Aegean/Olympic: Virtual merger now real October 2013

In mid-2009, the Greek diversified investment company, Marfin Investment Group (MIG), completed its purchase of the intangible assets of the state-owned Olympic Group (ie the airline brand, logo, three Heathrow daily slots, its domestic ground handling concession and its land use rights to two maintenance hangars at Athens for €105m). The deal was unsuccessfully challenged by a last-minute bid from Aegean.

Over a three year period, Olympic is estimated to have accrued a €300m exposure in purchase price, set-up costs, assumed aircraft lease liabilities and operating losses as it attempted to compete with Aegean. Rejecting the opportunity to re-invent itself as an LCC, it reformed the old highly inefficient state-owned model by dropping all long-hauls and other hopeless routes and immediately replacing elderly, fully depreciated, 737s and ATRs with new A320s and Q400s, at a high capital cost. Both Olympic and Aegean employed essentially the same, small-scale, legacy airline model, engaged in a brutal battle for market share, especially in the domestic market, and both lost large amounts of money.

In 2010, both carriers applied for merger approval to the European Commission and the national competition authority. The merger was not allowed, because of dominant position concerns, so the Greek solution was a virtual merger. Routes, fleets and fares were synchronised. Olympic sold its LHR slots to Aegean, withdrew from most trunk European routes and focused on trunk domestic, PSO and Balkan turboprop operations, while Aegean proceeded with a significant European expansion.

While this was a convenient arrangement, it did not translate into profitability. As the extreme Greek economy recession hit, traffic volumes collapsed (total domestic traffic fell from 6m annual passengers in 2008 to 4.1 in 2012), and both carriers were faced with drastic revenue reductions while sustaining legacy-type fixed cost structures. In addition, there was increased domestic trunk route competition from Cyprus Airways (now withdrawn) and a staged UK LCC expansion into Greece. Aegean reacted by slightly divesting its Athens presence and entering the seasonally attractive Athens-bypass leisure market. Olympic retreated further into the domestic and Balkan markets. Finally, Olympic and Aegean divided six domestic trunk routes in September 2013.

In essence, the EC was forced to accept the reality of the existing “virtual” merger and offer a stamp of approval. There had been no fundamental change in the domestic competition scene since the 2010 decision, but the rationale behind the 2013 approval was that Olympic was a failing company. The 2010 disapproval created a virtual domestic monopoly; now there is an actual domestic monopoly.

The Greek stockmarket liked the decision, one of the few pieces of good news in recent years, and Aegean’s share price has rocketed. Yet fundamental problems have not been tackled.

In a corner of Europe eminently suited to LCCs, Aegean is still a very traditional carrier, a sort of British Midland. It is vulnerable to attack from LCCs like Ryanair and easyJet offering direct service from northern European points to island destinations, further undermining the traffic that used to connect at Athens. easyJet might finally be tempted to establish an Athens base and enter the domestic market from there (it flies to Athens from multiple European points, but Ryanair won’t touch Athens because of the very high airport charges).

There is even the possibility of a Greek new entrant. Inevitably, monopolies attract challengers (the net average domestic fare is now at €60 for a typical 45 minute segment), and entering at the bottom of the cycle, encouraged by very low labor costs, to attack a legacy monopoly could be enticing. However, Aegean will probably enjoy a one or two year “honeymoon” before any serious contender can be satisfied on these issues:

• A more clear path on the Greek economy outlook;
• Uncertainty over the eventual ownership of Athens airport (and its future charges); and
• The outcome of the privatisation of some 18 regional airports, now in progress.