Onex Swallows WestJet — What’s For Dessert?
By Douglas Reid
History does seem to rhyme from time to time. So far, Onex Corp. has made more headway in 2019 in its pursuit of a major airline purchase, with its takeover offer to buy WestJet Airlines Ltd., than it did 20 years ago, when its bid for Canadian Airlines and Air Canada was declared illegal by a court.
Onex chief executive Gerald Schwartz learned something valuable from that foray: Some things are done better in private (and in a friendly way) than in public (and with a hostile bid).
This deal offered a considerable sweetener to WestJet’s share price – 67 percent above its pre-deal trading price. But that premium also sets a high bar for Onex to realize gains on this investment. It means the investment ﬁrm is unlikely to be satisﬁed with simply buying the airline and operating it as-is. There are other scenarios that could deliver bigger returns including one that is critically dependent on the federal government and the exchange rate.
That scenario envisages Onex eventually selling WestJet to an American carrier – a potential outcome I suggest be raised and resolved before WestJet shareholders vote on the rich offer.
Little Room for New Revenue
Here’s the strategic logic: Unless Onex knows something that no one else in aviation knows, there are few ways that they can earn more money in the medium term than current WestJet management – especially given the growth ﬂat-line forecast just out from the International Air Transport Association. That is not to suggest that WestJet’s current management has behaved optimally. They have deviated from the company’s historic success formula, eroded its once famous culture, and presided over an era of unspectacular returns.
In brief, they have turned WestJet into something more like Canadian Airlines. Lacking few viable routes to grow further, it made perfect sense for WestJet management and its board to agree to an offer that secures value for shareholders that the company was unlikely to have been able to earn any time soon in the market.
What does Onex do next? For one thing, once the ﬁrm owns an international carrier operating a range of aircraft types, it could try to acquire Porter Airlines and merge it with WestJet. Onex has plenty of available capital to ﬁnance such a transaction. Porter’s aircraft would also ﬁt well into the WestJet ﬂeet. A deal like this would play to Onex’s analytic strengths. It would tuck in some attractive routes both domestically and internationally and remove one potential acquisition candidate from the already thin roster facing foreign buyers.
Suitably bulked up, Onex could then move to harvest mode. In practice, this would mean securing an agreement to sell the entire operation to a U.S. carrier looking for growth – which is all of the U.S. majors. The WestJet acquisition will cost Onex about US$3.5-billion at today’s exchange rate. Futures market values suggest that there won’t be much movement in the Canadian-U.S. dollar exchange rate within the next few years.
U.S. Airlines Look for Growth
There is little question the major U.S. carriers have the ﬁnancial capacity to do a WestJet purchase at a price signiﬁcantly higher than what Onex is paying. According to the latest 10Q ﬁlings, Southwest Airlines is sitting on several billion in current assets, of which US$3.8-billion are cash or short-term instruments. American Airlines and United Airlines are in a slightly better position, and Delta is a bit worse off, having a higher amount of receivables. It is hard to believe that any of the four would be refused additional borrowing in a capital market awash with liquidity.
From the perspective of some U.S. carriers, the strategic logic of an acquisition seems unassailable. Delta already has a codeshare agreement with WestJet and the two have agreed to an unspeciﬁed joint venture. But American Airlines’ partnership with WestJet ended in 2018, so it has no alliance-based presence in Canada. As United is partnered with Air Canada through the Star Alliance, an acquisition would present some thorny competitive issues.
Taking United out of the equation, Delta seems to be the logical buyer, given the advanced state of its existing business relationship with WestJet. But buying WestJet from Onex would enable American Airlines to stymie Delta, open a protected market for the Oneworld alliance and secure a large share of cross-border trafﬁc in one move.
The question for Prime Minister Justin Trudeau and Ofﬁcial Opposition Leader Andrew Scheer is simple: “Would you permit Onex to sell WestJet to a U.S. airline, especially if it means job cuts?”
American and Onex tried this manoeuvre 20 years ago. Then and now, Air Canada’s response to an industry in play was to amass fresh assets – this time, with a putatively unconnected bid for Air Transat.
Southwest is a wildcard in all of this, as it was the role model for WestJet when the company formed in 1996, and may still see enough of its DNA in the current WestJet organization to shoulder the risk that accompanies post-acquisition integration.
The unspoken reality of any transaction involving a sale to a U.S. carrier is that the cost savings will be generated by the acquirer through various forms of efﬁciency-seeking. This means that Onex can say today, truthfully, that it has no plans to reduce the number of WestJet employees or push any other types of efﬁciencies into the company. But that does not mean they have not been contemplated elsewhere.
Which brings us to the federal government. Current federal law prevents a foreign buyer from owning a majority stake in a Canadian airline. But it’s hard to make the argument that airlines are “strategic” at a national level other than on nationalist or job-preserving grounds, so long as market entry is possible. And it is a truism in consolidative acquisitions of the type outlined here that there will be job losses, as well as a signiﬁcant transfer of corporate decision-making authority outside of Canada.
So the question for Prime Minister Justin Trudeau and Ofﬁcial Opposition Leader Andrew Scheer is simple: “Would you permit Onex to sell WestJet to a U.S. airline, especially if it means job cuts?” One could also ask the opinion of the new Premier of Alberta, Jason Kenney, whose philosophic preference might incline him toward a “yes,” but since ground zero for most of the job cuts and efﬁciencies will be in already struggling Calgary, he may undergo a change of mind.
The strategy of all parties is fairly straightforward. Right now the rhyme of history is clearly audible; it remains to be seen whether it becomes a full-on reprise.
Douglas Reid is an adjunct associate professor at the Smith School of Business at Queen’s University and is cross-appointed as a faculty member at Cornell University’s Johnson School of Business, where he teaches in the joint Cornell-Queen's Executive MBA program. A version of this essay first appeared in The Globe and Mail.