Rinascimento d'Alitalia:
Lufthansa takes on ITA  May/Jun 2023

The structure of the transaction provides for joint operational control by the Lufthansa Group and the Italian Ministero dell’Economia e delle Finanze (MEF) immediately after closing. The MEF will remain “on board” to support the execution of the business plan, and Lufthansa will appoint ITA’s CEO and one other member of the five-strong board of directors.

Why has Lufthansa decided to acquire the remnant of what had been for so many years as a financially inept basket case?

Lufthansa states that Italy is the fifth most important market for the group, behind the USA and “home” German-speaking markets of Germany, Austria, Switzerland (and Belgium?) and says the group carries more passengers between the US and Italy than it does between the US and Germany. In its presentation it also states that Milan in 2019 was the second, and Rome the sixth, largest destination for local passenger traffic within the EU (now that the UK has left). More generally, Italy is the third largest economy in the EU (now that the UK has left) and the third largest airline market in Europe.

Lufthansa is not new to Italy. Its regional subsidiary Air Dolomiti, based at Verona and fully consolidated since 2003, provides useful feed from the Po valley to the group’s hubs in Frankfurt, Munich and Zürich. (It did at one point try to operate a narrowbody operation in the country, dubbed Lufthansa Italia and based at Milan Malpensa with nine A319s. Started in 2009 — following a previous implosion of Alitalia — that operation was closed after two years of operations in 2011, with the excuse that it was impossible to make money operating an airline in Italy. It was also likely that they had also chosen the wrong airport.)

Among the other arguments in the group’s presentation to analysts on the announcement of the deal were:

• Attractive proposition to grow a profitable long-haul business in Rome;
• Well positioned to take advantage of Italy’s importance as a “top private travel destination”. (Note: for “private”, read “leisure”.)
• Potential to feed passengers into the group’s existing long-haul network and those of its joint-venture partners;
• Significant cost synergies;
• Opportunities for Lufthansa Cargo and Lufthansa Technik.

Carsten Spohr, the group’s CEO, specified three main reasons for the attraction:

• Geography. All the current LHAG hubs are northern Europe based (the most southerly being Zürich). He said: “I think we are missing a southern hub compared to our European competitors, especially for the growing traffic in and out of Africa and Latin America”.
• Capacity. He felt that Zürich and Frankfurt had both reached capacity limits, and while expansion could be possible in Munich and Vienna, there is growth potential in Rome.
• Local demand. Rome is a strong point-to-point inbound market — particularly from the US and Asia. Milan is a strong point-to-point outbound market.

Flag transformed

Lufthansa is keen to point out that the airline it is buying into is a vastly different beast from the predecessor.

Alitalia, effectively bankrupt and in “extraordinary administration” since 2017, shored up by “illegal” state aid of €1.3bn, was finally renationalised in March 2020. In its last year of operation it had carried 23m passengers with an operating fleet of 113 aircraft and employed nearly 11,000 people. (A strange comparison: in 2008, the year of Alitalia’s previous bankruptcy, the airline had carried 23m passengers on a fleet of 178 aircraft and had 11,000 employees). There are no publicly available financial details for 2019, but Alitalia’s revenues probably exceeded €3bn but it was reputed to be losing €1m a day.

The Italian government earmarked €3bn to set up a new flag carrier. The EU Commission, miffed by the previous (blatantly illegal) state aid, insisted that there should be a clear break and the investment (restricted to €1.35bn) be “in line with the terms that a private investor would have accepted”: Alitalia’s assets should be sold by open tender; the new carrier should not retain the Alitalia brand; the frequent flyer programme MilleMiglia should be sold to a third party (it was put up for auction in Nov 2021 and closed permanently in Jan 2023); the new carrier should not take on all the predecessor’s slots, particularly at Milan Linate.

ITA Airways was, unsurprisingly, successful in acquiring the Alitalia brand for €90m in an “open” tender, and started operations in 2021.

The new airline, Lufthansa avers, has been “fully restructured and set up as a structurally cost-competitive airline, with no legacy issues associated with the old Alitalia”:

• Pilots and cabin crew contracts renegotiated with no pension obligations inherited;
• Ground handling and maintenance fully outsourced;
• Homogeneous Airbus fleet;
• “Reset” of the IT and supplier landscape;
• Smaller short-haul network, long-haul focused on high yielding markets.

In 2022, its first full year of operation, ITA Airways carried 10m passengers on a fleet of 66 leased aircraft with 3,900 employees; it generated €1.5bn in revenues, and made an EBITDA loss of €338m. It apparently ended the year with cash of €418m and gross debt (all operating-leased based) of €1bn. The cash would stand at just under €1bn on a proforma base following the envisaged capital increase from the Lufthansa deal.

Network/fleet plans

Lufthansa needs to turn ITA Airways into a profitable airline. The first steps will be to ensure the network is complementary to the existing group network, develop Rome’s Fiumicino airport into a profitable hub, grow the long haul fleet from 14 to 24 aircraft, restoring connections to North and South America, and select Asian destinations. They plan to build on ITA’s dominant position in Milan Linate (where it has 60% of the slots); improve the profitability of short-haul by optimising the network and “expanding intermodality”.

The latter is an intriguing idea. Unfortunately, unlike at Frankfurt airport, the high speed trains do not have a stop at Rome’s airport — passengers have to connect in central Rome — while Linate is not connected to the rail network at all. Maybe they are thinking of buses.

Medium-term plans see growing the fleet back to 94 aircraft by 2027 — there are seven A220s and six A320neos on order from Airbus, while apparently there are also lease commitments (primarily with Air Lease) for 10 future A330neos and a further five A320s.

Synergies will presumably come from the the superior buying power and common back-office group functions of Lufthansa Group: fleet, fuel, ground processes, finance, legal and IT.

	In service	Avg Age (yrs)	On Order
A220	4	0.8	7
A319	16	16.7
A320ceo	26	15.6
A320neo	7	0.4	6
A330	10	10.6
A350XWB	6	3.6
Total	69	11.8	13

Competitive concerns

The deal will be subject to approval by the European Commission Competition Directorate. At the meeting Lufthansa said it expects that the competition issues will be relatively benign, particularly because ITA is so weak in its home market. ITA Airways overlaps with Lufthansa group airlines on only a handful of city-pairs representing 6% of ITA’s capacity. But where it does overlap, the combination could create monopolies on four city-pairs, and high market shares on another five.

The combination would also increase the group’s dominance at Linate — Lufthansa group airlines have 7% of the slots to add to ITA’s 60% (in 2019 the former Alitalia had controlled 70% of the slots). There is less of a problem in Rome where ITA has only 30% of the slots, and the Lufthansa group airlines 6%. (The second largest operator is Ryanair with 16% of the slots).

It is possible that Brussels will require remedies.

City-Pair		LHAG+ITA		#2	Share	Total Seats 2022 (m)
Milan	Brussels	66%		Ryanair	34%	1.77
	Frankfurt	51%		Ryanair	49%	2.18
	Hamburg	61%		Ryanair	35%	0.46
	Ruhrgebiet†	82%		Ryanair	18%	1.18
	Stuttgart	100%				0.27
Rome	Brussels	51%		Ryanair	49%	1.75
	Frankfurt	100%				1.02
	Munich	100%				1.33
	Zürich	100%				0.88

† Covering airports round Düsseldorf, Essen and Köln

A strategic struggle

The newly born ITA Airways is a shadow of its predecessor’s former self. Alitalia 25 years ago was the seventh largest airline in Europe, and the 27th largest in the world. Its network has halved from the 250 routes covering 140 destinations it operated worldwide prior to European deregulation.

Notes: † Europe excluding Türkiye, Russia and CIS

ITA Airways has inherited a weak position in its home market, with a mere 24% of domestic seat capacity, nearly half that of market leader Ryanair (see chart). It has only a 4% share of the market between Italy and the rest of Europe. The largest operators on routes from outside Europe into Italy are the superconnecting Emirates and THY, ITA itself having only a 9% share.

The real dilemma is that Italy is really two disparate countries within one. The north, and particularly the Po valley, is the wealthy industrial area and home to a third of the country’s population of 59m. The south — the Mezzogiorno — is relatively impoverished with regional annual per capita incomes less than half that of the North. The industrial north is centred in Milan; the political centre is in Rome. There are strong traffic flows between them undermined by the development of high speed rail.

Italy, like the other Mediterranean countries, is a tourist destination. Although Rome is a cultural and religious tourist attraction in itself, inbound tourist traffic is generally intent on reaching the leisure destinations, well away from the industrial or political centres: highly seasonal and price oriented.

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 feed the major European hubs on the North Atlantic (notably Frankfurt, London, Paris, Amsterdam, Zürich and Munich), South Atlantic (Madrid and Lisbon), or with the building of services from the superconnectors to the East via the Gulf or Istanbul. (Apart from Rome, Emirates flies into Bologna, Venice and Milan Malpensa from which it operates a fifth-freedom service to New York. THY attacks Bologna, Catania, Venice, Naples on top of Rome Fiumicino and Milan Malpensa).

Each of these is able to offer more numerous and convenient connections supported by underlying O&D demand — a factor exploited for many years by Lufthansa through its Air Dolomiti subsidiary.

Because of this, Italy is perhaps 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. Milan Malpensa may be better but is stymied by the attractiveness of Milan Linate for high yield point-to-point demand required. Rebuilding the Rome hub will be a challenge.

The most important long haul routes are to the US, driven by long-standing cultural affinities from the Italian diaspora. But they tend to be highly seasonal.

Italy has strong cultural links on the South Atlantic, particularly into Argentina and Brazil (the most popular destinations, behind the USA, of the Italian diaspora of the early 20th century), but the south western European hubs of Madrid and Lisbon may have more convenient routings and timings for a feed of passengers from Northern Europe.

More importantly the LCCs have successfully moved into the vacuum left by Alitalia’s implosion. Rebuilding the shorthaul network into Rome, where ITA has only 30% of the slots, to provide the necessary feed could be a costly exercise. Despite the renegotiated cost base, it seems impossible that ITA Airways' unit costs would be anywhere close to those of ULCCs Ryanair or Wizz.

Low risk acquisition

From Lufthansa’s point of view, it is moving into Italy in a relatively cautious manner. For the cost of a couple of aircraft it will be able to try its hand at creating a profitable network carrier in Italy, something generations of highly proficient international airline managers have failed to do.

Importantly for the group, it is initially acquiring only a minority stake and will not need to consolidate the losses or debt. It will only take a majority once ITA Airways is profitable. (This is the same process it followed when it acquired SWISS).

It also snatches the Italian carrier out of the hands of arch-rival Air France-KLM.