City: Hard landings

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The Independent Online
IF I WAS cynical, I would have said that Lord King has passed a poisoned chalice to Sir Colin Marshall, his successor as chairman of BA, with the deliberate intention of wrecking the company's performance and making his own term of office seem all the more glorious by comparison. The chalice in this case is the deal to take a 44 per cent stake in USAir, the North American airline.

I'm not a cynic, and I don't believe Lord King is quite that Machiavellian. But I cannot help suspecting this deal could go horribly wrong for BA.

Given the repeated cock-ups made by British companies investing in the US, one flinches when a large UK corporation starts throwing its money around on the other side of the pond.

Generalisations aside, the details are not encouraging. This is the big strategic play BA has been after for years. It creates the world's largest airline alliance and is meant to give BA access to the huge US domestic market. It cannot afford to get things wrong. But USAir is not BA's first, second or even third-choice partner. Its main merit seems simply to be that it was available, and that is not a compelling business argument.

BA has cleverly limited the downside with USAir by negotiating a 7 per cent yield on its investment, so some immediate return is guaranteed. In theory, the only way BA can lose all its money is if USAir goes bust. And by buying at the bottom of the cycle, it gets a big American airline relatively cheap - although it is paying nearly pounds 400m for a company whose market capitalisation is only pounds 320m.

However, the deal depends on a recovery in the US domestic air market which will drive USAir from heavy loss to profit within two years. And there is no sign of this. It is a measure of the fragility of the US market that a quarter of the country's entire airline capacity is flying under Chapter 11 bankruptcy protection. A huge shake-out is underway and it is not yet clear who the winners and losers will be.

USAir is not among the strongest players. Its second-quarter results last Thursday showed losses increasing from dollars 1.4 per share to dollars 2.0. The injection of BA money will strengthen its finances, but for how long? It is not hard to imagine BA being confronted with a nasty decision in a year's time: should it throw more good money after bad or write off the whole investment. This is a familiar quandary for a generation of English banks which invested in the US in the Eighties.

And just to add to the risks, BA can never have more than 21 per cent of the voting rights in USAir unless, as seems most unlikely, US legislation is changed. This, too, is a dangerous situation which British banks know more about than they would have liked.

BA is a strong company and need not be in a rush to do deals. It has another 40 days in which to carry out a due diligence investigation into USAir. I, for one, would not blame BA if it changed its mind.