in the cycle, some early transactions have come to market and attracted M&A interest.
Virgin Australia, which filed for bankruptcy in April, attracted interest from a range of bidders, including sovereign wealth funds, other international carriers and a number of private equity firms. The airline is in a unique position as one of only two carriers in the attractive Australian market. Not all distressed assets in the airline space will be in this position, but the Virgin Australia situation does show that a range of interested parties are ready to step in and do deals as the industry is reshaped by COVID-19.
This is already evident in the aircraft leasing market where BOC Aviation, the aircraft leasing unit of the Bank of China, has actively sought out deals that will allow it to consolidate the aircraft leasing market. The group has ambitions to invest up US$5 billion in new leasing deals, and has already struck sale-and-leaseback agreements with the likes of Cathay Pacific, United Airlines and American Airlines post-lockdown.
The aircraft leasing industry is a fragmented one, with a number of new players entering the market in recent years to take advantage of the growth in air travel. COVID-19 has changed all of that, and a consolidation—led by cash-rich lessors like BOC—could build momentum as greater numbers of leasing companies are stretched financially.
Irish regional airline CityJet, which at one point was planning a merger with Air Nostrum, is one provider that has gone bankrupt. Other leasing groups will face similar pressures, paving the way for rescue deals and mergers.
Outlook
The pathway back to flying full schedules will be a long one for airlines, with freight traffic leading the way, followed by domestic and then international flights. Industry M&A will be limited in the near-term as a result, as stakeholders will still be contending with uncertainty and weak cash positions.
Buyers for distressed assets are also likely to hold on until debts are restructured before stepping in to pick up assets, as has been observed in the helicopter leasing space prior to COVID-19.
But as balance sheets recover and capital markets reopen, companies that have survived will look to M&A to rebuild an aviation industry that will undoubtedly feel a lasting impact from the COVID-19 crisis.
