THE FINANCIAL AND OPERATIONAL CONSEQUENCES

OF THE MERGERS
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Corporations persistently look to mergers and acquisitions (M&A) as a means of entry in to new and other
existing markets notwithstanding the uncertainties and volatility in some of these markets with the aim of
achieving company objectives. Strategically, companies have often times utilize mergers and acquisitions
as a mechanism in order to survive and grow their businesses. In emerging markets, companies are
increasingly targeting attractive businesses both within and outside their industry/ country (Tom et al,
2008). While today`s M&As deals are exposed to global economic volatility, the obvious reality is that most
of these mergers and acquisitions have extensively failed to deliver according to the promises its investors
were made to believe. However, majority of these acquisitions have always ended up in a disappointing
performance due to their poor approach, understanding and management with up to 50% regarded as
normally disastrous (Business Week 1985, Louis 1982). In this research, a critical evaluation is conducted
between the mergers of Air France and Royal Dutch Airline- KLM that occurred throughout 2004-2008.

1.1Reasons for choosing the topic

Growth and expansion strategy continue to take the centre stage of the decision making process of most
company Boards and influence the minds of CEOs (Carey, 2000). One of the most preferred strategies
they often prefer to achieving these growth targets in order to satisfy the key stakeholders in their quest to
maximising shareholder value is Mergers and Acquisitions (M&As). Mergers and acquisition increased by
40% ($1.95 trillion) in 2004 worldwide, indicating the highest activity ever since 2000 (Thomson 2005). It is
surprising to note about this development considering that a number of research has revealed that
historically, almost half of all mergers and acquisitions have failed to achieve satisfactory results (Gadiesh
and Ormiston 2002, Gadiesh et al 2003, Kaplan 2002, Weber et al 1996, Schneider 2003). On the
contrary, a recent research in Australian established that shareholders value was improved for the first
time in many years (KPMG 2003). On the bases of these conflicting, contradictory and inconsistent
research outcomes and in the light of high increase in mergers and acquisitions arrangements in recent
years, it was therefore laudable to conduct a research on the financial and operational consequences of
these arrangements on an entity`s performance. Air France and Royal Dutch Airline- KLM were choosing
since their merger arrangement has been the biggest in the airline industry. This will therefore assist
corporations to discover and realize the consequences of these mergers and acquisitions on their
operational and financial performance. And also to provide CEO`s and companies directors with suitable
strategies in pursuing such strategy.

1.2Background of Companies
KLM- ROYAL DUTCH AIRLINES is a Netherlands based worldwide company that was founded in 1919 as
Dutch royal airlines for the people of Netherlands and its surrounding environments. In May 1921 the
organisation started its first passenger office on Leidseplein in Amsterdam to make possible its operational
activities as transport and cargo currier. The company achieved early success because as at the end of
1934 the airline has progressed in its operational capacity to begin trans-atlantic flight to run between
Amsterdam and Curacao. But unfortunately, their operations were affected by the world war II and brought
the entire operations to a standstill. In 1945 the company began its services with home flight due to the
war, and extended it in 1946 to outside boundaries like USA. KLM entered into so many contract such as

mergers and joint venturships arrangements with the view to expand its passenger traffic with other
airlines including NLM Cityhoper, NetherLines, Tansavia, Kenya Airways Northwest Airlines, etc
(http://www.tca.viscal.net/klm/history.htm).
AIR FRANCE on the other hand, is the company that came from the 1993 acquisition arrangement by
"Socit Centrale pour l'Exploitation de Lignes Ariennes of the asset of General Aeropostale after the
world war". But the company was struck by nationalization leading to the Socit Nationale Air France in
1946 accompanied by Compagnie Nationale Air France in 1948. After the liberalization of air line industry
in 1978 in US the activities of state-own airlines in French merged into Air France group in July 1994,
finally in 1997 Air France Europe absorbed into Air France. In 1997, Air France Europe was fully captivated
into Air France. The company`s stock was then listed on Paris stock exchange in 1999 with the holding of
62% for the state, which was well-dressed down to 55.9% finally. (www.airfrance.com).

1.3 Project Objectives

This research was commissioned in order to ascertain and establish whether or not mergers and
acquisitions do really have any significance financial and operational effects on the acquirer/ the merging
companies. This was involved detailed analysis of both "pre and post" merger results.

1.4 Research Questions

This research project responded to the following questions:
Has the service routes increased due to the merger?
Has the reliability and quality of service improved after the mergers?
Whether or not the check- in- times have been better off?
The type of criteria customers use in choosing an air line.

1.5 Significance of the Study

Since mergers and acquisitions have become a modern day business strategy been pursued by several
corporations without sometimes having regard to the operational and financial implications on the
company`s (shareholders) value. This research would however be useful in the following respect. It would
therefore:
Become additional useful information to research already undertaken on the impact of mergers &
acquisitions on the shareholders` value.
Provide knowledge and proper understanding on the effective and efficient approach to mergers and
acquisitions.
Serve as a useful guide for policy formulation and decision making tool to prospective and current CEO`s.
Serve as a basis of further guide for future research on M&A`s.

1.6 Scope of the Study

It is worth noting that even though there are numerous and different kinds of mergers and acquisitions that
have occurred over the years, but this research were however limited to the merger that occurred between
Air France and Royal Dutch Airline- KLM throughout 2004-2008.

PART TWO
INFORMATION GATHERING AND BUSINESS TECHNIQUES
2.1 Introduction
This research was exploratory which aimed at exploring financial and operational consequences of merger
arrangement between Air France plc and Royal Dutch KLM plc. It involved the application of qualitative
data that provided a thoroughly understanding on the impact of the merger on the company`s results
(Easterby-Smith et al 2002). This chapter however explained the research tools, techniques and methods
employed in achieving the aims and objectives of the research and also to justify the use of the research
methods employed. Research methodology is the account of the analysis and the reason for the part
technique(s) adopted in undertaking research. It does also seek to clarify the procedure adopted for the
research and involves: data collection, research design methods, field work, sampling, analysis and
interpretation of data (Jankowicz 1995), (Boyd 1981). As indicated by Oppenhein (1992) for every social
research there is the essence of examining the appropriate methodologies necessary for the conduct of a
specific study. Primary and secondary data are the two most important sources of data which are the
carriers of information (Ghauri et al 1995).

2.2 The Research Design

Research design is the entire approach for linking the theoretical researcher problem to the necessary
investigational study to permit the researcher to choose a study approach that allows constructive
responds to the research question within the constraints together with the skills affecting the study, time
and money. Furthermore Kinnear and Taylor (1996) also mentioned that it is the essential groundwork that
guides the data gathering and examination phases of the research. The research design models
appropriate to investigative studies are unlike those relevant to definite studies, making it important to
sustain the research objectives to aid in finding a suitable plan.

2.3 Sources of Data

Due to the nature of this research, both primary and secondary data were used for the conduct of this
study. The primary data were obtained through semi structured questionnaire which were designed and
given to both the customers and the employees of the Air France and Royal Dutch Airline- KLM to respond
to. In effect, a semi-structured questionnaires were used in order to obtain the relevant information, with
more open ended and multiple choice questions been asked in order for the respondents to express
themselves (Easterby- Smith et al 2002). The nature of the open- ended and multiple choice questions
asked, the sequence and logic of questioning that needed to be varied undoubtedly makes it the most
significant approach for this study (Easterby- Smith et al 2002; Healey 1991; Jankowicz 2000). The
secondary data utilized were gathered from published resources such as newspaper articles, textbooks,
search engines, books and academic journals (Ghauri et al 1995).

2.4 Data Collection

The researcher employed the use of semi-structured questionnaire as a method of data gathering in order
to achieve the research objectives. Since the number of features it has complements the aims and
objectives of this study. The researcher gained an in-depth knowledge on the nature and type of mergers
and acquisitions arrangements that do add value to the financial and operational performance of the
acquirer and those that do not. The questions used were simple and straight forward for the respondents.
Furthermore, some of the questionnaires were handed to the respondents while others were posted to

allow them fill and respond to the questions at their own convenient. In all a total of 76% of the total
questionnaire were responded to and returned back with the remaining 24% not received.

2.5 Limitation of data collection

Considering the cost and time availability to collect these data, it was however necessary to conduct the
research by using a major merger arrangement that has occurred in history. As mentioned by Kinnear,
Taylor (1996), when research objectives include identifying problems or spotting potential opportunities,
the use of exploratory research is the most suitable method. However, Easterby-Smith et al (2002) argue
that the knowledge of diverse research traditions allows an individual to adapt a research design to cater
for constraints. A qualitative research approach was used because it was an important way of discovering
out 'what happened; to inquire about new insights; to ask questions and assess phenomena in a new light'
(Robson 2002).

2.6 Pilot study

Bryman (2001) mentioned that questionnaire development is a learning process, and it was significant for
the ultimate questionnaires to function accordingly. As a result the content of the draft questionnaire was
pre-tested by my research mentor and three other customers who were already in the population to be
studied, to check for errors, accuracy and consistency. Questions that were not understood or seemed to
be confusing were appropriately revised based on the comments received in order for the questionnaires
to be relevant as possible (Keilley, 1999).

2.7 Sample and Procedure

As a result of cost and time constraints a total of 40 customers and 8 employees of the companies were
selected to respond to the questionnaires. There were not much significant differences with the selection of
these individuals regarding their age and level of patronage. Convenient sample were used indicating the
accessibility to those customers who were available to the researcher due to constraints (Keilley, 1999).
The questionnaires have been transcribed and analyzed with the use of a simple median, involving the use
of software (Microsoft Excel) to compute the numbers and percentages to clarify the distinction of the data
gathered as shown in the appendix.

2.8 Ethical Consideration

Saunders et al (2003) indicated that ethical issues occur whenever a research of any kind is been
conducted and must be taken into consideration since they deal with the tolerability of the researcher's
behaviour with regards to the rights of the information collection process for the research. Cooper,
Schindler (2003) in their study discovered the essence of ethics in a research is to guarantee that neither
the researcher nor the respondents (or people involve) suffer any adverse result from the conduct of the
research. The ability to search data and to inquire about clarification in the course of qualitative technique
will call for a wider extent for ethical consideration (Easterby-Smith et al 2002). Ethics was significance
since the data gathered through the questionnaires for instance, involved sensitive information (Denzin
and Lincoln 1998). Since the customers were asked to disclose information regarding their satisfaction and
other challenges pertaining to their use of Air France-KLM services, it was therefore significant to maintain
confidentiality, anonymity, and privacy of these respondents throughout this research. The respondents
were informed about the purpose of the research and hence the questionnaire. And also provided them
with the assurance regarding any information they provided on confidential matters.

2.9 Data Quality Issues/Analysis

As indicated by Easterby-Smith et al (2002), qualitative research`s reliability is concerned with the

probability of whether or not another researcher who has the same research question will arrive at similar
findings. It should however be noted that the semi -structured approach of data collection used has
limitations and therefore it is important in a qualitative research such as this to consider issues such as
validity, generalisability, bias, reliability, etc. Furthermore, Easterby-Smith et al (2002) mentioned that
reliable research seeks to find out answers to three questions. The first is 'will the same results be yielded
by the measure on other occasions? Secondly 'will other observers reached similar observations? And
finally "was the raw data analyzed transparently"? The question of reliability was answered through the use
of secondary data from the previous mergers and acquisitions research that have been conducted by
other researchers. The outcome of the research implies that findings are not intended to be repeatable with
the use of qualitative, non-standardized research as they reflect the reality at the time of data collection
since it might be subject to change (Marshall and Rossman, 1999) Since unreliability and bias could affect
the quality of the outcome of the research, considerable readings were made to ensure that the designed
questionnaire had the right sets of questions for the respondents to answer in order to accomplish the
research aims and objectives. Validity is about whether or not the results are what they come out to be
(Saunders et al 2003). Sample accuracy is more significant than its size, in that there is a compromise
between the theoretical sampling size and practical drawbacks such as costs and time. In terms of validity
the researcher deemed it to be important as the technique employed, the in-depth designed questionnaires
gave the researcher a hands-on experience and also to see the direction of the respondents through the
choice of their answers (Oppenheim 1992). The essence of this research was not to produce a mere
general theory bearing in mind the geographical location where the study was conducted and the sample
size used since the research findings are relevant to further research settings (Saunders et al 2003).

PART THREE
RESULTS AND ANALYSIS
3.1 AIR FRANCE- KLM GROUP
The declaration of merger between Air France and KLM in stock exchange with KLM becoming a member
of Sky Team alliance was made public in 2003, establishing Air France-KLM Group. Each company
identity was maintained to promote harmonisation of their service all over their complete route networks for
the interest of passenger's accessibility, finally in May 2004 the merger was completed, following a
surrender of 18.4% of French state equity held in Air France-KLM Group decreasing its venture to below 20
percent. Air France-KLM has become the leader and the largest air transport in Europe with a passenger
traffic of above 74.5 million in 2008- 2009 fiscal year. Operating in 244 destinations within 105 countries
around the globe, with employee turnover of about 107,000 to attain company objective, the operations of
Air Franc KLM among others include its core activities such as passenger, cargo and maintenance.

3.2.1 Financial performance prior to the merger of the two companies

AIR FRANCE -FINANCIAL YEAR 02-03 SCORES
3.2.2 Analysis of the z -score approach
The z-score is a measure use to establish if a corporation is whether or not secured and safe from or close
to a possible danger of insolvency and/ or liquidation according to its financial data during the period under
consideration. Certain five major ratios are normally chosen to find out an entity`s level of sustainability
with a predictive series of 1.8 - 3.0 through ratios.

The essence and the rationale behind this is that any score (s) over and above 3.0 indicates that the
company in question is safe and hence, a going concern. On the other, where the scores fall between 2.7
and 2.99 then there could be a signal of a worrying situation which management may have to look at?
Where the scores are showing 1.8 to 2.7, then there are clear signals and danger of the company heading
towards liquidation within the next two years.
The figures calculated have given these scores for the financial year 2002/03 for both entities. For Air
France 5.3932 and KLM 2.0793, these figures however mean that Air France scored higher than 3.0 which
is the safety point and therefore Air France is at a level beyond the scope of liquidation within the next two
years from the balance sheet date. This makes it more sustainable that without any merger or acquisition,
the company can continue in it operational existence till the foreseeable future. On the contrary, KLM
scores of 2.0793 is within the range of 1.8- 2.7 therefore management attention was needed as economic
failure was highly predictable for the next two years from the date of the balance sheet. KLM`s scores of
2.0793 sends the company in to a situation that is susceptible to any potential takeover so that the
shareholders` interest could be protected. As the ratios computation has indicated an unfavourable
financial performance from the company`s operations by even a loss of -0.06. This presents a view that
is disappointing because for every 1.00 of asset KLM utilised incurred a loss of -0.06 in 2003 and
0.00012 in 2004 before interest and taxation. However, Air France made a profit of 0.015 in 2003 and
0.011 in 2004 indicating efficient utilisation of every 1.00 assets producing income rather than a loss.
KLM again made just 0.79 & 0.73 in 2003 and 2004 respectively, whereas Air France realised over
and above that by earning 1.01 in 2003 and 0.96 in 2004 prior to the merger on their total assets.
KLM once more continued to struggle with its efficient fixed assets utilisation as these figures were
indicators. This was therefore a caution to the KLM management since the company`s value was
constantly declining, the total market value to its total liability was 1.04 and 3.12. In a situation where the
total market value of a company is equivalent to its liabilities (1:1), then there is the likelihood that that
company will be out of business and that was the case of KLM. Because it was clear that after settling their
liabilities, there will be nothing left for the shareholders. Even though in the succeeding year the total
market value of KLM was three times the liabilities (3:1)
For the financial year 2003/04 the scores are 5.3932 for Air France and 3.5496 KLM which were both
secured, all the same KLM still had operational and financial challenges that made them prone to
liquidation. Thus, rendered the acquisition of KLM by Air France a prospect and a means to survive and
also overturn the company (KLM) from its financial and operational difficulties.

3.2.3 Pre - acquisition financial ratios of KLM & Air France for the years 20022004
NATURE OF RATIO
3.2.4 Explanation and the interpretation of the ratios
Performance measurement ratios measure how efficient management have successfully converted
revenues generated into profits from its operations or core activities before charging expenses. These
ratios enable a distinct assessment to be established for the undertone of the merger. These calculations
have involved profitability, asset utilisation, operating profit, return on equity and return on asset ratios.
These ratios are all highly indicators as to how efficiently the entity has been managing its costs to its core
business, taking into account how significant cost is in creating value. An established relationship between
two or more competing businesses, performance is an essential to shareholders` value and wealth
creation, give that lenders, investors and analyst place more emphasis on them in their decision making.
The financial figures in the table above suggested that KLM had financial difficulties before the creation of

a single entity called `Air France -KLM Group`.

The operating profit ratio of KLM indicated a loss of -2% in 2003 but saw a slight improvement in 2004 of
+2%. Air France on the other hand maintained a positive result during the same period of 1.5% and 1.2%,
in 2003 and 2004 respectively. On the Return on Equity, KLM again made a loss of - 3% in 2003 even
though there was a small progress in 2004 by realising +2 %. Air France made +3% in 2003 and +2% in
2004, which was better than KLM. Return on Asset for KLM was -7% in 2003 and +0.4% in 2004 but Air
France had +1.0%; +0.7% in 2003 and 2004 respectively. Whereas KLM performance ratio improved
slightly in 2004, the cost savings had its penalty in relationship to revenue; a sign of inefficient cost
management resulted in awful state in revenue generation as well.
The financial leverage ratio which evaluate the firm`s association among debt and equity. Gearing ratio
determines the fraction of the capital employed that is hired from outside Equity of the entity, the portion
contributed by the stockholders' found and the correlation involving the two. It also tests the Leverage of
the asset in relation to borrowed capital, indicating the proportion of the asset finance by debt. Highly
levels of gearing ratio have both positive and negative consequences on the firm`s performance. For
example high gearing ratio indicates that the firm is depending enormously on borrowed capital in
financing its operations. On the other hand, lower gearing ratio shows the opposite. However if the
Leverage ratio is higher then, the indications are that the assets of the entity are massively finance by
debt. KLM`s gearing ratio for 2003 was 66% and 74% in 2004 with Leverage ratio been 0.45 and 0.68 in
2003 and 2004 respectively. Air France on the other hand, had 51% in 2003 and 52% in 2004 in its
gearing ratios. Its leverage ratio stood at 0.33 in 2003 and 0.34 in 2004. It was however clear that KLM
was highly geared before the merger took place with 74% more than the Air France 52%. This indicated
that 74% of KLM capital was made up of debt. Even though it may be seen as good in taxation sense but
the interest payments could pose a threat to the owners and may mean that no additional funding would be
made available to the firm anymore from its lenders. A comparison may have to be made between the tax
incentives the company may receive and the interest payments before depending so much on the debts
funds. This effect showed itself in the KLM`s interest cover of -5.3 in 2003 and +1.2 in 2004 which
evidenced that the firm was in financial predicament in which the lenders can compel the firm into
liquidation. This however made the merger between Air France and KLM a prudent and the best
alternative decision made by the management at the time to save KLM from further danger.
Earnings per share (EPS) of KLM before merging with Air France in 2003 were -0.9 and 0.5 in 2004. But
Air France`s EPS stood at 0.5 in 2003 and 0.43 in 2004. This ratio is a stock market ratio that considers
the productivity of the firm in terms of wealth creation according to each individual common stock. The EPS
ratio as one of the drivers of share price, the two year period improvement in EPS reflected in the share
price of the target company.
Share price -The value of a company is measured by its Share price on the market. KLM had a share price
of 5.74; 16.84 in 2003 and 2004 respectively, whilst Air France had 14.99 in 2003 and 14.13 in
2004. This was therefore expressed in KLM share price which showed an improvement from 5.74 in
2003 to 16.84 in 2004, a positive signal for the shareholders. Air France unfortunately lost because
there was a decrease in its share price, which was a bad news for its shareholders as their value went
down. This was probably one of the major reasons why the shareholders of Air France supported the
merger since they benefited from the share gains.

3.3 POST MERGER RESULTS

3.3.1 OPERATIONAL PERFORMANCE
This section analysed the operational result after the merger

3.3.2 Growth and Learning

Check-in-times
The concept of learning and growth establishes the Air France- KLM ability to create extra value through
an enhancement on stable bases within it functional activities. The respondent results as shown in
`appendix 3 ` and subsequently in "Graph 1", indicated that of the 100%, 37% said it takes up to 25
minutes to go through a check-in process which is the minimum minutes a passenger may spend in
checking -in, 45% mentioned that it takes them between 26 to 60 minutes to check-in while the remaining
18% takes more than 60 minutes before checking -in. With the highest number of passengers spending
more time before checking-in may have accounted and reflected in "Graph 4" where passengers indicated
that they prefer to select an air line with quality of service. The introduction of the internet check -in service
for passengers should allow customers with the flexibility of their travel arrangements, transferring
responsibility from the airline to the customers and this should probably help reduce this problem of delays
in passengers' check-ins.

Graph 1: Check in times after the merger

Increase in number of service routes
On the question of whether or not there has been any increment post the merger, 66% of these
respondents indicated "yes" with the remaining 34% saying "no" as depicted on the "graph 2" below. This
has however not been manifested in the company`s profitability since the value of the shareholders has not
grown over the four year period. The graph below tries to demonstrate the results pictorially.

Graph 2 Expansion occurred after the merger

Service reliability
The respondent were asked to respond to the question on service quality and reliability, but the level of the
percentages below may seem to show a contradictory view specially the case of `agree`, given that
customers indicated on `graph 1` above the long time they spend with their check-ins before boarding a
flight. This may be due to the fact that the customers notwithstanding the delays they experience still prefer
an air line that provides the quality serve which they indicated on "graph 4". There is no doubt that the
graph on the ranking of the air lines within the industry scored a higher percentage. The graph below
attempts to show the various degrees of agreements and disagreements.

Graph 3: Levels of service quality and reliability

Air line selection criteria
The criteria for selecting an air line drew the attention to the fact that quality is of utmost important with the
highest score of 42%. Even though fare could have been given much more score given that low cost air
lines tend to have more patronage but that had the second highest score of 34% while the least been
availability 24%. This however indicates that no matter how available an air line is, if the quality of it service
does not outweigh it availability, then customers will prefer that with high levels of quality. This is no wonder
Air France-KLM had the highest percentage of the service routes expansion of 66%.

Graph 4: Criteria passengers use in selecting an airline for their travel

Service Ranking
The ranking gave them 34% as been the levels of customers' satisfaction representing `good` while 22%
of the respondents ranked the service as poor. However, 8% of the respondents ranked their service as
excellent but 24% indicated they are satisfied with the services whilst the remaining 12% ranked the
services as fairly poor. These rankings are not too satisfactory given that 34% is not up to half of the total
rankings with 22% ranking the services as poor. If care is not taken the service may degrade further which
could lead to customers` total dissatisfaction and a rejection of their services.

Graph 5: How passengers ranked the service provision by the Air line
3.3.3 FINANCIAL PERFORMANCE
This section like the previous section analysed the financial result post the merger with the British Airways
used as the mirror firm.

3.3.4 Post merger financial ratios of air France - KLM for 2005-2008
TYPE OF RATIO
3.3.5 Financial ratios of British airways for 2005-2008
TYPE OF RATIO
In other to have a much fairer view of the performance of the merger, the post acquisition results of Air
France- KLM has been compared to that of British Airways which is also within the same Euro Zone.
British Airways performance during the period 2005 to 2008 suggested on an average operating profit
ratios of 5.7% slightly above Air France-KLM average of 5.0%. This however suggested that Air France KLM has not utilised it operational synergy to enhance its operating profit from the merger. In accordance
with the efficiency theory, the result could have been as a result of inefficient cost management in revenue
generation. Improper cost management strategy has had a declining effect leading to negative ratio of 5.3% as shown in `Figure 3` which will impact on the shareholders value/ wealth than growing it from the
impact of the merger arrangement. If the operating loss was not strategic by means of selling cheaper or
discounted tickets with the view to attract more customers in the long term price increase, then the
performance was not too encouraging. This does not even guarantee any assurance considering the fact
that these customers may switch their loyalty from future price increase to other competing but cheaper air
lines. Inability to generate profit from operation subsequent to the merger imply that Air France- KLM has
not regain its benefit from operational efficiency, rendering the view that size is important in maximising
market share of a firm through mergers unworkable. But instead boosting market share through organic
means will get the support of the investors looking at British Airways and Air France- KLM from the study.
The average gearing ratio of Air France- KLM is 49.75% with British Airways having 57.25%. The average
Leverage ratio of Air France-KLM showed 34% while British Airways had 31.0%. The gearing ratio of Air
France-KLM is quite reasonable compared to British Airways which is a positive sign as the proportion of
capital that is debt and equity is below that of British Airways. Low levels of gearing ratio are a good
suggestion of cash accessibility and prospect to borrow with no clause. This is an evidence to discourage
equity finance which is more costly than debt finance given that there is no tax incentives, the high
proportion of equity strengthen the fact that the merger was finance through share to share exchange
rather than cash and debt. This is thought to be more popular in merger finance than cash finance in
twenty first century in respect of the negative perception that associate with it from the observation of
shareholders about share dilution, practice that is common in Europe according to practitioners. Equity

allows rights of ownership in decision making while debts attract financial charge against the profit, in
situations where debt is lower then, interest cover will be lower. The average interest cover of Air France is
2 times below that of British Airways. Which suggest that earnings before interest and tax will be able to
pay interest twice, serving as cushion for the company to its lenders? Because the gearing ratios are lower
than probably usual, the indications are that Air France- KLM has not fully made the utilisation of their tax
incentives. Even though the gearing ratio generates the prospect for further borrowings at a lower cost of
capital by the firm, however the present financial figures showed contrary view. The negative interest cover
may not approve extra borrowings favourably and any debt finance requirement could attract higher
interest payment with covenants notwithstanding the benefit borrowed capital rewards, it could be
expensive. However, if the reward which is the tax incentives is higher than the loan interest then such
interest payments may be acceptable. One of the drawbacks of having lower levels of gearing is that it
passes on to the shareholders superior equity result in dilution of shares while lesser earnings per share
may have adverse effect by shrinking the value of the share price "as shown in figure 3" . But all the same
this could be overturn through redemption of share such as Buyback provided there are no specific limits
within the industry on how much debt a business can acquire. There is a strong indicator that Air France KLM has managed its financing of asset without any constraint from lenders considering the average
leverage ratio of fewer than 34%. This allows them the prospect of acquiring any further assets of their
choice without any restrictions. Return on capital employed ratio considers the profit generated relative to
capital employed if there has been any extra value. The data in "figure 3 & 4", indicated Return on capital
employed averages are Air Franc- KLM; 5.84%, and British Airways; 5.58%. Air France-KLM showed a
slight improvement compared British Airways. This establishes whether or not shareholders` wealth have
been destroyed or improved with reference to the capital available to the business. The 5.84% may seem
quite low especially if the inflation rate is high in which case the returns generated may not be worth the
risk taking. Air France- KLM`s average Earning Per Share stood at 1.34 while British Airways had 26.05.
Therefore Air France-KLM`s EPS is too low as compare to BA. Because this is an indication of a
company`s performance relative to equity. The weakening performance of Air France-KLM`s EPS showed
that, when company raised capital from equity, there will be dilution of share, a penalty of equity finance
which is unacceptable by investors.

AIR FRANCE-KLM SHARE PRICE

5.9 AIR FRANCE- KLM SHARE PRICE
Figure 5: Share price of Air France-KLM for 2003-2008
Share Price; determine the market value of a company to the stockholders, at a giving period. Air FranceKLM Share Price was 19.43 in 2005, 34.15 in 2006, 17.84 in 2007 and finally to 6.7 in 2008, a
decline of 66%. But British Airways moved from 353.25 in 2005 to 140 in 20008 a fall of 60% which was
less than that of Air France- KLM. This was however a deteriorating signal to the investors of the
company`s EPS. Air France -KLM Share price prior to the merger declined to almost 4.8% due to the
merger. The Air France share price prior to the merger was 14.13 and that of KLM stood at 16.84.
But four years later the combined (merger) result of both companies which is Air France -KLM indicated
rather a declining results with a share price of 6.7 shown in "figure 3" . This however confirms what
Stiroh (2000) discovered that Mergers & Acquisitions are not suitable means of reducing costs or
enhancing efficiency of a firm. Because as can be seen in the case of these two companies the combined
results has rather declined instead of the original motive of salvaging KLM from it financial difficulties. No
value has been added to the shareholders` investment but rather destroyed their value.

3.3 CONCLUSIONS

The study has revealed that the successful impact of mergers and acquisitions on a company's operational
and financial performance has always not been guaranteed. Even though there are so many
commentators and authors on the topic of mergers and Acquisitions who have indicated that the motive
behind these sorts of arrangements are to some large extent to increase the value of the shareholders
through economies of scale, synergy prospects, cost savings, etc. But the case study of Air France -KLM
showed a different view in that the results from their merger have rather declined instead of improving. The
company still do have operational difficulties which has therefore manifested in their financial results. This
is however opposite to the views of many CEO`s about M&As as a means of increasing company or
shareholders` value. The combined results of the two companies, thus post merger still do not show that
there have been any gains realisations from the merger. Air France -KLM are struggling in their operational
and financial performance.

3.4 RECOMENDATIONS
On the bases of the information gathered and the evidence revealed the researcher wishes to make the
following recommendation, since this may assist any further merger arrangements.
The present time taken for customers` check-ins may have to be improved upon to address any time
wastage.
Management may also consider outsourcing the other non-core operations at a lower cost in order to have
enough time to concentrate on core activities.
Management may also choose debt finance instead of equity but must ensure the tax incentives outweigh
the interest payments.
Fixed term investment cutback may be considered to generate sufficient cash flow to take care of frequent
expenditures.
The lower levels of operating profits showed that there are higher operating costs which management may
have to investigate if there are to create value for shareholders.
Service quality has a significant impact on the customers regarding the selection of an air line for their
travel. As a consequence the levels of quality will have to be improved in order to attract the highest
percentage of the customers since they rated it higher than any other criteria.
Low fares also play a critical role in the air line industry and therefore management may have to look at
their pricing policy since this could increase the current levels of sales.

AREAS OF FURTHER STUDY

The researcher wishes to suggest that further research may be needed to investigate other mergers &
acquisitions that have occurred in the airline industry to ascertain any other significant impact M&A`s could
have on entity`s operational and financial performance.