Five years ago flybe turned itself from a regional also-ran into a low-fares pioneer. Now chief executive Jim French is taking another big strategic step as his airline doubles in size with the acquisition of BA Connect
When it comes to playing on the regional stage, flybe refuses to follow the script. In the chronic business climate post-September 2001 this leading UK regional should, by rights, have simply faded away.
It was leaking cash and about to become another British carrier consigned to a footnote in airline history books. "We were going bust," says Jim French, chief executive of an airline that was formed in 1979 as Jersey European to serve some sleepy British islands located just off the French coast in the English Channel.
But French, who has led the carrier since June 2001, had other ideas. Now, six years later, he runs a low-fares player with a strong brand that makes a virtue of flying from the UK's regions and boasts of its green credentials by flying environmentally friendly turboprops. In recent months it demonstrated its lofty ambitions by doubling in size with the acquisition of the British Airways regional business BA Connect.
Flybe at a glance
Revenue $540.7 million
Operating margin -1.2%
Net margin -4%
Year end March 2006
Airline Business 2006 financial ranking 115
Airline Business 2006 traffic ranking 193
RPK growth (2006) -2.7%
ASK growth (2006) 4.3%
Load factor (2006) 63.2%
Flybe's transformation has included a return to profitability, albeit at a modest level. It moved into the black in 2005 after four years of consecutive losses. However, the fact that it has stayed alive is something of an achievement in itself. Flybe has not only survived it has grown, boosting revenues from £204 million ($414 million) in the year to March 2001 to over £300 million, and expanding its reach from the UK regions deeper into continental Europe.
Flybe's renaissance began with the decision to turn itself into a low-cost airline. Back in 2001 radical measures were desperately needed and flybe looked at the only successful airline sector - low-cost - to revive its fortunes. It took all the best bits of the low-cost model for itself: direct distribution, low fares, and a strong focus on ancillary revenues and added a few ideas of its own like charging for bags.
French lists a range of factors that make up its formula for success. Firstly, while flybe continues to sell its tickets through the Global Distribution Systems, its own website dominates the sales picture taking 85% of its bookings. This has helped slash distribution costs from £6.55 per passenger in 2003 to £3.72.
Secondly, flybe brought in many low-cost standards such as one-way fares, no refunds and credit card charges. The third factor has seen a focus on driving network efficiencies by concentrating on UK bases. This has helped reduce the number of crew bases from 14 to nine. Finally, flybe has selected what French calls the "perfect aircraft for our operation: the Bombardier Q400 and the Embraer 195".
"A lot of people thought we were off our trolley," says French, using the slang term for someone who has gone crazy. Irish flag carrier Aer Lingus, then led by Willie Walsh, underwent the low-cost conversion around the same time as flybe. "We're unique in that we're doing it with regional aircraft," says French, whereas Aer Lingus operated regular narrowbody jets.
The paths of French and Walsh were to cross a few years later. The genesis of the idea for flybe to buy BA's regional business dates back nearly a decade, but it took a chance meeting with Walsh at an industry dinner in March 2006 to set the ball rolling again. By then Walsh had moved from Aer Lingus to head BA. "I said to Willie: 'you and I should have a cup of coffee'," recalls French. The subject was to resurrect talks about coupling the two regionals.
A couple of months after the dinner meeting Walsh got in touch with French and the two started serious talks about flybe acquiring BA Connect. The deal suited both sides. BA was desperate to either turn around the loss-making business or sell it by 2008. For flybe the opportunity was too good to miss. "We are creating an airline of £600 million plus in turnover and the potential to carry 10 million passengers," says French. Moreover, taking over BA Connect gives flybe access to several major European cities, landing slots at major airports, and reinforces its already strong positions at the UK's Birmingham and Manchester airports.
However, BA Connect was a heavy loss-maker and had spent five years in the red. In early 2006 BA rebranded the carrier, which was known as BA CitiExpress, gave it a single-class cabin for non-London routes and cut fares by 40%. But this still wasn't enough. "The numbers were clearly not on track," said BA commercial director Robert Boyle when the flybe deal was announced in November 2006. The sale to flybe gave BA a better option than the "reality of a closure alternative", said Boyle.
Buying BA Connect also radically changed the risk profile for flybe's future growth. "We had 28 aircraft coming which we would have to find use for," says French. Rather than being used to launch new flybe routes, these aircraft are being used to replace BA Connect's four BAe 146s, seven Bombardier Q300s and 28 ERJ-145s. "This is a massive benefit," he says.
The integration challenge
French acknowledges that integrating and turning around BA Connect, which lost over £40 million in the year to March 2007, is far from simple. But it is moving swiftly to slash its cost base. BA Connect's headquarters in Manchester have been closed, as have its maintenance base on the Isle of Man, and its operations centre and base in Bristol. Loss-making routes have also been culled with 15 routes representing 172 weekly rotations axed immediately.
In addition, airport deals are being renegotiated to take advantage of larger volumes, flybe's aggressive ancillary revenue model is being introduced to BA Connect services, and all bookings will move to flybe's website. "The objective is that this all delivers cash benefits in the order of £40 million in the first year," says French. "This should stabilise the business."
This is the first phase of the turnaround. The second phase sees all 28 of BA Connect's 50-seat Embraers being substituted by Bombardier Q400s. "This will add £1 million per aircraft to the bottomline," says French. The Q400 has a cost advantage of £14 per seat over the jet, he says. It will take two years for all of BA's aircraft to exit flybe, but out of it will come "an exceptionally strong company", be believes.
The deal flybe concocted with BA cushions the smaller carrier as it digests BA Connect. It involves BA giving flybe just under £100 million in cash to help it with transition costs, including the removal of all the BAE Systems Avro RJ85s from the fleet and fulfilling pension obligations. Furthermore the operating cost penalties of flying the 146s and ERJ-145s are covered until they leave.
As BA chief Walsh said when the deal was unveiled: "When I say we sold BA Connect it's a very liberal use of the word sold." However, there is a potential silver lining for BA, which in return for supporting flybe's transition away from BA Connect's fleet has taken a 15% stake in flybe. French believes BA should get back the cash it has used to rid itself of its regional operations once flybe is floated in a few years.
On the surface the deal appears to be a coup for flybe, enabling it to take a massive growth step with a financial parachute attached. However, French is under no illusions about the magnitude of the task ahead. "We were not prepared to risk the business for this deal," he says. "But it is right for our business. We have created an airline of some size and scope." The beefed up flybe will now carry as many passengers a year as Sir Michael Bishop's bmi Group (just over 10 million), which has for years been the UK's second largest carrier after BA.
French says his management team, and flybe's experienced board, is up to the task of integrating BA Connect. He has 25 executive managers running the carrier and there are no plans at present to bring in further top level expertise. "We have a really strong structure and a team that is very capable of taking this on board," he says. "The big challenge is to develop line management - among cabin, ground operations and pilots."
The atmosphere at the ground roots of the airline has been somewhat agitated, especially trying to persuade BA pilots to transfer their flag carrier terms and conditions to flybe's. Then there is the task of keeping flybe's flight crew happy as the pilot seniority lists merge. There have been rumbles of unrest among both sets of pilots.
"Yes, there will be some short-term pain," says French. "Some are not happy and they will choose to leave." But he believes the vast majority of staff will choose to stay to grow with flybe, which has already ordered another $500 million worth of Q400s since the acquisition. The big test was to get BA staff to accept flybe's terms and conditions. "We knew we couldn't afford that," says French of BA Connect's cost base.
"It is a challenge and we know it's a challenge," he says. "Our management style has always been one of honesty and openness." In his annual letter to staff, French recognised that some former BA staff would not find flybe to their liking. "I respect that, and I said if that is the case, please leave and we will wish you every success in your new career. All I ask is for people to be honest with us and we'll be honest with you."
And a lot have left, at the rate of about 20 per month in the case of pilots, which is in line with flybe's expectations. "We don't want them to go, but we've built into our planning regime a significant attrition of 30-50% of all pilots," says French.
"The real challenge this summer is getting everybody on side - the rest is automatic, we've done it all before," he says. For French, much of the hard work has already been achieved with the unneeded bases closed, all weak routes axed and labour agreements thrashed out. The automatic part of the plan is substituting the BA Connect aircraft as new ones are delivered from Canada and Brazil. "This is almost a production line," says French. "We've got an aircraft coming every 20 days for the next two years. The training is just massive."
How successfully flybe absorbs BA Connect will dictate how profitable it will be in the financial year to March 2008. "It will be a hell of a result if we can maintain our level of profitability. The objective is to stay in the black if we can." Flybe has not released its final figures for the 2007 financial year, but is expecting operating profits of £15-18 million, which will be the highest in the company's history. This has come about as the routes launched in a blizzard of announcements in the past couple of years start to mature and deliver profits, in addition to improving loads and yields.
This follows an operating loss of £1.2 million on its flying operations in its 2006 financial year: a year that saw flybe expand quickly. The £1.7 million cost of delaying a public offering and another £6.4 million charge associated with the write down in the value of seven BAe 146s pushed the overall net loss to £9.3 million. Its revenues rose by 26% to £303.5 million.
French has a target of a 7% net margin for flybe in two to three years' time. Another target, to have around £100 million cash on hand, which is equivalent to its total outgoings for between three and four months, has already been reached.
Before the BA Connect deal, flybe was intending to launch an initial public offering this year. Bringing the BA operation into the fold has in a single swoop doubled the size of the business and in the process made it more attractive to float. However, this has been put off for a couple of years to give flybe time to integrate its new acquisition. "We're not giving a date for the IPO, but we will revisit it when we are ready," says French.
What flybe will not revisit is a move into 150-seaters, with the 118-seat 195 being its largest aircraft. It did lease three Boeing 737s 18 months ago as an experiment for routes into southern Spain. But the move "put us right on the radar screen of easyJet and Ryanair", says French. Like a failed move to capture leisure traffic at the UK's Liverpool airport, flybe acted quickly to leave the experiment behind when it didn't work. "Sometimes the biggest thing is to make a decision. You've got to admit your errors and change," says French.
Buying BA Connect helps arrest flybe's drift towards a leisure instead of business traffic bias. "Overnight it gives us a far more business to leisure balance," he says. Before the deal it was looking at a mix of 45% business to 55% leisure. Now this has shifted to a 60:40 mix. Even flybe's leisure traffic is higher octane than some. "Our leisure is VFR [visiting friends and relatives], island traffic and people with second homes in France. Ours is high repeat leisure as opposed to discretionary travel."
Its expansion plans, including the possibility of bases being established in continental Europe or further acquisitions, are on hold for two years, says French. At present the airline has no major route expansion planned for the next two years. Although the emphasis is mainly on substituting the BA Connect aircraft, it has recently unveiled some expansion in Geneva with new routes to the Swiss city from the Isle of Man, Jersey and Newquay.
Once the heavy substitution phase is over flybe will be ready to take the business to the next level, believes French. And there will be opportunities, probably involving various forms of industry consolidation. "A lot of things are going to change," he says. For French, the important aspect of the BA Connect deal is that it gives flybe the extra muscle it needs to become a major player whatever happens. "I would not have liked to be the one left at £300 million," he says.
French believes flybe's business can be defended against the likes of easyJet and Ryanair. "We can fly eight sectors a day with our Q400s for the same cost of four on 737s. In terms of frequency we can always defend ourselves that way."
It is also a big player at the relatively small airports it frequents. "Our mass in these markets has defendability," he says. In addition, it has several bases. "We haven't got one big lump - we've got several strong bases. The risk is spread."
With BA Connect coming under its wing, French is convinced flybe has stronger prospects than ever before. "As the largest and only low-cost regional airline in Europe, cash in the bank and a new fleet we are in a hell of a position to go forward."
Jim French is one of the best known names in the UK's air transport industry. This affable and likeable Scotsman began his career with Caledonian Airways in 1970.
A decade later he moved to Air UK where he built up a solid base of regional airline expertise in various roles in commercial, planning and marketing. In 1990 he was recruited by another UK regional, Jersey European. In 2001 he became its managing director.
French was appointed to the combined role of chairman and chief executive of flybe in March 2005 and headed the team that bought BA Connect in March.