As we talked about in our previous Airline Anchluss column, Lufthansa is in an interesting position in the European market at the moment.  With the new deal of Austrian Airlines moving ahead, they are well positioned to take advantage of the market once the recession crisis is over.   In the interim, they are in an excellent position to execute on their longer term strategies.  One of those strategies is what to do with bmi, which we will explore hypothetically in this post.   First, however, lets have a look at the latest earning reports.

 

The Latest on Earnings

 

This week Lufthansa reported a net loss of €265 MM compared with a restated profit of €44 MM from a year earlier. Hit hard in the past year has been the cargo business, as well as the other ancillary aviation businesses that Lufthansa’s has a stake in.  Specifically, we feel that as their airline customers look for cost savings of their own in areas like catering and handling where Lufthansa has significant global holdings. Click here for quick view of Lufthansa’s holdings in a .pdf format. (please note that this opens in a new window, and is in German.)

 

 The real bad news was that the deficit was wider than the €180 MM loss estimates that were coming from leading industry analysts.    

 There are few people who cover this sector better than Holly Hegeman of www.planebusiness.com.  

 

To quote Ms. Hegemann, ,  “Lufthansa reiterated that it will report “clearly positive” operating profit for the year, albeit with a “considerable” decline from 1.35 billion euros in 2008.

 

First quarter revenue fell 11% to 5 billion euros. The operating loss was 44 million euros compared with operating profit of 172 million euros the year before.”

 

 The tangled web that is Lufthansa

 

In our previous blog, Airline Anchluss, we went over the details of the Lufthansa/Austrian deal, and how that single deal could impact aviation in Western Europe.   In today’s instalment we want to take a broader look at Lufthansa ownership of British Midland, or bmi, and what implications that may have for the commercial aviation market in the EU.

 The fate of Heathrow’s Second Largest Airline is basically in Lufthansa’s hands

 

Sir Michael Bishop, the long-time Chief Executive of bmi agreed last year to sell a majority share of the carrier to Lufthansa.

 

Currently the bulk of the remaining shares are with Scandinavian Airlines (The SAS Group), which  is undertaking a painful reorganisation, focusing on freeing cash from assets such as its interests in Spanair, and its 20% stake in bmi.

 

Earlier this year Sir Richard Branson has “confirmed” his interest aquiring bmi, as it would allow him to create the short haul networks in Europe that have strategic value.  Since that first comfirmation, however, neither Virgin or Lufthansa have made any public comment.

 

So what is going on with bmi today?

 

bmi has had some changes in key management positions, this year, including a new the head of Marketing Katherine Gershon and new VP of Operations Martyn Bridger, both formerly of the British all-business class carrier Silverjet.    While Gershon has managed to begin to change the way people may thing about the carrier through a revised website and new ad campaign, we don’t see the revenue numbers reflecting a return on the new marketing budget. bmi has made some shrewd operational changes including new markets in the Middle East, Israel, and Russia while also cutting some domestic routes. 

 

bmi is also remained a member of STAR Alliance and coordinates with its other airline partners in the alliance.

 

So the stage is set, and you can begin to see why Lufthansa’s position is an enviable one.  Through long term strategic investment they have managed to now successfully gain majority control of London Heathrow’s second largest airline.   When you take a look at the strength and breadth of the airline holdings that Lufthansa has built you can be forgiven for thinking that Lufthansa has spun one of the strongest webs in modern airline history.

 

The Lufthansa “Fantasy Playbook” for bmi

 

With the Austrian Airlines deal seeming settled, it become interesting to thing about the commercial opportunities that bmi offers Lufthansa, particularly if it were to pick up the SAS share.

 

So we took out our numbers and began to look into our airline crystal ball (which as you all know comes without warranty for all but a glimpse of 1 hour into the future of aviation.)  None-the-less we stated to play Fantasy LH Boardroom.

With that we have come up with four potential scenarios:

One: If it is not broke then don’t fix it.  In our view, however, bmi is not poised to do anything unique in the market that Lufthansa could not do better, and more cost-efficiently, themselves.

 

Two: Keep bmi as they do Swiss, Germanwings, Lufthansa Italia and Austrian- as separate entities under their wing but with a shuffle of the boardroom chairs.

 

Three: Acquire the whole of bmi and promptly sell it off to a willing buyer with cash.  Logically this would be either BA or The Virgin Group, both of which are a little cash strapped at the moment.  We don’t see this happening, as the value to Lufthansa would be too great to simply sell, unless it began to desperately need the cash.  Well in the frame for interest in bmiBaby and bmiregional could be another regional player in the UK: Flybe.  This is a rumour that they strongly deny as ”pure industry rumour.” 

 

Four /Step One: Do nothing at the moment, but leverage bmi Heathrow real estate for an assault on lucrative London trans-Atlantic traffic when the numbers, especially business class numbers, begin to improve.

 

Four/ Step Two: Having taken the cream Heathrow slots for Lufthansa metal to begin taking London transatlantic market share, they could then move the focus of short haul operations to Dublin’s new terminal two building and take on Aer Lingus (if they are still around) and Ryanair.  In essence give Irish consumers a true choice from Ireland that has some service that might wine and dine passengers rather than nickel-and-diming them.   Obviously some rebranding may be required, as bmi may not sell as well as say Lufthansa Eire.

 

Would they be cannibalising their own traffic?

 

The short answer is that we do not think that they would be losing much of their trans-Atlantic loyalty from their German operations by doing setting up direct London-US routes.   Taking into account the new Swiss product offering, our estimates were less than 4% of Lufthansa and Swiss London traffic connecting across the Atlantic.  

We credit most of the up to their PrivatAir agreements, strong demand out of London City,  and a few hard to reach non-stop jewels like Portland (PDX) and Seattle which are smart bets for a busy business traveller.

 

If they were to try focus on Ireland, we believe that they could gain a significant competitive advantage by feeding Westbound Asian traffic through Frankfurt, Zurich, and Munich, while at the same time serving the Ireland-UK market at a decent profit.

 

So what are your thoughts on the subject?

 

We would love to hear your thoughts on the subject, and what you think may or may not happen in the scenarios discussed in this article.   Do you have any alternate theories?  So you think our numbers are out of the park?   Or do you think we might be on to something?    We look forward to your comments!

Disclosure: The author does not maintain any positions or contracts with the airlines and companies mentioned in this blog.

 

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Plane Business Banter at www.planebusiness.com

In my view, there are few carriers that can compare to Lufthansa for both strategic vision and execution. Their move to acquire the Austrian Group is just another in a series of decisions that demonstrating this strength. Unfortunately for Lufthansa something went a little amiss in this latest anschluss, but we do not think it is irreparable.

 

Ripe for Takeovers; but who can spare the cash?

 

Everyday more and more carriers are seeking shelter from the stormy marketplace through alliances, investment, and mergers. In just the past few months alone we have witnessed Ryanair’s hostile attempt to takeover Aer Lingus, as well as Italy’s new “Alitalia” emerge from a massive state-sponsored bailout. There has also been unprecedented consolidation in the Russian markets.

 

What is the source of Lufthansa’s Strength?

 

While certainly not a secret, Lufthansa goes about its business in such a way as to not court attention. While there has been some negative news for the Lufthansa Group, particularly in terms of their Cargo operations, they are still posting overall respectable €599 M profit today for the combined group which includes wholly owned SWISS, and Germanwings. Have a look at just how diverse the Lufthansa holdings really are.  (Please note, this opens a new window to the Lufthansa site, and the source file is in German- but you can get the idea.)

 

In February, Lufthansa made public its intention to add struggling carrier Austrian to its portfolio of fully owned subsidiaries. During the months of failed bids which included Russia’s S7, as well as several Gulf funds, Lufthansa carefully put together a deal to see that the integration of Austrian would success

 

What is wrong at Austrian and how does it affect the consumer?

 

Austrian suffered from the credit crunch much like any other carrier, and their latest strategy to expand their focus on long-haul connecting traffic did not get them either the load factors or yields that they had hoped for. After months of offers and due-diligence from an array of suitors, nothing materialised other than the deal from Lufthansa who are now offering €4.49 a share.

 

Even Austrian’s COO has gone on record as saying “the global economic crisis has now reached all markets, demand is collapsing and the outlook offers very little reason to be optimistic. We will continue as an airline, but not independently.” Now Austria’s State Holding Company obtained permission from the EC to keep the airline with a bridging loan flying while the deal with Lufthansa is being finalised.

 

From our view the integration of Lufthansa and Austrian makes sense. It has a complementary fleet type, the cultural ties are obvious, and Austria as a nation needs a carrier with a more diverse network of connections. Have you ever tried to fly from London to Salzburg? Your choices are fairly limited.

 

So what went wrong in Europe?

 

Enter stage right the cries of “foul state support and aid” from SkyTeam carriers who filed a motion with the European Commission to investigate the possibility that this deal could violate laws prevented so called “state support”. Where were these carriers when Italy’s Prime Minister was re-writing Italian Bankruptcy Code and making back end deals that resulted in the Italian State owning all of Alitalia’s debt, while it continues flying? Oh wait, Alitalia was one of SkyTeam’s very own.

 

Where are we now?

 

What we have now is a 200M Euro bridging loan that is keeping Austrian afloat, as the immediately slash costs and cut capacity while the issue of Lufthansa and Austrians tie-up is finalised by EU officials. In the meantime, SAS is looking to sell its stake in British Midland (bmi) along with their other holdings such as Spanair in a fight to get cash. Who might be the prime buyer for the bmi shares? I would think Lufthansa would have an interest.

 

One has to stand in awe of the Lufthansa strategic ability to position themselves in a weak market. From their negotiating majority ownership of British Midland (bmi) to their new investment in Lufthansa Italia the carrier has a strong strategic portfolio that is likely to pay off in the long term. They possess the diversity and required cash to survive this current economic downturn.

 

TWC’s Carter Stewart says, “If I were playing cards with Lufthansa I would be very conservative. We all know that Lufthansa is holding a winning hand, and unlike most carriers today they have the cash to make the bet. The question for all of us is how and when they are going to play it.”

 

In our next installment

 

In our next blog we will have a look at what we think the “Fantasy Playbook” for Lufthansa’s bmi holding could be.