Three years after placing Aeromexico and Mexicana in common ownership, Mexico's federal government is debating whether to keep the two airlines together or sell them separately.
Common ownership was never a perfect solution. Putting Aeromexico, Mexicana and their subsidiaries into Cintra, a holding company, was a stop-gap to save both airlines from bankruptcy. They owed millions to banks, which themselves were teetering, and regulators felt they could ease the burden on both by converting airline debts into Cintra shares. Through that capitalisation process, Mexico's five major banks became the owners of the country's two major airlines.
The CFC federal competition commission approved the deal as long as Aeromexico and Mexicana kept separate identities and management. CFC president Dr Fernando Sanchez Ugarte recalls: "In our view, the Cintra scheme was only transitory."
That was 1995, when Mexico was struggling to survive La Crisis, the peso devaluation that nearly bankrupted it. Fortunately, the international community intervened quickly and Mexico was back on its feet within two years. Indeed, its recovery was breathtaking, producing the fastest GDP growth in 16 years.
Aeromexico and Mexicana recorded the best and third best margins, respectively, among the world's airlines. Their combined revenues made them Latin America's second largest carrier.
In 1997 the banks decided it was a good time to cash out of Cintra, well ahead of the five-year limit regulators had given them to hold Cintra shares. Planning started for a secondary sale of 20-30% of Cintra's shares. Cintra chief executive Ernesto Martens said this initial public offering (IPO) would give shareholders a chance "to make their investment liquid".
During that same boom, Mexico changed in other critical ways. In the 1997 elections, the long-ruling PRI party lost control of the lower house. The new legislators wanted to re-open certain government decisions, including the one to place Aeromexico and Mexicana under Cintra's control. The new breed of lawmakers were suspicious of ties between bankers, business and the government, and were especially upset that Fobaproa, the government's new bank savings protection fund, had bailed out several banks and taken their Cintra shares.
Officials say the bail-outs were to save the banks; critics say they were partly to clean up Banco Mexicano's balance sheet before Spain's Santander bought it.
The other big change was that the competition commission, which plays a major role in Mexican aviation policy, concluded by the end of 1997 that Cintra's airlines had effectively ignored its direction to compete.
At hearings before the Chamber of Deputies, Mexico's congress, tourist officials and local communities railed against Aeromexico and Mexicana for charging high air fares. Smaller Mexican rival AeroCalifornia accused Cintra of using its government ties to stifle rivals. CFC president Sanchez told the deputies that his commission's attempt to mandate competition between Aeromexico and Mexicana had simply failed. He claimed the two airlines had scared off potential entrants, boosted market share at the expense of rivals, and charged monopoly fares on routes they dominated.
The immediate solution, Sanchez told the lawmakers, was to set maximum fares on monopoly routes, encourage new entrants, and require Cintra to offer Aeromexico and Mexicana shares separately - effectively forcing it into a partial divestiture.
The longer term solution, said Sanchez, was to review the whole concept of common airline ownership. He promised his commission would do that "before 2000". His aim now is to resolve that issue by the middle of this year.
These events had a chilling effect on Cintra's planned flotation. Following the public hearings, Cintra delayed its offering because of "market conditions". Martens insists the deferral had nothing to do with CFC's demand for separate offerings. Market conditions have worsened, but the unresolved question about Cintra's future will also have caused concern among investors.
The government took one other step to quell complaints about its links with Cintra. At CFC's urging, the transport ministry transferred its seat on Cintra's board to the finance ministry. "We thought it was a conflict of interest," says Sanchez, "and it would be in the best interest of competition to have SCT [the transport ministry] not participating in Cintra's board."
Little has changed in the year since Sanchez accused Aeromexico and Mexicana of controlling up to 80% of domestic traffic. One glance around Mexico City's Benito Juarez Airport tells it all. Rows of shiny Aeromexico and Mexicana jets occupy most of the terminal gates. The tired little fleets of AeroCalifornia and Taesa park out on a corner of the tarmac. Their undercapitalisation shows. Passengers can only reach them by bus.
Taesa remains upbeat about restructuring, which means finding a foreign investor. Since its public rampage against Cintra and the government, AeroCalifornia has said nothing.
The transport ministry has yet to act on CFC's request to re-regulate fares on 26 routes monopolised by Aeromexico and Mexicana. CFC and the transport ministry have tried to reduce entry barriers for competitors by eliminating all but the essential parts of regulations governing the qualification of new airlines.
Has any of this caused Aeromexico and Mexicana to compete more against each other? Probably not, says Sanchez. "They have little incentive to do so."
Allegro is the only other Mexican airline showing any interest in competing. Mainly a charter operator since 1993, it has applied to the US DoT for eight Mexico-US scheduled routes. Martens says Allegro has also increased seats on scheduled domestic flights.
Even though Allegro has not dented the incumbents' dominance, Cintra's fortunes have worsened. Through the third quarter of 1998, its net earnings fell by Ps247 million ($25 million). Quarterly operating results plunged 42%. This is not due to competition, but to Mexico's shaky capital markets and record-low petroleum prices that have made a buoyant economy nervy.
This decline has fuelled a new debate that could affect the size of the government stake in Cintra. Sources say it now owns about 11% of Cintra in its own right. Nafin, the national development bank, owns 5%, and Fobaproa's share has reached 35-40%. These government interests add up to about 55%. "Directly or indirectly, today the government is Cintra's main stockholder," says Sanchez.
Fobaproa's stake is caught up in an eight-month debate over President Ernesto Zedillo's plan to bail out Mexican banks. Fobaproa has assumed Ps650 billion in bad bank debts. Zedillo wants to clear these up at taxpayers' expense - a proposal that has drawn heavy flak. Late last year, a compromise was struck to subject these debts to an audit and then require banks to take back bad loans from Fobaproa and try, over the next 10 years, to collect them before the government picked up any balance.
Under this compromise, could some or all of Cintra's shares held by Fobaproa go back to the original banks? "Absolutely," says Martens. In fact, no one is sure. The answer may depend on whether the audit finds fraud in any of the loans secured by Cintra shares. So the size of Fobaproa's stake in Cintra could be in limbo for years.
Conversely, if Fobaproa keeps its shares and the government can reach an internal consensus, it can decide Cintra's future on its own.
Timing becomes critical. Zedillo's budget for this year allocates Ps24 billion to bank debt retirement. Unless critics derail this, Fobaproa will continue to hold Cintra shares while the debate over a long-term solution rumbles on. The question then becomes whether government entities can agree on Cintra's future while they still control 55%. Market conditions could be better, but Sanchez thinks prospects will improve enough for an offering before mid-year. "The objective is to privatise the government's holdings in Cintra," he says.
Separate flotations?Consistent with CFC's view that the time has come to separate Aeromexico and Mexicana, Sanchez would like to start that process with private offerings in each airline to separate foreign investors - probably airlines. Under Mexican law, the foreign limit on airline voting rights is 25%. Cintra's Martens will not discuss reports that Delta and United have explored buying stakes in Aeromexico and Mexicana, respectively. Without naming names, Sanchez will only go so far as to say "there is interest".
Assuming a successful private sale, Sanchez foresees that Aeromexico and Mexicana would then proceed with separate IPOs. Sanchez will not say whether they would be domestic or overseas or whether they would divest Cintra of all remaining shares.
CFC has several more bridges to cross before reaching such questions. The biggest one is to find a consensus with other government entities on objectives. There is little dispute about the need to privatise Cintra - if only because the government needs the money. But there seems no agreement on how that should be done.
Fobaproa and the finance ministry, for instance, are interested in maximising returns. That may not be consistent with competition. Sanchez notes: "A monopoly will fetch a high price."
The transport ministry, which no longer sits on Cintra's board but will have a major say in its future, supports deregulation but is wary of unrestrained competition that could relaunch fare wars such as those that bloodied the industry earlier this decade. But the transport ministry's main concern is that Mexico needs a dominant carrier to compete against foreign airlines.
Sanchez does not see how common ownership helps Aeromexico and Mexicana in foreign markets. They operate as separate airlines, with distinct niches and alliances with separate foreign carriers. Their only common branding is with AeroPeru under the Alas de America (Wings of America) banner.
Nor does Cintra's Martens stress common ownership as a plus in foreign competition. "Alliances help us do better what common ownership began," he says. But he adds that the most significant aspect in foreign competition is the relationships with partners - United, Delta, Air France and Alas de America.
The second most significant aspect is the integration of what Martens calls "backside" operations. Aeromexico and Mexicana share training, maintenance, IT and other non-strategic activities. If the two carriers did all these things separately, says Martens, "it would be a significant drawback".
Would it make even more sense to merge Aeromexico and Mexicana? Martens is non-committal. "We don't know if we're going to develop separate identities or a unified identity."
For now, however, merger does not look like an option. Apart from CFC's domestic competition concerns, the two airlines have very different relationships with their unions. Combining labour forces could be contentious and costly. Workers at each airline are still very loyal to their own carrier. "They have some sort of rivalry between unions," says Sanchez. "They don't want to be confused."
Even if the carriers somehow merged despite such obstacles, Sanchez thinks they would still be too small to compete against foreign rivals. "The only way to make [a merged Mexican airline] competitive would be to have an international partner, so that it really becomes part of a global network. We think it makes more sense to keep the two airlines competing domestically, and make international partnerships so they have more chance of competing globally."
That, of course, is what they now are doing on foreign routes and what they would do on foreign and domestic routes under CFC's split ownership plan.
Alliance plansCould such a plan perpetuate Aeromexico's current alliance with Delta and United's with Mexicana? Delta's purchase of a 35% stake in AeroPeru (acquired from Cintra) demonstrates its willingness to seal Latin partnerships with equity. American and Continental have followed suit. So far, United has not.
Even if United continues to shun equity links, other foreign carriers could be interested in a Mexicana stake. Lufthansa has been discussing a strategic compact for the past year with the carrier. Mexicana's vice-president for international sales, Carlos De Uriarte, predicts that his airline will join the Star Alliance this year.
The transport ministry's tilt towards common ownership for Aeromexico and Mexicana could be based on an assumption that they would lose their "backside" synergies if they split. From CFC's perspective, however, that need not happen.
CFC does not view such joint operations as anticompetitive. "Even if Aeromexico and Mexicana were owned separately, they could still share catering, they could jointly own a maintenance platform, and so on," says Sanchez. CFC would frown on joint planning or route allocations because those could restrict consumer choice. Otherwise, the two airlines "could even go to Boeing or Airbus and negotiate jointly for aircraft or jointly [negotiate finance] with a bank", says Sanchez.
So how does common ownership help Aeromexico and Mexicana compete better with foreign airlines, especially when there is no current plan to merge them? The answer may lie in attitudes in other parts of Latin America. Officials still pay lip service to competition, but social progress has not kept pace with reforms. Boom-bust cycles, such as those that have rocked Mexico, have spawned complaints throughout Latin America about capitalismo salvaje - savage capitalism. No one admits they would prefer the old days, but as Julian Sevillano, Miami consultant to a number of Latin airlines, observes: "There is still much nostalgia about the old patriarchal system."
So Cintra may be caught between two cultures. One favours global links and more competition, the other fears the disorder and disruption that competition can bring. This is not the first time CFC has faced such a debate. "In Mexico's privatisation processes, we have had different views," says Sanchez. "For instance, with the railroads, we had come to an agreement to find a way out of the differences. This is not uncommon."
The biggest difference, he notes, is that "unfortunately, the airline industry has not been deregulated as much as other sectors. Airlines are viewed as something of a national symbol".
Sanchez says CFC is midway towards a Cintra consensus with other government entities. It is a delicate task because no ministry has the right to overrule another. Even Fobaproa, which is not a cabinet ministry, enjoys its own autonomy.
An agreement to split Cintra could unleash a round of foreign investment in other Mexican airlines. American Airlines wants to boost the competitive strength of its local partner, AeroCalifornia, and might be willing to invest. Continental has often been mentioned as a Taesa investor. But none of this is likely to happen until government entities settle Cintra's future.
What if they reach an impasse? Sanchez doubts they will, but if so, "it's a decision that may have to be taken to the highest level". Mexican aviation is nearing a significant crossroads.
Source: Airline Business
