It looks like another David-Goliath contest - the innovative young challenger versus the stodgy old incumbent. Aerolineas Centrales de Colombia (Aces), the challenger, is raising capital, seeking foreign partners, training young managers, and replacing used aircraft with a shiny new fleet. Until recently incumbent Avianca, which lost out to KLM as the world's oldest airline by only a few months, had the bloated bureaucracy typical of older Latin American carriers, changed leaders too often to develop any direction, and seemed uncertain how to cope with real competition.
But this contest is proving more complicated than the Biblical one. An incumbent airline, it seems, enjoys real advantages and Bogotá-based Avianca's new leaders have a few fresh ideas of their own. It is far from clear how much Aces can challenge Avianca as Colombia's leading carrier.
The difficulty facing Aces lies in the fact that Avianca has become more formidable. Gustavo Lenis, Avianca CEO, is the first to admit his airline had 'lousy service' and was 'not ready to compete' when Aces emerged earlier this decade. When Lenis took over at Avianca four years ago, he told everyone: 'To survive we have to be good again.'
To 'be good again' Lenis launched a painful but successful restructuring. He cut Avianca's workforce from 11,000 to 3,200; offered such incentives as extra pay for learning English; measured service through passenger polls; cut unit costs from 16 to 11 cents per available seat-mile with a goal of 9; launched a campaign to boost on-time performance; convinced mechanics to accept a pay system that proved better than their own union's; and took other steps to 'change the inside culture'.
The result, claims Lenis, is higher morale, a turnaround of Avianca's market share decline, and its first profits in years which began in 1993 and resulted in a US$18.2 million net profit in 1996.
Changes still underway include realigning regional routes so that domestic subsidiary SAM will fly all sectors under 90 minutes. That should allow Avianca to focus its international service on long-haul routes. Beyond its new London route launched in May, Avianca has no plans for other routes. It does however hope to add capacity to several destinations, notably in the US.
Lenis also recognises the potential of Bogotá as a gateway between Europe and South America. Routes between Europe and South America's southern cone are too far for nonstops with most equipment. That raises Bogotá's geographic value and puts Avianca in an enviable position. Lenis did not cheer the demise of Viasa, but it gave Bogotá at least a temporary edge over Caracas, and he is anxious to exploit it. Schedule planners are busy now adjusting connection times between Avianca's transatlantic and South American flights.
Aces remains unfazed. 'By 2005 we aim to be the best airline in Latin America,' says Juan Emilio Posada, president and CEO. This seems an ambitious agenda for an airline formed by a coffee growers' association to link their plantations to the rest of the world, especially when its first scheduled flight overseas was only five years ago. Colombia's coffee federation still owns 54 per cent of Aces directly and another 44 per cent indirectly through its control of a shipping line that is Aces' second major shareholder.
Medellin-based Aces is only a fifth of the size of Avianca, but it is already Colombia's second airline. It has the most extensive domestic network and schedule in Colombia with the second highest market share, and flies to Panama, Puerto Rico, Costa Rica, Dominican Republic, and, most importantly, Miami. More significantly, it alone among Colombia's carriers aspires to spread its wings.
'This is a real company owned by real people with their own money,' says Thomas J Gallagher, managing director of CIBC Wood Gundy Securities, which helped Aces last year with its fleet analysis. That's an important distinction in Latin America - many are not. 'The people who run Aces have a very clear idea of what they want to do.'
The best evidence of this is the three-step restructuring Aces has started - to increase capital, find one or more strategic partners, and refleet. These inter-related steps are designed to boost the carrier's prowess and presence and render moot Gallagher's other observation, that 'before now noone had ever heard of them.'
Early in May Aces' current shareholders paid in US$10 million in additional capital, twice the size of any previous contribution, to boost the company's balance sheet. Shareholders have also left all profits in the company for the past 12 years. In the last five years alone that boosted capital by over $12 million to more than $25 million. Another $5 million in new money is still to come from the proposed new partner. That will complete a recapitalisation adding 56 per cent to the airline's equity.
The next step is to offer about 30 per cent of this to one or more outside investors. Colombia limits foreign ownership to 40 per cent. 'The exact amount will depend on our advisers,' says Posada. Deutsche Morgan Grenfell and Avmark are advising Aces on a placement strategy, which will depend mostly on who they identify as a likely partner. 'Our goal is not just to raise money,' explains Posada, 'but to find the best strategic partner.'
He refuses to say who that might be, but admits, 'I cannot deny that the easiest potential investor would be an airline that could help us enlarge the network and give us access to technology.'
Any overseas sale will be privately placed. Even though it could be priced as high as $50 million, underwriters have told Posada that Aces is too small for an overseas initial public offering. Moreover, Posada explains, 'our fleet plan does not allow enough time for us to take the steps necessary' for a successful IPO.
However, Aces plans to list on Colombia's stock exchange, mainly for tax reasons and to give local investors a chance to become minority shareholders. 'We have customers who want to be part owners,' says Posada.
Aside from making the company more attractive to potential partners, the other aim of the recapitalisation is to help finance four A320s Aces has on firm order, with four on option. 'Clearly we foresee that we will order all eight,' says Posada, who plans to replace the eight Boeing 727s Aces now flies. Six of those 727s are on operating lease, but Aces will acquire all its A320s on export-credit backed finance leases. Airbus was 'commercially more aggressive' than Boeing, says Posada. The European manufacturer has already placed aircraft in Costa Rica and Ecuador, but Posada says Airbus 'was explicit about using Aces as a case to build upon in Latin America.'
Posada offers two reasons for choosing expensive new aircraft over used A320s. First, new aircraft come with full support - 'The baby comes with all the diapers,' as he puts it. Second, 'If you want to be the best Latin American airline, part of it is having a modern fleet.' Gallagher also sees the decision to acquire a new fleet 'as a way of making a statement about the quality requirements of the airline and what they want to achieve.'
Posada knows he will have to work the new A320s twice as hard as his 727s to pay for them. His new fleet plan calls for a boost in daily utilisation from 5 to 10.5 hours. One luxury that will disappear is the single-class 727s fitted with only 98 first class seats that now fly economy passengers between Colombia and Miami. The load restrictions imposed by the hot-high airports at Medellin and Bogotá meant that Aces decided to spread seats out rather than rope off rows of empty ones. The A320 will operate with less penalty, and hence more seats.
Aces needs more long hauls to keep average sector lengths up while flying A320s on both domestic and international services. Aces and Avianca are awaiting the allocation of seven more US frequencies negotiated last August; Aces would especially like the six new Miami frequencies.
But Aces needs more long-range flights for other reasons as well. 'We need a better balanced route portfolio,' says Posada. Forty five per cent of Aces's costs are in US dollars, compared with only 22 per cent of its revenues. Inflation keeps eroding Colombia's peso and increasing Aces' foreign exchange exposure. 'We need more international routes to give us a natural hedge,' Posada explains. If he cannot find enough scheduled service, he will use the A320s for charters, he adds.
Aces still only flies 5-7 per cent of all passengers to or from Colombia. Its market share is growing three times faster than the traffic, but it will not be long before Aces hits some fundamental constraints. First, it is expanding at a time when domestic and regional traffic is flat or falling. Colombia's domestic traffic dropped 12.5 per cent in the first quarter compared to a year ago due to a slowing economy. Latin Trade magazine says Colombia has experienced 'one of the worst climates for business confidence in the last decade.'
Traffic to neighbouring Venezuela has plunged since its economic crisis last year and, with 109 per cent inflation, Venezuela's crisis continues. Even without this, Aces would hesitate to enter Venezuela when noone is sure what will happen to Viasa's routes. Other economies in the region are more stable, but open skies on Andean Pact routes between Colombia, Bolivia, Ecuador, Peru and Venezuela have attracted more capacity than traffic. Thus, Aces may only be able to grow by taking market share away from others. That usually comes at the expense of yield.
Second, Aces is entering an arena where competition is tougher. It backed off from New York after seeing the bare knuckled way Avianca, American and Continental Airlines are competing for Colombian traffic. 'As soon as we learned that Continental planned flights from New York, we dropped our plans,' recalls Posada. 'We cannot afford to fight just for the sake of fighting.'
Aces is still 'an ethnic airline,' Posada admits, but he knows it must attract non-Colombian, English-speaking customers to grow. Even though Miami has the most potential, Posada also knows that means flying straight into the lion's den (see feature page 40). 'We have to be careful of mega-competitors. They have demonstrated their ability to put a whole ton of seats in the market.'
Aces's third big challenge is that most of Colombia's bilaterals, negotiated in an era when Avianca was Colombia's sole flag carrier, do not allow multiple designation. The US, UK, Andean Pact, and Chile are the only exceptions. Posada concedes it is hard to convince aviation and foreign ministry officials to open bilaterals for a second airline because 'Avianca always opposes it.' But a second carrier could also create dilemmas.
The Argentine-Colombia bilateral is a case in point. Aces wants to fly to Buenos Aires. Ernesto Vasquez Rocha, who doubles as legal adviser to Avianca's president and executive director of the Association of International Airlines of Latin America, explains: 'Historically, Argentine airlines have enjoyed fifth freedom rights north of Colombia. Capacity is strictly controlled. Any increase in capacity in order to permit another Colombian airline would increase the fifth freedom rights of Argentine airlines. It is a very difficult aeropolitical situation.'
Vasquez thinks multiple designation on most Latin American routes is unlikely because the traffic will not justify it. Nor does he foresee an imminent movement towards open skies. Andean Pact and Mercosur delegates have started discussing one South American common market. 'But there are many differences,' Vasquez warns.
Smaller nations are reluctant to open their markets to such giants as Brazil and Argentina. Vasquez predicts open markets will come sector-by-sector, starting perhaps with automobiles, then commodities, and so on. 'Open skies will come last.'
The few bilaterals that allow multiple designation are no panacea for Aces. Andean Pact routes are already saturated, US routes are capacity controlled, and the UK is too far away. The Chile bilateral is the only other one allowing more than one airline, but Chilean authorities have thwarted plans by Aces to launch Santiago flights jointly with Mexicana, Posada says, 'so we're re-evaluating the whole strategy.'
While Aces seeks places to fly, trouble is brewing in the form of the American-Avianca alliance. If approved, it would lock up 85 per cent of Colombia-Miami capacity. With Avianca's local subsidiary SAM feeding the alliance, even Aces' domestic success would be jeopardised. 'We keep telling our government this alliance is bad, and I will do my best to prevent it,' Posada declares. But he feels like a voice in the wilderness because none of the other Colombian airlines appear to have any interest in the issue.
If Washington and Bogotá approve the pact, Posada knows Aces will have to find its own alliance partners. Continental Airlines, the only other US passenger carrier serving Colombia, is high on the list as a potential investor, strategic partner, and saviour.
Aces lacks the tools to match Avianca's prowess, and really has no such pretensions. The real question is whether it can still be Latin America's best niche airline when it must compete against a bigger rival which has shaken off complacency and found new ways to exploit its incumbent advantages. 'Changing conditions have caused Avianca to change.' says Gustavo Lenis. 'We have our act together now. This is a renewed company.' The contest between Colombia's challenger and its renewed incumbent looks set to be a long one.
Source: Airline Business