ANALYSIS: Why Etihad's James Hogan is empire building

Abu Dhabi
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A few eyebrows were raised two years ago when Etihad Airways sailed to the rescue of troubled German leisure carrier Air Berlin. But what at the time looked like an opportune move to grab a slice of one of Europe’s major markets became the launch pad for a major investment programme across the globe, and in doing so has allowed Etihad to carve out a strategy that sets itself apart from its Gulf rivals.

The surprise deal saw Etihad buy a 29% stake in Air Berlin, and invest $255 million over five years to support its fleet development and future network growth.

The Abu Dhabi government-owned UAE carrier, which marks its 10th anniversary this year, has assembled an “equity alliance” that comprises shareholdings in five carriers in Europe, Asia and Australia, and approval is close for a sixth, in India’s Jet Airways.

“What we’re doing is building a strategy to drive traffic over the hub to give me the network that is competitive with my two near neighbours,” says Etihad president and chief executive James Hogan. “My fiercest competitors are here in the Gulf. This strategy is part of how I differentiate and build a network to compete.”

He divides Etihad’s equity alliance into two groupings: “The ones where there is a management contract: Air Serbia [previously Jat Airways] and Air Seychelles, and the pure strategic investments: Virgin Australia, Aer Lingus, Air Berlin and Jet [Airways].”

Despite having been involved with Air Berlin for 18 months, Hogan is reluctant to reveal how long it will take to return the airline to solid profitability. The carrier suffered a net loss of €420 million ($570 million) in 2011, but thanks to “non-recurring events” (the sale to Etihad of its TopBonus loyalty programme), the German airline scraped a small net profit of €7 million last year.

But Hogan says the success of Etihad’s tie-up is measured in two aspects – from a shareholder perspective and from a commercial point of view. “If you look at the commercial agreement, we’ve exceeded our revenue targets and we’ve already clawed back our initial investment of €105 million in cost synergies. So as Etihad, it’s ahead,” he says.

“In regard to the ongoing rebuilding of Air Berlin... the issue is to work with the management team and use group deals to help them reshape their cost base. It’s a long road – it’s a traditional airline and it takes time for a traditional airline to turn. But we’re confident that [Air Berlin chief executive] Wolfgang Prock-Schauer is on the right track for us as a long-term shareholder, with [restructuring programme] Project Turbine.”

Hogan adds that without “a total unfair airport tax”, he is sure that Air Berlin would already be profitable.

The deal for a 24% stake in India’s Jet Airways is still awaiting final approval, but the process is “on track”. This is a clear strategic move to grab a bigger slice of the Indian market, Hogan says.

"Millions of Indians travel internationally every year, and that’s growing at 10%. That’s a huge market of opportunity. Etihad has taken advantage of the new foreign direct investment rules, and to invest you need a good partner. We’ve had relationship with Jet Airways for a long time.”

Some question the wisdom of buying a stake in another loss-making airline, and Hogan concedes that “all businesses go through difficult periods”, but he sees the move as “a true win/win” for both parties.

“Over a period of years our allocation ramps up from 12,000 seats a week to 50,000. We fly to nine cities today,” Hogan says. “When we max out, between us we’ll be flying from Abu Dhabi to 26 cities in India. We will grow our presence in Bombay and New Delhi, so now long-haul flying [from India] to the USA will be over Abu Dhabi.”

Observers believe that if Etihad and Jet pull off their plan, it will catapult the Abu Dhabi carrier forward in its battle with market leader and local rival, Dubai-based Emirates, which dominates the India-UAE sector.

Jet’s acting chief Hameed Ali said in August that the Etihad investment would “significantly change the landscape of the business”, and enable the Indian carrier to benefit from better bargaining capacity and improved connections.

Etihad is seconding three executives to the Jet management team, and Hogan is “very confident, as partners, that we’ll see Jet Airways move into profitability in an acceptable timeframe”.

The deals to sort out the loss-making national carriers of the Seychelles and Serbia came after the countries were already in the spotlight for Abu Dhabi investment. These two management contracts resulted from approaches from the local governments, and were agreed with the proviso that the “debts of the past” would be written off.

Etihad’s conditions included that the management teams would be replaced and the airlines would be “right-sized”. The airlines’ fleets and networks have also been revamped, with Etihad-common aircraft types introduced, some routes dropped and others launched.

The medicine helped at Air Seychelles, which turned a $25 million loss in 2011 to a $1 million net profit in 2012, and should remain profitable this year, says Hogan.

While not strategic, Hogan says that both these shareholdings and management contracts provide Etihad with feed and access to key markets, and bring more strength to its growing Abu Dhabi hub. He is guarded about the amount of money Jat Airways has been losing, saying only that its deficit is “considerable”. But he confidently predicts that the relaunched Air Serbia will be in the black within two years.

And while emphasising that Etihad Airways is his “number one priority”, Hogan does not rule out further moves. He admits that his corporate strategy team have had many knocks on the door from willing potential partners, but only serious propositions clear the evaluation process and reach his desk. “We’re not a bank. We’re not here just to create a collection of brands. We’re here to create an equity alliance strategy where we all win,” he says.

Hogan does not have a Willie Walsh-style “shopping list”, but “if there was a compelling opportunity, yes, we’ll consider it”, he says. “Our shareholder is very clear: if it doesn’t make commercial sense, do not step in to it.”

There are three key criteria that Hogan and his team examine when considering a strategic investment: do the networks match; would the deal bring “scale or reorganisation opportunity”; and does the airline have a good management team in place.

The last point is important, as Hogan does not want Etihad’s own team distracted – and this is what, he says, sets the Etihad strategy apart from the empire building of Swissair more than a decade ago.

“In the investments we look at, we put in management teams – but they report to a board. We have representatives on the board, but those CEOs are responsible for their own day-to-day business,” he says. “This is the big difference when people say Swissair tried this. Swissair took management control.”

“Scale” is a word Hogan repeats often, pointing out that Etihad and its equity partners operate a combined fleet of 500 aircraft, and this also helps with buying power: “We’re achieving considerable group deals, which is the important flip-side of this equity strategy: to build scale and improve unit cost,” he says.

As Etihad has grown in stature over the last two years it was at the centre of another eyebrow-raising development, when Air France-KLM – once highly vocal in its suspicions about the Gulf’s fast-growing carriers, and their support from local governments – agreed a commercial tie-up with Etihad.

“With Air France and KLM, who were doubtful about the Gulf airlines in the past, we actually brought them to Abu Dhabi and they saw our business,” says Hogan. “We took them through the treasury function. We explained why we don’t have unions and why our productivity is far greater. We took all the myths on. And they saw this was a well-run business.”

Hogan says that the might of Air France-KLM, when combined with Etihad and its partner airlines Air Berlin, Aer Lingus and Air Serbia, means that “coming out of Europe we are far stronger than the offering that Emirates has”.

And Etihad’s link with the old guard does not end there: “We have a good relationship with Air Canada and with American Airlines, with whom we have codeshares,” Hogan says. “People who work with us and come into our world see this is just an airline which is 10 years old [and] started with a clean sheet of paper. Quite frankly any other CEO doing what I’m doing with an airline that’s only been around for 10 years would be doing the same.

“This crossroad of the Gulf – of Abu Dhabi, Doha and Dubai – that’s the old Silk Road. So we don’t think of traditional traffic flows. And these markets have huge traffic flows.”

Etihad thinks of itself as a “crossroad”, playing across all the global alliances – an approach that differs from local rivals: Qatar Airways has jumped in with Oneworld, while Emirates – although also agnostic towards the global groups – is forging strong ties with one partner, Qantas.

Hogan views the Qantas/Emirates romance, which blossomed earlier this year, as further proof that the concept of the global alliance is a “model that’s fractured”. He has consistently stated that he sees no value for Etihad to join Oneworld, Star Alliance or SkyTeam: “We work with airlines across all the alliances. The problem [with joining an alliance] is that while we’re not aligned, everybody’s prepared to work with us.”

But this position would not prevent airlines in which Etihad holds a stake from being in an alliance “if it is the right thing for them to do”, he says.

Air Berlin is currently the only one of the six equity partners that is aligned – it was in the process of joining Oneworld when Etihad acquired its 29% stake.

“As a shareholder, we could have discouraged the Air Berlin alliance move, but I’m happy for Air Berlin to work within Oneworld, if it benefits Air Berlin,” says Hogan.

Jet Airways has been the subject of much alliance speculation, in particular about joining Star, and again Hogan says membership would not be discouraged “if it made sense for Jet and it improved their business and didn’t impact our business". In any agreement there are ‘carve-outs’ where there are areas of overlap, he says.

Etihad carried 10 million passengers in 2012, but Hogan is guarded on any growth forecast for this year. “We brought in 15 aircraft last year, so we’ve seen growth in passengers, ASKs, cargo ATKs and revenue,” he says. “What’s important is we’re getting the load factor and the RASK that we’re targeting.”

Etihad currently serves 94 cities with a fleet of 80 aircraft, including freighters, and is looking to add destinations in “all parts of the world”, says Hogan. “We’ve just gone into Latin America [Sao Paulo]. There will be more flying announced shortly into the USA and more European flying. We’re building frequency in Southeast Asia and into China and into India,” he says.

And after steering the carrier to a first, albeit small, profit in 2011, Hogan is confident Etihad Airways will remain in the black for a third successive year: “And it will be better than last year,” he says. Net profit rose by 200% to $42 million last year (its fiscal year runs to the calendar year), while revenue was up 17% to $4.8 billion.

The challenge now for Hogan and his management team is to perform the same magic with the balance sheets of Etihad’s equity partners.