Can FS make Alitalia
run on time? May 2019

Two years ago Alitalia ran out of cash and was put into short-term emergency administration, getting a government loan of €900m to be repaid within six months. The idea was to allow the administrators the time to find a buyer for the flag-carrier. The period of special administration has been extended several times and now is due to expire at the end of June. Meanwhile this month, various unions staged an industry-wide 24-hour strike causing an irritating level of flight cancellations. Ostensibly this was to protest at the lack of progress in securing a future for Alitalia; it could also have been because this is Italy and it was May.

Various potential bidders have come and gone — including easyJet and Lufthansa — while Air France-KLM, with its own problems and having already been badly burnt, refused to take part. Those still in the frame appear to be Delta and Ferrovie dello Stato (FS, the Italian state-owned operator of railways and motorways). The excuse for the further extension of the loan to the end of June was to allow FS to “develop a credible business plan”. You would have thought that the two years since having been told to invest might have been sufficient for a rail operator to learn about the aviation business, and work out how to justify an investment of a few billion euros.

The Italian Government appears to have run out of plausible choices to push through a restructuring of the flag-carrier, without incurring the wrath of Brussels for providing (illegal) state aid without a rational business investment case. The state-owned Poste Italiane (the Italian postal service) was forced into investing in the last Alitalia restructuring in 2013 (designed to prepare it for the Etihad investment in 2014), along with Italian banks Banco Intesa Sanpaolo and UniCredit. All of these will have lost their equity investments. Poste Italiane refused to countenance the idea of further investment.

On the face of it FS might be a good choice as a major shareholder. It appears to be a profitable and commercially oriented business. Its accounts show revenues of €12bn in 2018, up by 30% from the prior year levels because of acquisitions; operating profits of €714m and net profits of €559m. It has €48.4bn in net invested capital and equity of €41.8bn. It has investment grade credit ratings of BBB from both Fitch and S&P.

But it is a government-owned entity and its all important credit rating is linked to that of the Italian State.

FS runs the Italian railway system — the operation of Trenitalia along with the network infrastructure and stations — on a long term virtual monopoly (although, unusually, there is a smaller private competitor, NTV, on the high-speed rail network, owned by Global Infrastucture Partners). It also owns ANAS (in charge of the construction and maintenance of Italian autostrade and state highways) along with Italian bus operator Busitalia, the c2c rail franchise in the UK, Thello in France (operating night trains between Paris and Venice) and Dutch bus operator Qbuzz.

FS mentions in its accounts that one of its corporate objectives is to develop the rail networks in Italy to encourage a modal shift to rail away from air transport for short-haul journeys. The development of the “Frecciarossa” high speed line between Turin and Naples via Milan, with top speeds of 300km is a major achievement (the journey time between Rome and Milan is just under three hours and that from Naples to Milan around four hours). Further expansion is planned.

It has had an effect. The Italian domestic air market as a whole has been virtually static over the last decade (while that between Rome and Milan has halved). Alitalia remains the largest player with 41% of the seat capacity on offer (see table); but it has shrunk its offering by an annual average of 3% in the last five years and its share fallen from 50% (although Ryanair has grown by an annual average 7.7% and pushed its share of domestic capacity to 33% from 23% in 2013).

An article in Il Sole 24 Ore in March suggested that FS had reached an agreement with Delta. FS would take a maximum 30% stake in the new Alitalia (it doesn’t want to endanger its credit rating or its ability to fund infrastructure spending, its raison d’être), with Delta taking an initial 10% stake that could rise to 49% over four years were the new Alitalia to be profitable, and the Italian Government suggesting it would take a direct stake of 15% so long as the business plan, at least on paper, appears able to succeed.

Delta’s interest fits in with its strategy of taking minority stakes in overseas carriers to help cement and intensify joint venture operations. Since 2010 it has acquired stakes in Aeroméxico, GOL, China Eastern, Air France-KLM and Virgin Atlantic (see Aviation Strategy Jan/Feb 2016 and Jan/Feb 2017). Its interest in Alitalia would be to bring it fully back into the SkyTeam antitrust-immunised joint venture on the Atlantic. It might even be able to exercise effective control and provide strong commercial experience, though it would be limited under European law to a maximum 49% equity stake.

This FS business plan envisages eliminating loss-making short haul feeder flights by creating inter-modal connections with the high speed rail network — hardly a recipe for success or one that addresses Alitalia’s fundamental problems. (It doesn’t particularly help that Italy’s high speed trains — designed to provide fast city-centre to city-centre transport — do not stop at the airports.) But FS still has to find other investors for the remaining 45% of the equity.

However in establishing a new company to create the newest Alitalia what would the investors really be acquiring? The fleet is mostly leased, and the few aircraft it does own are more than 20 years old. But It has 67% of the slots at the heavily constrained Milan Linate and a handful remaining at London Heathrow.

Meanwhile that six-month Government loan of €900m in May 2017 to keep Alitalia afloat until a buyer is found is subject to an EU investigation for illegal state aid. The loan is now due to be repaid at the end of June, while the EU investigation will probably not rule until a sale is completed. Caveat emptor.

Brand decay

Alitalia has allowed its “natural” position as the national flag-carrier of Italy erode so much that it has probably destroyed what was once a national brand. Alitalia’s share of seats in the Italian short/medium haul market has fallen from 31% in 2010 to 15% in the 2018 schedules. The largest carrier in this market is now Ryanair with a 26% share of the total departing seats. Excluding domestic operations, Alitalia’s share of international short haul capacity has fallen to 7%. In the last five years it has shrunk capacity while the market has grown by an average annual 6.3% (see table).

Long-haul markets have been equally affected. On the 2008 restructuring Alitalia moved its long-haul hub back to Rome from Milan Malpensa. It is still the largest player, but Its share of long-haul seats has fallen to 18% of the total, closely followed by Emirates on 16% and Qatar on 8% — each of which have increased their offerings into the market by an average annual 9% and 13% respectively in the past five years. Capacity on long haul has increased by an average 10% a year in this period, but Alitalia’s growth has been a mere 3% a year.

A divided country

Italy is really at least two disparate countries within one. The North, and particularly the Po valley, is the wealthy industrial area: a continuation of the “blue banana” distribution of European population density that runs from London through Paris, the Rhine valley to Turin. The South — the Mezzogiorno — is a relatively impoverished area with regional annual per capita incomes less than half that of the North. The industrial North is centred perhaps in Milan, the mercantile centre; the political centre is in Rome on the northern borders of the Mezzogiorno. There is strong air traffic demand domestically between Rome and Milan and Rome and Naples, weakened by the introduction of high speed rail. There is strong demand from the Mezzogiorno to the North, ideal for for low cost airline competition against road and bus transport. However, there is also strong demand from the Po valley on longer haul routes, and this (without having to go through Milan) is easily diverted to other European hubs for long haul connections (notably Frankfurt, London, Paris, Amsterdam, Zürich and Munich), or with the building of services from the superconnectors to the East via the Gulf or Istanbul.

Italy is not suited to operating traditional transfer hubs in Europe. Rome is too far south to access convenient connections on the Atlantic or to the Far East except perhaps from within Italy, while Milan Malpensa is stymied by the attractiveness of Milan Linate for high yield point-to-point demand.

In Alitalia’s last suggestion of a restructuring plan in 2016, the then CEO, Cramer Ball, highlighted the structural realities: 75% of Alitalia’s total traffic was carried on short haul operations; 50% of all its traffic transfers; and transfer traffic makes up 85% of long haul traffic. Management at the time claimed that long haul operations were profitable.

Clear Asset Sale?

The Italian Government appears to have taken over the sale of a failed national asset as if it were still majority shareholder. It appears to want to preserve the notion that it is essential for a nation to have a flag carrier, although the real reason probably has more to do with long-standing vested interests. Notable in the process of European consolidation have been the failures of such flag carriers as Sabena, Swissair, Malév, Cyprus and Olympic. In each case the respective Governments walked away: Sabena and Swissair ended up through their successor companies, Brussels and SWISS, to be owned outright by the Lufthansa Group; Malév and Cyprus were allowed to dissolve, but other airlines moved in to provide air services on a more efficient, commercial and profitable basis.

Perhaps Italy should be taking a lesson from the experience of Greece in its “privatisation” of Olympic in 2008. In that case the Greek Government put the core assets up for sale — essentially the brand and airport slots at Heathrow — bribed the staff through generous redundancy packages, assumed the problem of disposing of unwanted ancient owned aircraft and dissolving leases, to allow the new owner to start with a clean slate.

The new owner, Marfin, sold the “new” Olympic two years later to Aegean. And Aegean is a highly cost efficient operation that has since made a great success in the Greek market (see Aviation Strategy, April 2018). Italy doesn’t have the equivalent of Aegean, but perhaps the closest is Air Italy.

Air Italy

At the beginning of 2018 Qatar Airways took an effective 49% stake in Meridiana, Italy’s second largest scheduled airline based in Olbia on Sardinia. The airline rebranded itself as Air Italy, moved the base of operations in Milan to Malpensa from Linate with the aim of establishing a feeder hub. It has ambitious plans significantly to grow its fleet from the 11 it had at the date of the announcement (three 767s and eight 737NG) to 50 units by 2022. It has since replaced the 767s with A330s leased from Qatar (with Qatar’s high quality in-flight spec) and taken three 737MAXs out of a commitment of 20.

Air Italy currently operates to 26 destinations and has plans to build its network to 50 in the next three years. It seems to be pursuing an interesting long haul strategy of seasonal services from Milan: eg while it does have year round operations to New York and Miami, it has only summer operations on the Atlantic to Los Angeles, San Francisco and Toronto switching to winter operations to Mombasa, Maldives and Zanzibar.

The original plan was to become an all-Boeing operator, leasing 787-8s from Qatar as that carrier took deliveries of its new 787-9s, and building its leased 737MAX fleet. Given the delay in deliveries of the 787 programme, and with the problems with the MAX, it could move to an all Airbus fleet. Qatar has a policy of operating a very young fleet, and while the Gulf goes through its current difficult operating environment, it is still taking deliveries on its substantial orderbook. But Qatar has been ostracised by its neighbours and has been leasing out excess capacity. It currently has 27 A330s and 40 A320 family aircraft which it could gradually lease out to its Italian associate.

It may take Air Italy a long time to become a credible alternative flag carrier. But the move has not escaped the notice of the US “Partnership for Open and Fair Skies”, backed by the three major US carriers (including Delta, purported to be interested in investing in Alitalia) in its continuing campaign against “unfair” competition by the Gulf Carriers. It claims “the only reason a failing airline like Air Italy can continue to launch new routes without consumer demand is because of Qatari government dollars designed to fuel unchecked growth”, and that Qatar Airways is using Air Italy to “violate” the Open Skies agreement between the US and the State of Qatar.

The claim has been roundly refuted by Qatar and Air Italy as being without foundation, while JetBlue, FedEx and Atlas Air have also rallied against “this disinformation campaign” emphasising the “illogicality” of Delta’s position.