Airline consolidation is back on the agenda as the economy recovers, says David Churchill
After a year when the name of the game for the world's airlines was simple survival, their realistic goal now is how to exit the recession to best advantage. Already, the desire to merge is back with a vengeance, putting some reputations on the line - not least for British Airways CEO Willie Walsh and several other high-profile players. But the likely reshaping of the aviation world in the coming months will have its impact on all, especially corporate travel buyers and business travellers.
Yet anyone who believes the turbulent times are truly over should think again. International Air Transport Association (IATA) director-general Giovanni Bisignani is in no doubt that the crisis facing the world's airlines is continuing, with IATA's latest forecasts suggesting that collectively the global airline industry is set to lose nearly US$4 billion in 2010. This will be after a year when the airlines will probably have lost around US$11bn.
More to the point, Bisignani says the fall in passenger yields this year of about 12 per cent overall - and 20 per cent in Business Class - will be the worst ever in IATA's 65-year history. "The global economic storm may be abating, but airlines have not yet found safe harbour," he says.
In fact, globally, nearly 30 carriers have gone under so far since the start of 2008. The attrition rate would have been even higher if it were not for the state-sponsored rescue of airlines that probably should have stopped flying - with Alitalia the prime example earlier this year. Asia's biggest carrier, Japan Airlines (JAL), was also struggling to restructure with state aid this October.
Even so, IATA still has some 230 airlines in membership - accounting for about 93 per cent of global scheduled air traffic - and Bisignani is not alone in thinking this remains too many. "The ability to merge or consolidate across borders represents a lifeline for airlines, yet this is restricted by governments," he points out.
It may seem strange that the head of an industry body representing the world's airlines thinks there should be fewer carriers. But this just reflects basic reality: even with recession-generated capacity cuts, there is still too much capacity in the airline world for the level of projected demand.
Yet, even on a global basis, the airline industry remains fragmented. "Aviation is a global network business with big potential economies of scale, yet no airline has even 25 per cent of total revenues," points out US Airways CEO Doug Parker, who merged America West Airlines with twice-bankrupt US Airways in 2005. "And we have six airlines with a share of only about 10 per cent or more, so it's obviously highly fragmented."
If aviation was an 'ordinary' industry - such as telecoms, cars or pharmaceuticals - it would face few restrictions on how it was organised on a global basis. But airlines are not ordinary in most senses of the word, given the allure and status attached to flying. "It attracts a lot of interest because people think it's a glamorous business," explains former bmi chairman Sir Michael Bishop. "But I can assure you it is not - for most of the time."
Bishop's £223 million sale last summer of a controlling stake in bmi to Lufthansa, after a wrangle over the price, has been one of the few major airline deals to take place during the recession. Even so, it was not unexpected (Bishop had agreed a decade ago to give Lufthansa first refusal to buy in 2009) although the German carrier appears uncertain of what to do with its 'prize', which is set to make losses of about £170m this year.
Lufthansa, which this October bought out the remaining 20 per cent stake in bmi held by SAS for £38m, is looking at a range of options. These include keeping the airline as a stand-alone operation or breaking it up, possibly selling the regional business, flying Embraer jets, to Flybe and the bmibaby offshoot to Jet2.com owner Dart Group.
But Lufthansa has more of a problem with the main bmi operations out of Heathrow, where it accounts for some 11 per cent of the take-off and landing slots (compared with about 42 per cent owned by BA). Before the recession, bmi's slots were valued in its balance sheet at £770m, although now aviation analysts thinks they are now likely to be worth much less to cash-strapped rivals.
BA has long coveted the bmi slots at Heathrow but could struggle to raise the finance and would likely run foul of the competition authorities. But there are plenty of interested parties - about a dozen, according to Lufthansa, including Virgin Atlantic.
A Virgin deal for the Heathrow end of bmi would not only bolster its position as BA's main rival at the airport but also perhaps bring it into the Star Alliance, of which bmi is a member and Lufthansa a founder. At present Virgin is one of the few major airlines still remaining outside the three main airline alliances.
Lufthansa, however, is in no rush to sell bmi's Heathrow slots at depressed prices and Virgin's position is complicated by the fact it is 49 per cent owned by Singapore Airlines which, even before the crunch, made clear it was considering ending the Virgin relationship. A merger between Virgin and Lufthansa would have great attractions for Singapore Airlines' CEO Chew Choon Seng, who brokered the original £600m deal and would mean he could at least get some of his (or rather parent company Temasek's) money back. However, it probably has less of an appeal to Lufthansa's savvy CEO Wolfgang Mayrhuber.
But Sir Richard Branson has a reputation for achieving the unexpected, so watch this space.
Yet while bmi is the potential catalyst for mergers and acquisitions action, it is British Airways that is hoping to enter 2010 in a much stronger position. By the end of this October a decision on whether BA and American Airlines should be allowed, at the third time of asking, to merge their transatlantic operations was due to have been handed down by the US Department of Transportation. The EU, which was also considering the proposed alliance this October, gave notice of its own concerns about a link-up.
The problem for the regulators - as it was when BA and AA tried twice before, in 1997 and 2002, to achieve an alliance - is that it would strengthen BA's existing dominance at Heathrow.
Any approval, therefore, would almost certainly see BA and AA being forced to reduce their slot allocations at Heathrow, which from BA's point of view would diminish the benefits significantly.
But BA chief Willie Walsh desperately needs a deal of some sort. He has been in tortuous negotiations with Iberia Airlines since the end of July last year over a merger, which must count at something of a record. As Buying Business Travel went to press, the talks were still under way.
The pressure on Walsh, however, to achieve a deal was exacerbated by the collapse of secret talks late last year to merge with oneworld partner Qantas. The negotiations had been going on at the same time as Walsh was wooing Iberia - which, unsurprisingly, did not go down too well in Madrid.
Yet apart from the Iberia saga, future continental consolidation seems to be fairly limited. Lufthansa has spent much of this year finalising the acquisition of struggling smaller carriers Brussels Airlines and Austrian Airlines, but has also shown some interest in SAS. If Iberia and BA do not conclude a deal, Lufthansa would probably be interested, as would Air France-KLM.
Air France, which successfully merged with KLM in 2004, ended up with a 25 per cent stake in Alitalia earlier this year after the airline's rebirth. But its ambitions are now likely to be further afield, especially in the fast-growing Far Eastern markets.
However, the US remains the real prize for European carriers. Air France's strategy has been to seek a revenue-sharing alliance with the merged Delta and Northwest which was formally signed in May this year, although agreed a year earlier. Lufthansa's approach to the US has been to embrace the model of buying a 19 per cent stake in US 'feeder airline' JetBlue, and in October started a code-share agreement for flights into and out of New York JFK.
Talks are also continuing between US and EU transport officials over the second stage of the Open Skies agreement following implementation of the first stage in the spring of 2008. The EU wants a relaxation of curbs on foreign airlines owning US carriers, while the US agenda is linked to night flights and environmental issues. A new deal is supposed to be finalised by the end of next year or else, in theory, the current Open Skies freedoms will be withdrawn, although this is unlikely.
But China is also potentially set for its own consolidation wave now that its economy is booming again, such as a merger of China Eastern Airlines and Shanghai Airlines, especially since both are based in Shanghai. Beijing may also revive pre-recession plans to bring to together many of the country's 24 airlines to create a 'super-carrier' to take on the Western giants.
The pace of global airline consolidation, however, clearly depends on the speed and scope of the economic recovery. In particular, the airlines remain vulnerable to another spike in the oil price as global demand recovers - even at around US$70 a barrel at the start of October they remained high by historical levels.
Yet while consolidation might in theory be bad news for travellers and buyers - on the basis that reducing the number of players leads to less competition - there is some evidence that its impact is not as great as feared. A US academic study into the impact of Delta's merger with Northwest a year ago found no evidence of higher fares on all but a handful of routes.
Where fares might have risen, the economists (from the University of California and a Massachusetts consultancy firm) suggested these could be offset by increased traveller benefits, such as more frequent flights and access to a wider route network. But it also remains the case that the recession has obviously helped keep fares in check and the history of airline pricing shows a natural desire to maximise revenues when market conditions improve.
While there is all still to play for by a number of airlines as the economy recovers, one deal that may not happen is for Europe's biggest airline in terms of passenger numbers - Ryanair - to try again for struggling Aer Lingus, in which Ryanair already owns a 29.8 per cent stake.
Ryanair CEO Michael O'Leary, who has had two previous bids rebuffed, told shareholders at the airline's recent AGM that he was "highly unlikely" to try again. Yet with O'Leary nothing is as it seems, so few would be surprised if Irish airline consolidation reaches its logical conclusion some time next year.
Key players: what next?
Willie Walsh, British Airways CEO, may have to pull off some sort of a merger before the end of the year or else his days at the airline could be numbered.
Sir Richard Branson, president of Virgin Atlantic, could achieve the sort of transformational deal he has always dreamed of with a three-way link-up with bmi and Lufthansa.
Wolfgang Mayrhuber, president and CEO of Lufthansa, may be looking for one last major acquisition before possible retirement at the end of next year.
Pierre-Henri Gourgeon, CEO of Air France-KLM since the start of the year, may look to the Far East for an alliance or acquisition.
Gerard Arpey, president and CEO of American Airlines, needs a BA alliance or else will be under pressure to take a new direction.