Wednesday, December 06, 2006
Consolidation is the word

The airline industry is all of a flutter as the past few weeks has seen a flurry of possible merger and takeover activity.

Firstly, Ryanair launched a bid for newly privatized Aer Lingus, then US Airways said it wanted to buy Delta Airlines once it had come out of bankruptcy. Continental has said it will acquire rather than see market share eroded. Air France and Alitalia are talking, and now Qantas of Australia has received an offer from Macquarie Bank and others.

The question is whether there are any common strands that can be drawn from so much activity in such a short period of time.

In one sense there is no connection – after all, Ryanair buying Aer Lingus is miles apart from a takeover of Qantas – and yet the connections are everywhere.

The driving force behind the activity is a need for the industry to consolidate. There are too many airlines chasing the same passengers and capacity. In the U.S. it has been the growth of Jet Blue, Southwest, Airtran and the like, which has finally forced the majors to do the hard work of cost cutting and re-think their strategy. But the cost base of a full-service carrier is always going to be higher, so they are diversifying to more profitable grounds, such as growing new international markets. Delta has launched more than 50 non-U.S. routes this year alone. In addition premium cabin prices are holding up relatively strongly as against economy tickets.

The whole landscape has changed. When United attempted to buy US Airways in 2000 the regulators said “no” on competition grounds. But today with so much competition the rationale for a Delta/US tie up, or a Continental/Northwest connection (even a Continental/United?) stands far more chance of receiving regulatory approval.

In Europe it is a similar situation in competition. Aer Lingus has transformed itself into a hybrid airline. Low cost in Europe, full service when operating long haul. When Ryanair launched its bid, it was chutzpah pure and simple. After all, the Irish Government didn’t float Aer Lingus on the stock market to have its chief competitor try to buy it in the same week !

It comes as absolutely no surprise that Michael O’Leary has failed, and is now a major shareholder in his principal competitor – a deeply uncomfortable position for both parties and one that cannot survive without tears.

Qantas is simply a very good airline, with very strong routes and an excellent management. And that’s why Macquarie wants to buy it. Regulators refused the joint request with Air New Zealand to code share across the Tasman Sea, but even so, the airlines will try to reduce Australia-New Zealand capacity to prop up prices (subject to Virgin blue and other new entrants spoiling their game).

Nor does there seem to be any immediate danger that the Australian government will grant Singapore Airlines long standing request for fifth freedom rights from Australia to the U.S. Qantas’s most profitable routes, then, seem safe for the moment. With the Qantas/BA partnership having a stranglehold on the Kangeroo Route, it’s not surprising Qantas is in demand.

It’s consolidation, consolidation, consolidation. It’s just about everywhere. All the airlines I have written about have either done, or are doing the hard work of reform, route pruning and cost cutting. And the ability to find intriguing ways to get around international ownership rules (Swiss and Lufthansa, KLM Air France) mean European airlines are in demand. Even Alitalia of Italy, which is extraordinary. The airline will run out of money next year (the Italian Prime Minister’s words, not mine) and the talk is who will merge and create an alliance or have a dalliance. The latest suitor is Air France.

Alitalia doesn’t as yet deserve to be saved. It has not gone through the painful process of reform that others like BA, Iberia, Aer Lingus have been through (pure co-incidence that they are all OneWorld carriers). The airline has lost money consistently, even though it has good hubs in Rome and Milan. Air France/KLM will rue the day they ever got involved, if the deal goes ahead!

So, to conclude. Consolidation is on the cards. It’s going to happen. It’s just a question of who merges with whom. I am not going to predict which ones will win or lose – that’s a mug’s game. I am just going to say, “Watch out.” The airline you are flying today could have new owners this time next year.
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