In European passenger aviation 2015 began much as expected – further pressure for restructuring. Two events this week presaged much of what we can expect in the coming twelve months. First, Cyprus Airways was grounded indefinitely when the EU Commission’s State Aid investigation led to a ruling requiring the company to repay 65 million Euro in illegal subsidy from the Cypriot government. Cyprus Airways is 93 percent owned by the state and the government has failed to find a buyer for the carrier – despite Ryanair’s interest back in August 2014.
“Cyprus Airways has received large quantities of public money since 2007 but was unable to restructure and become viable without continued state support… injecting additional public money would only have prolonged the struggle without achieving a turn-around,” EU Competition Commissioner Margrethe Vestager said in a statement.
The EU Commission has been using a “one time, last time” principle regarding state aid allowing a one-off subsidy allied to a credible restructuring plan. The EU’s analysis suggested that no such credible plan existed for Cyprus Airways (like they did with Malév Hungarian Airlines back in 2012).
In practice, the EU Commission’s efforts to eliminate State Aid in the sector has led to the effective privatisation of losses since several airlines who were sold off or privatised have continued to make losses that have been borne by private investors (Air France/KLM, Lufthansa Group etc). As an aside, this in contrast to the banking sector where losses have paid for by taxpayers through massive bail outs.
In the US, failing airlines can be subject to Chapter 11 bankruptcy proceedings to allow senior management to ‘restructure’ the airlines and continue operating. In 2005, United Airlines won permission from their bankruptcy judge to renege on the airline’s pension scheme releasing United from $3.2 billion in pension obligations for 134,000 employees and sending them to the US government’s agency, the Guaranty Corporation, to take care of the obligations. Here the court effectively transferred losses to the US taxpayer in sharp contrast to the EU approach. Upon exiting Chapter 11, the company awarded senior management in excess of $100 million of stock options and restricted shares.
In related news, Aer Lingus senior management has rejected a renewed offer from British Airways. The revised takeover bid made at the end of December was for 2.40 euros per share. The Irish airline had turned down a previous approach in December claiming it undervalued the business. Effectively, BA wants to acquire Aer Lingus to do two things: (a) get its hands on Aer Lingus’ slots out of London Heathrow and (b) strengthen its grip on North Atlantic traffic. An acquisition of Aer Lingus would require the support of Ryanair which has almost thirty percent of the company. Ryanair has in the past failed to take a controlling stake in the business. The next largest shareholder in the Republic of Ireland’s government who would also have a veto on any change in ownership.
Even if BA could get the shareholders of Aer Lingus to agree, the takeover between be subject to the EU Commission’s regulatory approval given it could harm competition on certain routes, or give an undue advantage to BA in terms of take off and landing slots (precisely the two reasons for the acquisition in the first place).
British Airways and the group to which it belongs, International Airlines Group (IAG), is considerably bigger than Aer Lingus. According to CAPA analysis, BA’s weekly seat capacity to North America is seasonally between around 80,000 and 100,000 seats, compared with Aer Lingus’ winter 2014/2015 capacity of just under 10,000 and its summer 2015 capacity of almost 17,000. Iberia’s varies between 7,000 and 14,000 weekly seats.
Moreover, Aer Lingus’ hub at Dublin airport has two important assets that increase the value proposition of the airline. The first is its geographical location at Europe’s western edge on the way to North America from most of Europe – making flights from there shorter than from London. Second is an agreement for US customs pre-clearance, which is faster than in most major US gateway cities and which allows passengers to exit the terminal building on arrival in the US with no further immigration formalities. Last but not least, Aer Lingus’ cash position is healthy further making an acquisition more attractive.
In broader competitive terms, two factors may also be weighing on the minds of management at IAG. First, Virgin Atlantic‘s joint venture with Delta makes it the single biggest JV across the North Atlantic (approximately 17 percent of seat capacity). BA has been in a long running competitive battle with Virgin Atlantic over the years including prosecution for dirty tricks campaigns. In 1993, Virgin had accumulated evidence of BA employees poaching Virgin customers and tampering with confidential company files. Virgin also claimed that BA’s had been undermining the company’s reputation among investors and in the press. In a court hearing in 1993, BA apologised “unreservedly” for an alleged “dirty tricks” campaign against Virgin Atlantic. BA also agreed to pay damages of £500,000 to Virgin boss Richard Branson and £110,000 to his airline, as well as incurring legal costs of up to £3m. The fight reignited in 2006 when a tip-off from Virgin led to US and UK competition authorities investigating BA for alleged price-fixing. Virgin escaped without penalty for blowing the whistle, while BA was fined £121.5million.
Second, an Aer Lingus acquisition would give IAG the biggest total share of transatlantic traffic relative to two other US-European joint ventures. Currently, Lufthansa-Air Canada-United have a joint venture controlling just over 25 percent of seat capacity followed closely by American Airlines-BA-Finnair and Iberia with Delta-Air France/KLM on 24 percent. If Aer Lingus joins the One World family, this would take British Airway’s participation in the JV to over 27% of seat capacity.
However, if Virgin were to join SkyTeam (which includes Air France/KLM and Delta), the group would control 30 percent of the North Atlantic seat capacity.