Briefing Notes On The Onex Bid & Related Issues


Briefing Notes on the Onex Bid & Related Issues
Thursday, August 26, 1999

On the Onex Bid

  • Onex Corp.’s proposal is to buy all the shares of Air Canada (through a temporary shell company called "AirCo"), for either $8.25 cash or one share in AirCo. AirCo would then offer Canadian Airlines shareholders an opportunity to exchange their shares for either $2 cash or .24 shares in AirCo. The offer to merge with Canadian Airlines is contingent on the company’s successful takeover of Air Canada; if the company does not succeed in buying Air Canada, then the merger with Canadian would not proceed.
  • The total acquisition is valued at $5.7 billion, but there is only about $1 billion in new money being put up: $250 million by Onex, $500 million by American Airlines ($225 million of which it is technically lending to Onex), and $250 million borrowed by Onex from the TD Bank. Most of the total cost of the takeover ($3.9 billion, or 70 percent) reflects the assumption of the existing debt of the two airlines. As we’ve stated before, the banks have been the only beneficiaries of airline deregulation.
  • It is assumed that only about half of the existing shareholders of the two airlines will want cash (rather than new AirCo shares) in return for their existing shares. If more want cash, then the Onex bid does not have enough new money in it. Assuming that half the shareholders do choose cash, then the restructured company will have an equity base of about $2 billion and its shares should trade at or above $10 (versus trading levels of $6 for Air Canada and $1.50 for Canadian prior to the government’s Section 47 announcement two weeks ago).
  • Onex is bring more nerve and ambition to the deal, than hard money. It would emerge with a 31% stake in the new company, on the basis of its $250 million cash injection (plus the other money it is borrowing from AMR and TD Bank). Onex would thus take control of a huge company (with 40,000 employees and $9 billion in revenue) with a relatively small equity injection. The resulting company would be heavily indebted–but then, both existing airlines are also heavily indebted, so there’s nothing new there.
  • American Airlines is interested in this deal for several reasons. It put $246 million into Canadian Airlines in 1994 (an investment which it has since written off, but is nevertheless interested in recouping). With the new money it is now putting up, its total investment in Canada reaches $750 million. Under the Onex plan, it will receive lucrative new business for its CRS system, and new Canadian feeder traffic for its Oneworld global alliance. The Onex proposal also helps American avoid the negative alternative: Canadian’s bankruptcy, the final loss of its initial $246 million, and the subsequent loss of all of its Canadian CRS and Oneworld business. Finally, American Airlines also gets to poke a stick at one of its US rivals–United Airlines–which would lose its Canadian feeder traffic for its Star Alliance. [As in Canada, airline competition in the U.S. is often more concerned with damaging a company’s rivals than it is with serving the consumer.]
  • American Airlines has a lot to gain from the Onex offer, but it would be wrong to label it an AMR "takeover". AMR’s stake in the new company would be 15 percent, versus the 25 percent voting share and 34 percent actual share that it holds in Canadian Airlines. Moreover, AMR currently has veto rights over any strategic corporate investment decisions at Canadian, which it would lose in the merged airline.
  • Onex estimates that 5000 jobs would be cut from the merged airline (a loss of 12.5 percent). The losses are expected to be shared about 50:50 between existing Canadian Airlines and Air Canada employees (with Canadian Airlines workers therefore bearing a disproportionate share of the layoffs due the expected closure of several major facilities, including the head office). Many analysts suggest this job loss estimate is conservative. Onex CEO Schwartz has also implicitly accepted Bay Street estimates that the merged airline could cut its total costs by some $900 million (which is only about 10 percent). This doesn’t suggest that staff would be cut by much more than 5000. The experience of airline mergers (in the U.S., particularly) suggests that subsequent cost savings are usually lower than pre-merger estimates. Over a two-year transition period, much of those 5000 positions could be offset through normal attrition. At the same time, assuming continued growth in Canadian airline traffic, the new airline would need additional staff to meet new demand, further offsetting some of the staff cuts.
  • If the merged airline succeeds, Onex stands to make a huge profit. If the market value of the new airline grows by 50 percent in 5 years (not at all unreasonable given the depressed market value of the existing airlines), Onex makes a 300 percent gain. If the market value doubles, Onex makes a 600 percent gain.
  • Onex is a holding company with assets of $6 billion, controlled by 12 large financial investors, led by Schwartz. Schwartz has ranked among the best-paid CEO’s in Canada for several years. In 1997, for example, he was paid a total of $19 million (including exercised stock options), making him the second-best paid CEO in Canada. The company has a good track record of buying leveraged stakes in troubled companies, helping them turn around, and then selling out for great profit afterward.
  • The contrast between the relatively small investment that is actually being made by Onex, and the huge potential profit the company stands to generate, is striking. On these grounds alone there is an argument to be made that the merged company should be very generous in the way it handles any post-merger downsizing.

On the Air Canada Pilot’s Bid

  • The Air Canada pilots are terrified about losing their current places in the seniority hierarchy (which allows high-seniority pilots to fly larger planes for much higher salaries). This is not such a concern for other bargaining units. Layoffs in the wake of an airline merger are an obvious concern for all bargaining units. By fighting for a lengthy merger transition, generous severance benefits (including buyout packages), and hopefully a no-layoff pledge by the new company, the negative impact of the post-merger downsizing can be abated.
  • The Air Canada pilots are hoping to launch a competing offer for Air Canada’s shares, to prevent Air Canada from being merged with Canadian. They may be backed in this effort by Air Canada’s management, and possibly by United Airlines (which stands to lose Canadian feeder traffic if the Onex proposal succeeds).
  • Any true employee buyout offer would be hopelessly underfunded. Someone needs to raise close to $2 billion to buy Air Canada on the open market (not to mention assuming the company’s large debt). The pilots cannot do this. Past employee buyouts have only succeeded (in their initial goal of taking over the company) when there is no equity left in the company (because of looming bankruptcy). The workers then step in by offering wage concessions to attract new loans to keep the company in business, in return for token "shares." In the current case, Air Canada has $1.8 billion in equity and is clearly a going concern. Each Air Canada worker would have to put up about $80,000 (on average) for the workers to buy the company. If the pilots alone were buying the company, each pilot would have to put up some $750,000.
  • In reality, the "worker buyout" would just be a front for another group of private financiers who want to challenge the Onex bid. This might be a consortium of private investors assembled by Air Canada or United. Competing bids for the company might be welcomed, especially if it gives us a chance to negotiate or lobby for a better outcome for workers. Many analysts expect other offers to buy the two airlines to come forth from private investors, regardless of what the pilots do. But it shouldn’t be confused with "worker ownership." In practice, the pilots would be a "front" for private investors (likely including foreign investors) to a far greater degree than Onex can reasonably be seen as a "front" for American Airlines.
  • The pilots are not interested in merging the two airlines. Their proposal thus will not address the key issue for the federal government: preventing the bankruptcy of Canadian Airlines and the loss of 16,000 jobs. The federal government is thus unlikely to grant any regulatory concessions to the pilots’ bid.
  • The pilots’ proposal should be firmly rejected. Employees have suffered enough through the past decade. Now the pilots want workers to put up their own money to preserve an economic situation (two airlines, excess capacity, wasteful duplication, financial instability) which is fundamentally unsustainable, just so they can keep their existing places in the seniority structure.

On Air Canada

  • The CAW has argued consistently that Air Canada was not really a "winner" in the destructive form of competition that was sparked by deregulation. Its "victory" over Canadian Airlines was rather hollow indeed: a huge debt load, junk-bond status, and mediocre profitability. More important at present, the company is a sitting duck for a takeover because of its financial underperformance.
  • Workers who thought they didn’t have to worry about the turbulent situation in Canada’s airline industry just because they happened to be working for the company which seemed to be "winning the war," are now being proven wrong. As usual, workers are always vulnerable without contract and legislative protections, regardless of how "successful" their company may be doing.

On Merging the Two Airlines

  • Many people have argued for some time that a merger of the two airlines was the most economically sensible way to restore some stability to Canada’s airline industry. The factors preventing this included Air Canada’s official lack of interest in a merger after 1992, the difficulties posed for airline unions by a merger, and the federal government’s official two airlines policy. The government has apparently abandoned that policy, and Onex is constrained neither by Air Canada’s management nor by union concerns. Hence a merger is now feasible.
  • Now that one financially and organizationally viable merger proposal has been put on the table, a merger of the two airlines at this point is fairly inevitable. The irrationality of the existing airline structure has been widely acknowledged. No-one in the financial community or in the government will now be interested in finding some means of allowing the two-airline status-quo to continue limping along.
  • The downsides of a merger for airline workers, obviously, are the layoffs that would result and the huge difficulties of merging seniority structures. The upsides are that the number of layoffs would be much smaller than in the event of a Canadian Airlines collapse, and the remaining workers will be in a relatively strong bargaining position in the merged entity (with a reasonable expectation of job security and future bargaining gains).

On the Government’s Role

  • Transport Minister Collenette was quoted on Wednesday as saying "We are a bystander at this stage." This is an incredible admission to make: the government explicitly claims it is standing back to simply watch as decisions are made that will affect thousands of workers and the future structure of the whole industry. [In reality, of course, the government is not a bystander; they are engaged continuously in negotiations with the major players seeking assurances about future regulatory decisions and actions.]
  • There is a huge opening for us to argue to the government that the current malaise in the industry is largely the result of poor federal policy, and hence the federal government must take on its share of the responsibility for finding (and financing) a solution. "You created this mess, you’ve got to help solve it."
  • The Onex proposal would produce a dominant airline with a near-monopoly position, a significant foreign financial interest, and continued financial vulnerability (due to its high debt load and the risk of future economic downturn). All of these factors demand a pro-active government role in the restructuring process, to ensure that the interests of workers and communities are reflected in the process (not just the interests of financiers), and to ensure the future stability and efficiency of the industry in the wake of a merger.

Our Messages

  • Any restructured corporation (a successor to Canadian Airlines, or a merged airline) should commit to no involuntary layoffs. Downsizing can be handled through normal attrition and early retirement and other incentives. The government should help to finance these restructuring costs.
  • The process needs a strong government role to protect workers, communities, and consumers. The government should take an equity stake ($300 million) in Canadian Airlines or in a merged airline; it should have at least as much a voice at the directors’ table as does a foreign airline. The government must also closely monitor fares and capacity in the industry, and ultimately begin to redevelop the legislative and institutional capacity to intervene in these decisions where necessary. Onex has indicated that it expects (and accepts) federal oversight over its pricing policies in the wake of a merger.
  • We must ask two key questions of the government at this moment when the legitimacy of deregulation is more in doubt than at any time in a decade. Do they admit that deregulation has been a costly mistake and contributed to the current mess? And without renewed government involvement in the industry, why shouldn’t we expect a similar crisis to arise in 5 or 7 years, once other companies have stepped into the industry with dreams of becoming a second national carrier?


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