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Etihad's stake strategy faces new test with Alitalia move

02/06/2014 | Reuters

A potential deal to buy a stake in troubled Italian airline Alitalia CAITLA.UL could be the biggest test yet for Abu Dhabi-based Etihad's strategy of using stakes in ailing airlines as an easy way to expand its global footprint.

Etihad's collection of minority airline stakes stretches from the Seychelles to Ireland and Australia, and dates back to the purchase of an almost 30 percent stake in Air Berlin (AB1.DE) at the end of 2011.

What Etihad calls its "airline equity alliance" strategy differs from that of larger regional rivals Emirates EMIRA.UL, which is striking out on its own, and Qatar Airways, which in a surprise move, turned to the OneWorld airline alliance last year to boost its network coverage.

Lacking large populations in their own countries, the Gulf airlines need to feed more traffic from other countries through their hubs in order to fill their planes after a massive order spree at last year's Dubai air show.

Etihad, which has driven restructuring and job cuts at Air Berlin and Air Serbia, has via the equity stakes and code shares diverted more passengers from its partners' planes to its Abu Dhabi hub while avoiding the costs that being a member of a traditional alliance entails.

"From the airlines they have acquired, we can see a regional spread across Europe and Asia-Pacific, giving them access to very populous countries, which brings more passenger flows and, ultimately, more sales to their operations," Euromonitor analyst Nadeja Popova told Reuters.

In 2013, Etihad's code shares with other airlines and its equity partners brought 1.8 million passengers onto Etihad flights, helping total passenger numbers rise 16 percent to almost 12 million. Emirates carried 39 million passengers in its 2012/13 fiscal year, also a 16 percent increase.

The equity stakes strategy could also bring procurement benefits, analysts said, because by agreeing contracts that cover its equity partners, Etihad can ask for better deals when it comes to buying planes and services such as maintenance, IT and catering.

"When we sit down with Boeing (BA.N) or Airbus (AIR.PA) , our discussions are now about 500 aircraft, it's the same with the engine makers," Etihad chief executive James Hogan said last month at an event in Berlin.

Hogan said that the $105 million to buy a 29 percent stake in Air Berlin was recouped within 6 months thanks to additional revenue and cost savings. However, the airline has since given a 195 million euro loan to Air Berlin and spent another 184 million euros on buying a 70 percent stake in its Top bonus frequent flyer program.


Investing in Alitalia would be Etihad's first sizeable investment in a European legacy carrier though and brings with it a host of thorny issues that other potential investors such as Air France-KLM (AIRF.PA) have not been able to resolve.

Alitalia and Etihad are in the final stages of due diligence and sources close to the matter say a deal could involve Etihad buying a 40 percent stake for as much as 300 million euros.

Etihad has said it will only invest in Alitalia if it fits with its network, if Alitalia has a credible plan to return to profit and can bring it synergies.

"Any issues that may prevent the establishment of an appropriate business plan will have to be resolved to ensure the plan can be implemented to move Alitalia to sustainable profitability," the two companies said on Sunday.

Alitalia offers access to Europe's fourth-largest travel market and flies 25 million passengers a year. But the airline loses 700,000 euros a day and has net debt of more than 800 million euros. Alitalia completed a 300 million euro capital hike in December, which analysts said then would keep it flying for six months.

While Italy's government has said it is optimistic about a possible deal, analysts said an agreement was far from certain and expect tough negotiations on debt and additional cost cuts in the upcoming weeks.

Etihad will want to make sure that neither Rome's politicians nor Italy's notoriously feisty unions stand in the way of a joint strategy in the future.

"Etihad doesn't want to have anything to do with Italian unions and will make sure that a deal with labor groups is found before it comes in," Andrea Giuricin, CEO of TRA Consulting said.

Chronic political interference in Alitalia, which Rome considers a national strategic asset, has been a major obstacle in previous negotiations between Alitalia and foreign bidders.

But with other potential suitors few and far between, analysts said Alitalia - and ultimately Italy - may have to negotiate on Etihad's terms.

"If the talks with Etihad break down, I don't see any other alternative than Alitalia going to the wall," said Carlo Stagnaro, head of research at think-tank Bruno Leoni Institute.

Rivals Easyjet (EZJ.L) and Ryanair (RYA.I) are also using the weakness of Alitalia to expand aggressively in Italy, making life more difficult for any investor.

The competition on the shorter, point to point, routes means Etihad will focus on long-haul, should it invest in Alitalia.

"They can't win the point to point battle with Ryanair and Easyjet," Goodbody Stockbrokers analyst Donal O'Neill said. "They're playing in a market which is unfamiliar territory for them and that will really incentivize them to say we will only do feed."


Certainly the prospect of an Etihad investment in Alitalia has ruffled some feathers, with Germany's Lufthansa calling for the European Commission to take action in a fierce rejection of the deal.

Etihad's stake-building strategy and its code shares with Air France-KLM also call into doubt the future of the traditional airline alliances - Star Alliance, OneWorld and SkyTeam, groupings that Etihad CEO Hogan has described as "fractured."

"What role the alliances will play in the future is unclear, but it looks like it is a business model that will not last in its current form," Tanja Wielgoss, Berlin-based partner at consultancy AT Kearney told Reuters. "We see a tendency towards more focus on growing organically or via acquisitions."

Analysts also say the increasing ties between the likes of Etihad and Air France-KLM, or Qatar and British Airways owner IAG (ICAG.L) could prompt Emirates to rethink whether it can continue going it alone.

"Five years ago, these guys wouldn't look at each other in a room," Goodbody's O'Neill said.

"I think both Emirates and Lufthansa will realize that if they really want to grow in North America and South-East Asia, where they are weak respectively, then they have to cooperate."

Still, Etihad's strategy does not have everyone convinced.

"I find it difficult to fully understand what they're trying to do," said airline analyst James Halstead, managing partner at UK-based Aviation Strategy, adding that Etihad could have just agreed code shares with airlines without needing to buy stakes.

"Maybe it's a shot of brilliance by James Hogan. I'd like to give him the benefit of the doubt."

(Additional reporting by Stanley Carvalho in Abu Dhabi, Tim Hepher in Singapore, Praveen Menon in Dubai, Conor Humphries in Dublin; Editing by Giles Elgood)

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