Alitalia's Milan decision could destabilise sale process

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Alitalia has been bleeding money for years and Milan Malpensa has been a millstone around its neck. But the carrier's attempts to cut its ties with the airport and the political maelstrom this has caused could destabilise privatisation efforts

How do you solve a problem like Alitalia?

This question has been perplexing the Italian government and the loss-making carrier's management for years, yet still the beleaguered airline faces the very real prospect of running out of cash before it has a chance to be privatised and turned around.

Alitalia's decision to drastically pull back capacity at Milan Malpensa and drop its dual hub structure to focus solely on Rome Fiumicino has caused a storm of controversy in northern Italy's Lombardy region, which threatens to destabilise the outgoing Romano Prodi government's plan to sell its stake in the airline to Air France-KLM. The government has until mid-April to try and push a sale through ahead of the general elections, but with such strong political pressure from Lombardy, compounded by plans outlined by potential rival bidder Air One to maintain Alitalia's Malpensa hub, there is no certainty this will happen.

Before getting bogged down in the politics of it all and the "will they, won't they be successfully privatised" debate, it is important to understand the history of Alitalia's relationship with Malpensa to gain a clearer picture of where it all went wrong, why the carrier deems it necessary to slash capacity so severely and what ­impact this could have on the ­airport and the region.

Northern hub

Malpensa opened in 1998 with the original plan being that foreign airlines serving Milan Linate would move their operations to the newly expanded airport, making Malpensa the main international airport for northern Italy and leaving Linate as more of a domestic, short-haul facility. But this never really happened. There was a barrage of complaints from airlines about the accessibility of Malpensa, which is located some 50km (30mi) outside Milan city centre compared to Linate's more convenient location 10km from the city. Eventually, after intervention from the European Commission, it was decided that some European flights would still be permitted to operate from Linate. According to Alitalia, the result has been that 62% of passengers originating from Milan and 92% of passengers originating from the wider northern Italy region do not use Malpensa as their departure airport for intercontinental flights. Instead they use Linate to connect at other European hubs, such as Frankfurt and Paris.

Not enough investment has been made in improving access to the airport, according to Milan-based analyst Giuseppe Siciliano, who accuses Milan airports operator SEA and Alitalia of blaming one another rather than taking action to improve matters. "The new Malpensa opened in 1998 but still after 10 years major investments are needed to improve accessibility," says Siciliano. "Alitalia has blamed Malpensa's operator for not improving efficiency and the airport company has blamed Alitalia for not increasing Malpensa capacity."

Under its de-hubbing plan, Alitalia will this summer cut the number of weekly frequencies from Malpensa to less than 400 in May from over 1,000 in February (see chart). Alitalia says the cuts are necessary because of "the impossibility for the company, as things stand, to manage two hubs efficiently and productively". It adds that "under current conditions it is impossible to run a dual hub system efficiently because of the continuing accumulation of business losses, most of which are related to Malpensa airport". However, Alitalia does not plan to completely abandon Malpensa it aims to grow the operations of its low-cost subsidiary Volareweb at the airport.

David Jarach, professor of air transport marketing at SDA Bocconi School of Management in Milan, says Alitalia's problems at Malpensa stem from its failure to develop a proper hub system at the airport. "Since the beginning Alitalia never created a real hub at Malpensa - it had no local maintenance base and it never made any serious investment in its long-haul fleet," he explains. "This created a duplication of costs because the crew had to be flown in from Rome before every flight." Jarach adds that "serious investment" is required from SEA to create "a new batch of carriers to replace Alitalia at Malpensa", but says in the short-term "it is difficult to see another hub carrier at Malpensa". Siciliano believes Malpensa's future relies on Italy liberalising its bilateral agreements with other countries because "at the moment these are restrictive for companies other than Alitalia and airports other than Fiumicino". However, he adds that Malpensa's market in the mid- to long-term "would make up for the loss of Alitalia".

Legal action

In the meantime, SEA confirms that it has taken legal action against Alitalia over its decision, and says it fully supports calls from Milan's mayor and others for a three-year moratorium on cutting Malpensa services to allow the airport time to attract other carriers to fill the void. One carrier that is keen to fill some of that void is Ryanair, which in September submitted a proposal to SEA to invest $840 million in Malpensa, basing 12 aircraft at the airport and launching 50 international routes. However, Ryanair says it has yet to receive a response from SEA and "would welcome feedback from them" on the proposal.

Jarach believes the intention behind the calls for a moratorium is "to expel Air France-KLM from the negotiations". The Franco-Dutch carrier is in the midst of exclusive privatisation talks with Alitalia, but this has led to attempts from Italian carrier Air One's parent company AP Holding to derail the process to clear the way for potentially making a binding offer of its own. "If the pressure mounts there is a risk that the French could abandon the field - in this case the solution for Alitalia could be bankruptcy," warns Jarach. Air One says it is "immediately ready to be the main Malpensa operator thanks to our plan for Alitalia, which foresees not only keeping it active, but furthering its development on an intercontinental scale". But there is scepticism as to whether Air One has the ­resources to rescue Alitalia.

"The probability of Air One's plan being a serious plan relies on the extent to which the banks will be involved," says Siciliano. "Air One can't deal with such a huge expansion plan without the support of financial institutions and it's not clear what form of support is available." Jarach adds that if Air One were to become Alitalia's new owner, there is a danger that not much would change: "There would be problems to turn around the combined companies because Air One's management is very weak, and there is the risk that the old logic of Alitalia would continue." In his view, much-needed changes would be made under Air France-KLM: "Alitalia would likely, if not certainly, become a regional carrier. It would have a smaller amount of long-haul operations with most of the long-haul operations funnelled through Paris. Rome would become a secondary hub to serve Mediterranean destinations."

But there is no guarantee that even Air France-KLM could succeed in turning Alitalia around, according to British Airways chief executive Willie Walsh. "I don't think Air France-KLM acquiring Alitalia, if they are successful, is a guarantee for future success," he says. "Alitalia has got some serious issues that they need to address and, to be honest, they should have addressed them years ago."

Restructuring

Air France-KLM's plan for restructuring Alitalia would involve an immediate €750 million ($1.1 billion) capital increase, the acquisition of the carrier's entire share capital through an exchange offer and a long-term investment of €6.5 billion. AP Holding in December submitted a non-binding offer to Alitalia, under which it envisioned investing €5.3 billion into the carrier by 2012, and positioning it as the "fourth European full-service airline".

Alitalia, which is reputed to be haemorrhaging €1 million a day, has already said it needs a €750 million cash injection during the first half of 2008 to enable it to sustain adequate liquidity levels. The carrier recently raised €92 million from the sale of three London Heathrow slot pairs and this "gives it enough cash until May", says Jarach, but after that "it will have serious problems to pay for fuel and salaries".

Under Italian law when a government collapses it is only supposed to deal with ordinary administrative matters, and Jarach says it is "controversial to say that the sale of a flag-carrier" falls within that realm. Whatever the outcome, crunch time is approaching for Alitalia.

Alitalia is chopping its operations at Milan Malpensa by over 50% as it finally axes its dual hub strategy