Forecast: Consolidation - Obstacle Course

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It was a year which began with rumours of US carrier mergers and high-profile knock-backs to the embryonic long-haul all-business model, and ended with a run of airline collapses and ever-spreading merger and acquisition moves in Europe.

The last year, fuelled by a mix of necessity and opportunity, has seen a big consolidation wave. But amid ever-more ambitious consolidation efforts, topped by talks on a first cross-continent merger in the guise of British Airways and Qantas, most industry experts still believe too many regulatory hurdles remain for real consolidation to take place.

"There are two ways you get consolidation. One is through airline collapses with the survivors getting larger as they fill the gaps and the other is through mergers and acquisitions," says aviation consultant and former Olympic Airways chairman Rigas Doganis. "In a way the charter market is a model for what could happen [in Europe]," he says. "It is the charter market which has led consolidation, where the four largest companies have become two. But the advantage charters enjoy is that the rigid nationality rules do not apply to them. They do not lose their traffic rights if ownership changes. That is still a brake on really full integration for network carriers.

"In the US, consolidation can take place because they are in one market. In Europe the real consolidation will not take place among European [network] carriers until third country nationality clauses are removed. These constraints apply to Asia as well."

 

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In terms of airline consolidation through collapses, 2008 has seen more than its share (see box). The tone was set when Italian regional carrier Alpi Eagles ceased flights three days into the year. By spring a spate of carriers, suffering from rising fuel prices, had followed. Despite relief in fuel prices during the second half, the developing financial crisis and economic slowdown drove more collapses. Many others continue to urgently seek funds or have pulled back and restructured.

Doganis expects this to continue, notably in the low-cost carrier sector in Europe where smaller carriers will collapse or be acquired leading to a growing dominance by "Ryanair, easyJet and probably Air Berlin".

Similarly the low-cost sector, within Europe and the US, because it is largely domestic or intra-EU, is largely free to pursue consolidation unencumbered by the risk of losing traffic rights. "The problem for the legacy carriers is they still have to maintain a charade of nationality," says Doganis, pointing to the need to keep separate nationality-based brands under a joint holding, thus losing many cost savings opportunities.

US Consolidation

In the US, long anticipated consolidation among the major carriers finally took hold with the merger of Delta Air Lines and Northwest Airlines last summer. While further mergers, notably around United linking up with US Airways and Continental Airlines, failed to materialise, the latter did switch allegiances and is now allying itself alongside ­United and Star Alliance.

"I think everyone has been looking at how does one best configure a US network carrier to be part of a global alliance. And to some extent they have been competing with American Airlines' position," says US aviation ­consultant Bob Mann.

He suggests American has been overhauled by first a combination of Delta/Northwest and its SkyTeam joint venture partners Air France-KLM, and then from Continental switching allegiances to United and its Star proposition. Consequently he says this drove American to step up its alliance position by increasing co-operation with oneworld transatlantic partners. American, BA and Iberia have filed a fresh attempt for antitrust immunity on European-North American routes.

"All this is driven against the idea that every global alliance is looking for the strongest American partner. It will be a continuing proposition," says Mann.

Speaking during a recent Star Alliance meeting in Chicago, both US Airways chief executive Doug Parker and United Airlines head Glenn Tilton predicted more consolidation. "Of course, mergers are coming. It's just a matter of timing, of all of the stars to be in alignment," says Parker. "We just have to get through this downturn." Tilton, while sceptical of cross-continent moves, says "consolidation is inevitable".

Attention switched to Europe in the second half of this year as BA and Iberia announced merger talks in July, though progress has been sluggish amid reported Spanish concerns relating to the UK carrier's pensions deficit.

"It is a complex process," says Iberia chief executive Fernando Conte. "We are advancing substantially and in the next two months will have reached one crucial point in the discussion - the model, synergies and the structure of the company."

Germany's Lufthansa has embarked on an eye-catching acquisition trail, acquiring an initial 45% stake in Brussels Airlines full equity control of German regional Eurowings agreeing the purchase of a 42% stake in Austrian Airlines and will in January increase to 80% its stake in bmi after Sir Michael Bishop exercised a long-standing put option.

"We don't buy airlines just to have airlines," Lufthansa chief executive Wolfgang Mayrhuber says. "Only by combining our powers can we hope to find an answer to the global challenges currently facing our industry. For European business and Europeans as a whole, it is vitally important that we create an airline alliance consisting of profitably operating airlines."

Doganis suggests Lufthansa's strategy is less about cost ­synergies and more about market dominance. "It's trying to get dominance in a number of European markets. It's buying airlines, a huge part of whose market is short-haul. That market is going to be attacked by the low-cost carriers. I think Lufthansa is buying trouble," he says.

Asian Opportunities

Consolidation moves in Asia have largely revolved around China and India. In China the last year has been dominated by ownership moves surrounding China Eastern Airlines. Amid financial difficulties facing the whole sector , consolidation appears likely and a merger between China Eastern and Shanghai Airlines is anticipated. Meanwhile, overcapacity and a slowing market prompted sharp cutbacks in India, culminating in the surprise partnership between Jet Airways and Kingfisher Airlines.

But wider acquisition and merger moves across Asia face regulatory hurdles, notably surrounding foreign ownership limitations. "The issue keeps on coming up," says Association of Asia Pacific Airlines director general Andrew Herdman. "What is it about foreign equity that is more attractive than domestic? It is the discipline that goes with foreign equity. That is what has driven consolidation in other sectors. It seems logical the international airline market will follow suit at some point. But it needs a change of thinking from governments.

"I think over time we will see a number liberalise, but it is a slow process," says Herdman. "But it is wrong to categorise Asia as fundamentally different. The US still has very strict ownership rules. Europe is nationality blind, as long as you are from Europe."

The most ambitious development emerged in December when BA surprised everyone - including Iberia - by announcing merger talks with an airline on the opposite side of the world, Qantas. The carriers were looking at a tie-up through a dual-listed company structure. But the complexity of a cross-continent merger has many questioning if the regulatory hurdles can be overcome, while Doganis says: "Given the geographic separation, can you still get the benefits of integration and will they outweigh the costs [of having separate brands]." Just weeks after announcing their talks, BA and Qantas now say a deal is off the table for now.

Even within local markets, consolidation is not straightforward. Ryanair has so far been thwarted in its attempt to take over Irish rival Aer Lingus, while Air France-KLM's aim to bolster its London City Airport operations through VLM were held up by competition issues. The deal was agreed on Christmas Eve last year, sealed on Valentines Day but only approved in October after slots were released for a new entrant on the London City-Amsterdam route. "During the takeover process, we spent a lot of time with lawyers in each country to see if there would be any problems," says VLM managing director Johan Vanneste, noting no problems were expected. But the UK's Office of Fair Trading became involved in response to a complaint. "We have not been able to do anything for the last 12 months," adds Geoffrey O'Byrne White, head of Cityjet, the Air France unit now cleared to work with VLM. "In the banking sector you can see it is possible to merge overnight, but it is typical of the airline industry."

Much of the co-operation moves have been borne out of necessity. Major consolidation in Italy, with the merger of its largest carriers, Alitalia and Air One, and the restructuring of airlines in Russia under the ­RosAvia grouping, stem from addressing airline financial difficulties.

So will the tough market conditions fuel more consolidation and act as a catalyst for a change in thinking among governments? Herdman says: "When there is a downturn, there may be more people interested in exploring the benefits, but the rules have to change. The real issue is what will persuade governments to move forward with real liberalisation, is it likely to be when the market is growing or when the industry is under strain? You can argue it both ways. In some cases governments, I'm afraid, will become more defensively minded."

In the US much depends on the outlook of the new Barack Obama Administration. "There are a lot of antitrust-friendly aspects of the Bush Administration that may not continue," says Mann. But he adds: "Some of the changes might be surprising. I think it's unwise to conclude all the pro-labour [positioning] will translate into protectionism. I don't think it will. I think we'll see more globalisation and more opportunities, but they will be more fair."