Airlines eye consolidation as open skies deal looms
The takeover rumour mill is working overtime in Europe’s airline industry as the major players begin to jostle for top spot in a sector that is expected to see consolidation like never before.
The incoming “open skies” agreement between the European Union and the US is set to liberate the historically highly restricted transatlantic route when it is signed in Washington later this month.
It will also open up the possibility of consolidation among Europe’s mainstream airlines – a risky business under current rules, where tie-ups between rival EU groups can lead to valuable US landing rights being lost.
This week Ryanair boss Michael O’Leary said he wanted to start a low cost transatlantic airline after the “open skies” agreement with fares starting as low as £7 (€10.30). Meanwhile, privately owned Canadian carrier Zoom Airlines is understood to be planning to introduce a low-cost transatlantic service as early as June, with fares from £129 (€189).
Spanish airline Iberia looks set to be one of the first groups to be swallowed up under the “open skies” merger and acquisition frenzy. The group is mulling a £2.3bn (€3.4bn) private equity bid with a board verdict expected imminently, but a swathe of similar potential takeovers are circling the skies.
Italy’s Alitalia is being eyed by groups including Russia’s largest carrier OAO Aeroflot and Italian bank UniCredit, while British Airways and Virgin Atlantic are both said to be keen on snapping up BMI.
But this is only the start, say some in the industry who are predicting the “open skies” deal to bring a transformation of the world’s airline business, which is tied up in a maze of bilateral and multilateral agreements.
The agreement is the third of its kind to be signed in the past 60 years, with the Chicago Convention just after the Second World War laying the foundations for civil aviation. The 1993 creation of the Single European Market led to the deregulation of air traffic in the European Union, which in turn saw the creation of low cost, or so-called “no frills”, carriers.
This latest agreement promises to be a further milestone. Open skies deals already exist between the US and many countries in Europe, including France and Germany, but there are 11 EU countries that do not have this privilege, with Britain, Spain and Ireland among them.
Private equity giant Texas Pacific Group (TPG) certainly seems to see the merits of the agreement, judging by its recent interest in the sector. Aside from its €3.60 a share offer for Iberia, it is also one of the Macquarie-led consortium bidding for Australian airline Qantas and recently tied-up with other venture capitalist groups to stalk Alitalia.
TPG’s Iberia offer has thrown the spotlight on British Airways, which owns a 10% stake in Iberia and is in the privileged position of having the option to increase its holding to 30%. BA is widely expected to involve itself in a bid for the group in some way, whether by counter-bidding or joining forces with TPG, although the airline itself has suggested it would not make a rival offer.
For BA, the benefits of the open skies deal must seem few and far between. Its share price slumped 8% on news that the EU and US had reached a draft agreement in early March as investors feared its protected position at London’s Heathrow Airport could be under threat.
Airline analyst Howard Wheeldon at BGC Partners said BA was likely to opt for a collaboration of some sort with TPG if the Iberia deal goes ahead. He notes that Iberia does not come without its problems, saying that the group needs “significant management attention” and has been dogged by accusations of poor customer service for years.
But it is the pre-eminent European-Latin America carrier, which is an area in which BA has traditionally been weak, and it could significantly enhance the airline’s international status and competitive position.
“If BA walks completely away from Iberia, it may have lost the last real opportunity to play a significant role in mainstream European airline consolidation,” said Mr Wheeldon.
But, as BA’s chief executive Willie Walsh pointed out recently, while the key strength of the Iberia deal is seen to be its network with Latin American countries, there are treaties between Latin America and Spain preventing a non-Spanish carrier from buying the routes. This is ultimately what might hold back much of the predicted consolidation in light of “open skies”, according to Panmure Gordon analyst Gert Zonneveld.
With every country having bilateral agreements, EU airlines that consolidate would have to set about re-negotiating all of those outside of the EU/US deal. Air France has spent the past three years doing this after its takeover of Dutch airline KLM in May 2004 and it may put off all but the very determined, said Mr Zonneveld.
He added: “It’s a bit of a frenzy at the moment. There’s a lot of takeover talk, but I’m not sure how much will actually result in transactions. You’ll maybe see the number of long haul traditional airlines shrink in Europe, because there are probably too many around and they’ll be absorbed in larger carriers.”
The predicted mass consolidation in the sector could also be hampered by the cost involved in buying an airline, although private equity firms can provide a useful source of capital. Many airlines seem in the meantime to be opting for the more immediate and less complex option of simply adding new routes.
Virgin Atlantic is “actively looking” at expanding its Europe to US offering, considering launching flights from key hubs such as Paris, Frankfurt, Amsterdam, and Madrid to New York within two years.
The move could offset the additional competition it faces on its home turf at Heathrow. It is one of only four carriers currently allowed to fly transatlantic routes from Heathrow, alongside BA, United Airlines and American Airlines, but will certainly face some additional competition post “open skies”.
BMI in particular is seen as the biggest competitive threat because it is already the second largest carrier behind BA at Heathrow.
But there is also set to be competition from business-only transatlantic airlines, such as Silverjet, which will be able to extend its existing services, plus the emergence of low cost airlines to the States.
For groups such as BMI, “open skies” is a ticket to some of the world’s most lucrative routes. It was also a surprise to many, with the agreement coming much earlier than anyone expected. Its sudden emergence has led some to believe that it was something of a rush job, with EU negotiators caving in to US demands.
For example, the US will still have a 25% cap on foreign ownership of its airlines and while US carriers will be able to fly passengers from one European city to another, the opposite will not be true for EU airlines.
US airlines will also retain their monopoly over carrying US government employees, except to and from smaller cities. Citigroup analyst Andrew Light said: “The EU/US Open Skies proposal offers little additional benefit to European airlines – negotiators would appear to be in a hurry to secure a deal at any cost.”
For customers it promises to bring fares down as greater competition forces carriers to cut prices. In terms of the industry, there will undoubtedly be winners and losers and it is a small step in what promises to be a lengthy process worldwide.
