BA set for take-off as deal nears to close £2bn pension hole

It has taken 16 months of long, hard negotiation for British Airways to reach the point of resolving its biggest single headache - the £2.1bn deficit in the airline's pension fund. Unions willing, closure is at last at hand.

After a breakthrough in talks last Friday between BA and its four main unions, shop stewards throughout the airline will be asked this week to recommend a deal which will more than halve the deficit at a stroke and eliminate it altogether over the next 10 years.

There is some confusion over how unanimous the four unions which make up the BA Forum - the pilots union Balpa, the Transport and General Workers, Amicus and the GMB - were in endorsing last Friday's deal. Although the Forum issued a statement saying it "undertook to recommend" the new pension arrangements, this apparently is not binding on any of the individual unions. Indeed the GMB, the smallest of the four, went as far as to criticise BA for "jumping the gun" in claiming that a deal had been agreed.

Crucially, however, the BA management, led by its chief executive Willie Walsh, is understood to have received the backing of its pilots for the new pension deal, Balpa having previously been the most belligerent of any of the airline's unions.

Provided the deal is accepted by the membership of the four unions, BA will make an £800m cash injection into its pension fund followed by further payments totalling £150m in the following three years provided the company's cash balance remains above £1.8bn. In addition, BA has agreed to raise its annual pension contribution from £235m at present to £280m.

In return, employees will offer one-off sacrifices worth a further £400m along with changes to future benefits, including the capping of future pensionable pay rises at the rate of inflation.

The thorniest issue to tackle has been the retirement age, with BA's pilots in particular jealously guarding their right to stop working at 55 on a full pension. Under the new deal, BA will in effect introduce a sliding retirement age, depending on the level of contributions employees are prepared to make. At a contribution rate of 5.25 per cent, the normal retirement age will rise to 65 but any employee prepared to contribute 8.5 per cent will be entitled to retire at 60. Retirement will still be possible at 55 for air crew but only if they increase contributions from the present level of 6.5 per cent to 17.5 per cent.

Tackling the pension deficit has been Mr Walsh's biggest single priority since he took over at the helm of BA 15 months ago. It is easy to see why. BA has by far the biggest deficit relative to its market capitalisation of any FTSE 100 company. Moreover, the sheer size of the deficit has acted like a ball and chain around its chief executive's legs, preventing him from taking any strategic initiatives of any note. Free from these shackles, BA can now move ahead.

First, and most significantly, it can proceed with a replacement order for its fleet of long-haul aircraft. In the short to medium term, BA has two requirements - to add a further 10 aircraft to its existing fleet of 114 long-haul jets to cope with the expansion of its intercontinental network, which is growing at a rate of 3-4 per cent a year and then to replace 34 of the oldest jets in its fleet - 20 Boeing 747-400s and 14 Boeing 767-300s - with brand new aircraft. Together, these two orders could be worth about $10bn. But eventually, BA will need to replace all 114 aircraft, making the final cost of the programme at least three times that amount.

Boeing and Airbus were invited to tender before Christmas and a decision on which aircraft BA will choose is expected in the next three to four months.

Second, the BA board can give serious consideration at last to restoring the dividend, which has not been paid since the terror attacks on New York and Washington in September 2001. Compared with those dark days five years ago, BA is in a much stronger financial position today. Its debt has shrunk from £6.6bn to £1.5bn and there is about £2.5bn of cash in the business. In theory, BA could resume dividend payments this year when the board meets to decide its policy in May. In practice, many analysts expect it to wait a further 12 months in order to consolidate its financial performance and reach its goal of a 10 per cent operating margin.

Third, BA will hope to win back investment-grade rating for its debt. The two ratings agencies Standard & Poor's and Moody's both downgraded BA's debt to junk status in the aftermath of 9/11. A return to investment-grade rating would cut the airline's costs of borrowing - an important issue given that it is preparing to spend billions of pounds on new aircraft.

Keith Williams, BA's finance director, said he expected the two ratings agencies to be in contact over the next few days to review their recommendations on the company. But in a sign that BA's credit quality is already seen to be improving, the cost to those who hold its debt of insuring against a default has begun to fall. Alas, the BA share price did likewise yesterday, having risen as much as 3.3 per cent in early trading before niggling doubts began to set in among dealers about whether the pension agreement was as watertight as BA said.

Nevertheless, BA's shares are hovering near to eight-year highs and this raises another intriguing question: will the resolution of the pension deficit make BA a more attractive takeover target? The stock has been buoyed by bid speculation in recent months. The ambitious Dubai-based carrier Emirates has been cited more than once as a possible suitor, even though current ownership rules in effect prevent it from taking over BA. In order to operate flights within the European Union, BA needs to be 51 per cent owned by EU nationals. In order to be guaranteed landing rights in countries outside the EU, it has to be 51 per cent UK-owned.

This has not stopped the rumour mill churning and the latest theory is that BA could fall prey to a takeover by private equity - an idea given some credence by the fact that Qantas of Australia has just agreed to be bought by a consortium including Macquarie Bank and Texas Pacific.

Not everyone is sold on the idea, however. Chris Avery, aviation analyst at JP Morgan, says: "I am at a loss as to why deeply cyclical businesses such as airlines should suddenly be seen as a bid play. It would be a very strange stage in the airline cycle to bid for a company which is on the point of achieving record margins but which also has an enormous capital investment programme ahead of it. This does not put it in the kind of sweet spot that private-equity firms look for."

Mr Williams will not be drawn on the subject of whether BA itself will now be on the lookout for takeover opportunities of its own. "Resolving the pension deficit is helpful in providing the climate for M&A activity but there is nothing in the wings at the moment."