airberlin: an airline in search of a strategy May 2014
When a company mentions the words “going concern” more than once in its annual report, it usually a little concerning. The fact that airberlin, Germany’s second largest airline, felt the need to use the phrase a dozen times in its 2013 report (twice as many as in the previous year), without even once mentioning its aircraft order backlog, may perhaps suggest that it has become necessary for the directors to convince themselves and the auditors of the fact.
The company’s annual report does not make pleasant reading. In the year to end December capacity fell by 5% as planned but passenger numbers declined by 5.5% to 32m. Revenues dropped by nearly 4% (with a 5% decline in ticket sales) to €4.2bn while published operating results slumped to a loss of €232m, against a profit of €70m in the previous year. The latest cost saving programme (under the soubriquet “Turbine”) is said to have generated over €200m in cost savings, but the underlying EBITDAR margin slipped 2 basis points to an unsustainable 9% — the lowest level since 2003.
Moreover, the €232m loss is stated after non-recurring exceptional income of €60m, relating to profits on asset sales and indemnities (in the previous year the company had recorded a profit on the sale of 70% of its frequent flyer plan to Etihad).
Reported net losses came in at €316m compared with a reported €7m profit in 2012. On the balance sheet the company reported negative equity of €186m and a cash position of only €223m, a paltry 5% of annual revenues.
The results for the first quarter of 2014 do not make much better reading — although to be fair this is the weakest period of the year and this year the period did not include Easter. The number of passengers fell by 1% but capacity had grown by 4%; the load factor fell by 4 points to 82%. Published operating losses improved slightly to €182m, which prompted the company again to state that its Turbine programme is working (the aim is to generate a cumulative reduction in running costs of €400m by the end of 2014). Unit costs fell by 8% but yields were down 4% and unit revenues by 8% giving total revenues down by 4% (and ticket sales were down 5%). Net losses swung in at €210m compared with €196m in the prior year period. As a result the negative equity on the balance sheet worsened to just short of €400m.
At the same time as the publication of the annual results (delayed a month as the company no doubt debated the question of whether it was a “going concern”) airberlin announced an emergency recapitalisation. Major shareholder Etihad had agreed to inject a further €300m in the form of a perpetual payment-in-kind convertible bond and extend its existing shareholder loan of $255m (of which less than $100m drawn, and due to expire in 2016) by five years. In addition, the company announced the issuance of a new €250m senior bond (€100m of which is to redeem existing debt). Because of the peculiarities of accounting standards, the perpetual bond can be treated as equity on the balance sheet and thus can be seen to offset the existing negative equity. The conversion terms on the bond (at the equivalent of €1.79 a share) would potentially give Etihad a 70% stake in the company — well above the 49% limit for non-EU nationals.
The company recognises that the Turbine programme is not going far enough and has created a new position on the management board of a Chief Restructuring Officer to pursue a new restructuring programme, while stating that Etihad would “further support airberlin and help the business restructure and return to sustainable profitability”.
Etihad has apparently placed two executives in the business (James Hogan, CEO of Etihad and his CFO already sit as non-executive directors on the board) and hired a management consultancy to “re-engineer airberlin”.
Hogan is nothing if not consistent — exactly the same strategy is being applied to similar crises at Jet Airways, Etihad’s Indian investment — see this page.
airberlin should be in a relatively strong position. It is the second largest carrier in Germany (the largest outbound tourist market in the world) and with 32m passengers carried a year the seventh largest airline in Europe. It is the largest operator in Berlin, Düsseldorf and Palma de Mallorca. It has seemed to have had a relatively cosy duopolistic relationship in its key German speaking markets (Germany, Austria and Switzerland) with Lufthansa — which has been relatively happy to have airberlin help keep out the European LCCs. Up to now however, its strategy has appeared confused.
airberlin is one of the few former charter carriers to convert to scheduled operations. When it came to the markets in its IPO in 2006 it sold itself on the basis of being a low cost carrier (that being the flavour of the month). At the time half of its services were still on charter operations from German regions to the short haul leisure destinations in the Mediterranean. It had built a hub operation in Palma to funnel demand from the disparate German regions onward to Spanish leisure destinations — although short haul transfer hubs in Europe are somewhat questionable — and had a burgeoning domestic and intra-European City Shuttle service.
In quick succession it acquired dba, to become the second largest German scheduled carrier and a contender to Lufthansa, and Düsseldorf-based LTU, a charter carrier with an extensive long-haul operation (both acquired airlines were financiallly very weak), hoping to become a grown-up intercontinental player and described itself as a hybrid scheduled and leisure carrier. By 2008 it had grown to carry 30m passengers a year and had plans to continue to grow strongly.
Since then growth has faltered. The number of aircraft in the fleet reached a peak in 2010 at 169 units and has since fallen to 140. The number of passengers carried peaked in 2011 at 35m 11% higher than in 2013. Total capacity in ASK in 2013 was 1% higher than five years ago, although it has been able to improve load factors by 6.5 points over the period and demand in RPK is up by 10% compared with 2008 — a compound average annual growth rate of 1.8%.
The company seems to have been trying to reinvent itself as a full service carrier at “affordable” fares. In July 2010 it announced plans to join the oneworld alliance (this came into effect in March 2012 after the usual eighteen month gestation period). In December 2011, meanwhile, it struck a strategic partnership with Etihad, after the super-connector increased its equity stake to 29%, and formed what appears now to be the corner-stone of what has been called Etihad’s Egocentric Equity Alliance. As part of this arrangement, airberlin and Etihad have been generating closer cooperation — with wide-ranging codeshare agreements (including some with Etihad’s other codeshare partners, Air France and KLM); pooling of the airberlin 787 orders with those of the Gulf carrier; and reciprocal pilot exchange.
When the company came to the markets in 2006 it had equity on its balance sheet of €197m and managed to publish a net profit for 2006 of €50m up from a prior year loss of €116m. This was also the last year it made an underlying operating profit. Since then unit costs have grown by 58% (or an annual average of 6.7%) and unit revenues by 44% (or an annual average of 5.3%). Over the period airberlin has lost a total of €1.1bn and has tapped shareholders for €480m (excluding the recently announced perpetual bond).
The emergency recapitalisation probably does not go far enough. The balance sheet includes intangible assets of some €415m — a large part of which refer to the slots at airports capitalised on the acquisition of dba and LTU. Excluding these from the net assets give negative shareholders’ funds of €813m at the end of March. On-balance sheet debt totals €1.1bn (a minority of which relates directly to aircraft funding), but a capitalisation of operating leases could add an extra €4.1bn to liabilities.
Against this there is only €273m in cash and equivalents. The cash from the Etihad convertible is due in three tranches through the current year. On a proforma basis (and treating it as equity) shareholders’ funds would fall to a negative €513m against net debt including capitalised leases of €4.4bn — but at least it will provide gross cash equivalent to two months’ revenues.
airberlin in its current structure is possibly incapable of being profitable. As it moves towards trying to be a full service network carrier and as it moves closer to Etihad, as seems inevitable, the charter operations and leisure oriented European routes might become increasingly non-strategic. In particular the intra-European leisure transit hub in Palma, despite previous protestations by the company, is probably in reality badly loss-making. There have already been some suggestions that the group may consider separating into two — a scheduled operation based in Germany attractive to Etihad, and a charter business.
This in turn however may not go far enough. A prime problem is that whereas it has a relatively competitive cost base in comparison with Lufthansa as a group, Lufthansa has been pushing its non-hub routes into relatively low cost germanwings (narrowing the unit cost differential on like-for-like basis). It too suffers from the same problems as Lufthansa in the German market — the country’s federal structure provides a disseminated population distribution; and although its hub in Düsseldorf may be in the relatively densely populated North Rhine Westphalia, the airport (the third largest in Germany after Frankfurt and Munich) is heavily congested with limited possibility for expansion. At the same time — even after the current Turbine plan to reduce unit costs by 8% — it is at a significant cost disadvantage to the main European LCCs (see chart).
Etihad’s interesting strategy
Etihad is pursuing an interesting strategy (see Aviation Strategy November 2013) in trying to catch up with its neighbours Emirates and Qatar in gaining global market presence to push traffic through its Abu Dhabi hub by buying stakes in moribund carriers. While spending a small fortune on airberlin it has also taken a stake in Darwin — a small Swiss regional airline — and renamed it Etihad Regional, and acquired the maximum possible stake in Air Serbia (the former JAT). It is currently also reputed to be in discussions to acquire up to 49% of Alitalia for perhaps €500m.
While officially Etihad legally cannot be seen to have majority ownership or exercise control in a European airline, it appears obvious that it is providing significant input into the possible direction that airberlin may take in its restructuring. One strange (and perhaps logistically unlikely) possibility could be that a re-engineering of airberlin may be connected in some way with Etihad’s plans for a recapitalised Italian flag carrier. If it were, this may well create a significant nuisance to the three top European network carriers, in providing a fourth force after they have done so much work in consolidating the industry.
The European Commission, meanwhile, has started to investigate the level of control exercised by non-EU shareholders of EU and EEA airlines (including, to keep it fair, that of Delta in Virgin Atlantic). Lufthansa in particular will be in a quandary. It has been particularly vocal in its objection to the super-connectors’ picking up traffic from behind its Frankfurt or Munich gateways, and yet up to now seems to have been fairly happy in having airberlin as a weak competitor and a shield against Ryanair or easyJet.
Whatever the criticisms of the level of investment by Etihad in airberlin, it has allowed it a modicum of breathing space to carry out a wide-ranging restructuring. Pointedly James Hogan dismissed concerns about the extent of airberlin’s losses, saying: “If we were not convinced airberlin could be re-engineered we would not have invested”. However, there may be more problems when airberlin seeks further equity injections from shareholders in the next downturn — if not before. Meanwhile, the new Chief Restructuring Officer, however permanent his position may be, is in for some interesting times.
|2013||Q1 2014||Net bond issues||Proforma|
|Adj shareholders' funds||(602)||(813)||(513)|
|Long term debt||784||860||150||1,010|
|Short term debt||235||214||214|
|Cash and cash equivalents||223||273||450||723|
|Cash % annual revenues||5.4%||6.6%||17.4%|
|Debt/debt + equity||1.22||1.59||1.25|
|Debt/debt + shareholders' funds||2.44||4.12||1.72|
|Debt/debt + equity||1.03||1.08||1.02|
|Debt/debt + shareholders' funds||1.12||1.19||1.11|