Airlines and Internet stocks: total opposites? April 2000

Airline stocks are now so out of favour that the stock–market is coming up with some bargain valuations at the opposite end of the spectrum to the Internet miracles.

Currently, the trendiest of stocks, in the TMT (Technology, Media and Telecoms) sector, are trading at a price to cash flow ratio of around 58 in Europe. The rest of the market is rated at 9.3 times cash flow, while airlines are languishing at about 5.7. The ratings are even lower in the US at 3.8 and slightly higher in Asia/Pacific, 6.0, where the outlook is improving quite rapidly. (Tables showing the key ratios, as estimated by Goldman Sachs, are on page 2.)

Consequently, market capitalisations are feeble compared to fashionable stocks. BA has a market capitalisation of the equivalent of $5.8bn; Lufthansa, the most successful of the Euro–majors, is being traded at around $8.8bn. Ryanair at least commands the respect of investors: its value, $2.2bn, is the equivalent of 17 times cash flow. This is an even higher rating than Southwest, currently 10 times cash flow, but Southwest has now bypassed American and United to become the most valuable airline stock in the US — valued at $9.2bn.

These valuations compare with, for example, $11.3bn for Priceline.com, the new and as yet unprofitable ticket auctioning service. They are dwarfed by the Internet giants like Amazon.com ($22.8bn) or Yahoo.com ($90bn)

Not old economy

The situation is even worse for some airlines, including BA, Air France, SAir, American, Delta and Continental. Their stock–market valuations are the same or very close to their book values — in other words, the stock–market does not appear to be attributing any value to non–tangible assets like slots, routes and brands. Yet airlines are not just "old economy". They are driven by many of the same forces that impact TMT companies. Demand for business travel, for instance, is closely connected to the global demand for communication. Demand for leisure travel is derived from the expansion of the whole entertainment business. Demand for VFR travel will presumably not be replaced by electronic messages.

E–commerce depends on the timely physical delivery of goods, a service that is provided not just by the specialists like UPS and FedEx but also by airlines with integrated cargo systems like Lufthansa and KLM.

Airlines have tried various tactics to get in on the high tech stock boom. Emulating high tech start–up companies by not producing profits has proved to be fruitless for airlines as far as the stock market is concerned. More seriously, the stock- (continued on page 2) market does not seem to have paid much attention to the airline industry’s initiatives in, for example, Internet sales, the creation of multi–airline portals, etc.

In this regard the stock–market is probably correct. Clearly, significant savings can be made by selling through Internet sites rather than using traditional travel agents, but there are no, or very low, barriers to setting up such a B2C (Business to Consumer) Internet sales operation for other airlines. So, as the Internet becomes the main medium for airline distribution, all the cost savings will be passed on to the consumer.

There may be more potential in the B2B (Business to Business) sector where electronic markets being planned by the major manufacturers. Boeing, BAE, Lockheed Martin and Raytheon have announced the establishment of an electronic exchange in which they will conduct most of their purchasing of supplies and sales to airlines. Airbus is setting up a competing exchange.

Even at today’s prices there is little sign of a surge in M&A activity. Foreign ownership restrictions and golden shares have put a severe dampener on transactions in Europe and Asia; in the US opposition from the regulators is preventing further consolidation. And the most successful airlines are those that have followed clear independent growth strategies.

But what about airlines as part of one of the TMT empires? This might be one way of unlocking value in the airlines. Admittedly, there are few indications that this will happen, but buying an airline might be a tempting hedge for a highly–rated, cash–rich Internet company.

A slightly strained analogy would be AOL’s purchase of Time Warner — the USbased Internet provider deciding to absorb the traditional entertainment company whose films, publications, television programmes etc. will all be marketed via the Internet.