Making M&A Pay

Customer-centric business models demand changes in the way finance directors work. Their knowledge and skills become more closely linked to sales, operations, marketing and strategy. They are no longer the chief scorekeepers, but play a vital role in uncovering the value (and risks) in the strategic actions their companies take.

The benefits of changing the scope of the finance team have been clearly shown in the case of FlyBe, which became Europe’s largest regional low-cost airline following its acquisition of BA Connect in March 2007. Every acquisition brings the challenges of integrating two businesses to derive maximum value, and here the role of the finance team can have a major impact.

"Finance is seen as an important cog in the machinery of FlyBe, and in the last five years we have moved a long way," says Andrew Knuckey, finance director of FlyBe. "Finance is not just seen as keeping score for the rest of the business." Knuckey’s team is embedded within all aspects of the FlyBe’s business. It provides quarterly forecasting, has dedicated finance analysts for each specific part of the business, and is organised in such that it can match a team of finance specialists to the structure of the business as it changes and grows.

This structure works well, and the finance team is perceived to be a fully engaged part of the business, as can be seen through the input it had in the detailed planning of the BA Connect acquisition.

"With 3,000 employees we are a big business, but we must have fleetness of foot, and that is mirrored in the structure of the finance team. We can’t create silos into which people disappear," Knuckey says.

IDENTIFYING VALUE

Having worked for 20 years at KPMG before coming to FlyBe, Knuckey has witnessed his fair share of M&A deals. During that time he saw some acquisitions fail to deliver the perceived value – and some in which value was destroyed rather than created.

This insight has served FlyBe well, bringing to the fore the need to identify tangible sources of value in any acquisition as early as possible. Its influence on the due diligence process is clear.

"Due diligence is sometimes focused mainly on financial and legal issues, but ours went across the board," notes Knuckey. "We had a six-month, open book due diligence process for the acquisition. We needed to have a good understanding to achieve the seamless integration of the two businesses. The process put us in a good position to identify where to focus our efforts in the restructuring plan. Our strategy did not change with the acquisition. BA Connect fits well with our business," he adds.

In a deal that saw FlyBe add many new routes, almost double the size of its fleet and significantly expand its workforce, the success of the BA Connect purchase depended largely on planning, which was made easier by the fact that both buyer and vendor were committed to driving it forward. "Both sides wanted to make it work," Knuckey recalls. "BA still has a 15% stake in FlyBe, so both sides were keen to get the right structure for the deal."

BA Connect was a heavily loss-making business, so owner BA was willing to fully fund the transaction, in order to protect FlyBe’s financial position during the transition. Cash funding of £96m covered the inefficiencies of operating 50-seat jets and offered some protection of the future values of the aircraft over their serviceable life.

In a similar vein, BA also provided FlyBe with commercial support – embodied in a one-way codeshare agreement on all previous BA Connect routes – to smooth the transition of its customers to the FlyBe brand.

TOUGH CHOICES

The high level of cooperation between vendor and purchaser in the acquisition may be uncommon, and certainly simplified some aspects of the deal, but as with the integration of any two companies there were still some hard decisions to make to ensure that the structure of the enlarged enterprise would deliver quickly deliver on the potential synergies.

Inevitably, some of the hardest decisions concerned staff. Elements of BA Connect and FlyBe inevitably overlapped, though in many respects the two businesses complemented each other well. Staffing issues had to be resolved quickly in order to yield maximum efficiency gains and get the new company into the right shape for future growth.

As well as pulling some of the unprofitable routes, immediately after the acquisition FlyBe closed BA Connect’s Isle of Man maintenance and finance operations, and its operations centre in Birmingham.

Finding the right balance in streamlining the workforce depended largely on the preparatory work, in which FlyBe’s finance team played a vital role.

"We were dealing with loyal, highly skilled BA Connect employees, so these decisions were never going to be easy, but we had to remove duplication," states Knuckey. "We had those capabilities in Exeter already. Nevertheless, we still managed to retain 1,200 of the 1,700 employees.

"The two airlines had relatively few overlapping routes and high quality workforces, but BA Connect was losing money and we needed to stem those losses quickly. We identified deliverable synergies and cost reductions in the pre-acquisition work."

Thanks to the wide-ranging and thorough due diligence process, FlyBe knew all about the company it was buying and could get one step ahead in planning and budgeting for the post-merger enterprise.

"Planning stood us in good stead. Within three weeks of the merger we were operating as a single company. It happened very quickly, thanks to hard work and commitment. There were, of course, huge challenges and an enormous amount of work, but there was nothing unforeseen and it has gone exceptionally well," Knuckey says.

In many ways, FlyBe’s strategy and its offering to the market differ greatly to those of other low-cost airlines. While the focus at this end of the market is often on radial services to key hubs, FlyBe has a strategy based on regional airports, as well as routes from Gatwick.

Some 70% of its services are on UK-to-UK routes, and average flight time is less than one hour. Furthermore, it has a heavy bias towards business users and those visiting friends and relatives, meaning it is less sensitive to changes in passengers’ discretionary spend. It operates a fleet of aircraft that mainly have less than 80 seats, enabling it to make the less dense routes profitable. It has also placed great emphasis on customer service.

Another of FlyBe’s successes before the merger was its ability to generate ancillary revenue – a core element of the low-cost air travel market. Some airlines in the sector charge for checking bags into the aircraft’s hold, or for a choice of seat, though much ancillary revenue is generated from onboard sales.

FlyBe has one of the best records in the sector for expanding these revenue streams and anticipates ancillary revenue for the next financial year to reach £8 per passenger. BA Connect, by contrast, had found it hard to develop streams of ancillary revenue upward. This became, therefore, one of the most significant opportunities for revenue growth for the post-merger FlyBe.

Another key objective was fleet renewal, to maximise profitability from the enlarged portfolio of routes, and from Knuckey’s perspective as head of the finance team this is where FlyBe has a phenomenal opportunity to improve fuel efficiency and reduce a key element of operating cost.

Research data suggests that for FlyBe, fuel is a smaller percentage of total operating costs than for other low-cost carriers, and it aims to improve on this further.

Similarly, Knuckey feels that the finance team’s approach to managing fuel price risk has been successful, and will remain a key focus. Its formal hedging policy sees it mitigate the risk of price fluctuations up to a year ahead to at least give the airline some capacity to predict the impact of fuel costs on planning, budgeting and revenues.

As a growing business in a fast-moving market, FlyBe will continue to face many challenges and the structure and input of the finance team will be crucial in helping the company address them. The next challenge for the finance team will be the planned flotation of FlyBe, which was already part of the airline’s strategy before the acquisition.

Knuckey acknowledges his predecessors for starting the process of bringing down the internal walls and embedding the finance function firmly into the wider business. He believes that the successful acquisition of BA Connect is proof of the value this process has brought to the airline, showing that the right internal structure, detailed planning and clear paths of communication between all parts of the business uncovered the value in the deal. He expects that this will be further emphasised in the IPO process.