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four basic scenarios September 2015 Download PDF

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Remarkably few airlines in Europe since the introduction of liberalisation have successfully transferred from the charter sector to mainstream scheduled operations. airberlin is one such that has tried — evolving into a strange hybrid. Normal independent airlines with airberlin’s financials would be faced with bankruptcy. But airberlin, with its Etihad ownership, is a peculiar case.

airberlin started life as a Berlin-based charter carrier in the late seventies and launched into scheduled services following European liberalisation (for its early development see Aviation Strategy March 2004). It came to the markets through an IPO in 2006, describing itself as a low cost hybrid carrier; and then went on an acquisition spree.

In short order it acquired dba (Munich-based domestic carrier originally developed by British Airways as its foray into European deregulation), which provided it with a ready-made domestic network and a plethora of corporate accounts with which it thought would allow it to compete effectively against Lufthansa; Belair, a Swiss-based charter carrier; Vienna-based Niki; TuiFly’s scheduled operations; and Düsseldorf-based LTU to provide access to long haul leisure scheduled and charter routes. It also tried to acquire former Lufthansa charter carrier Condor — but this fell by the wayside in the wake of rising fuel prices and cartel office opposition.

The strategy at the time was described as one to cement an effective benign duopoly in the German speaking countries alongside Lufthansa to provide a barrier against the insurgence of the growth of LCCs (primarily Ryanair and easyJet). Lufthansa would concentrate on operations through its hubs at Frankfurt and Munich; airberlin would be allowed to develop hub services through Berlin and Düsseldorf.

The LTU acquisition could not have been executed at a worse time. 2008 saw fuel prices rise to over $140/bbl and the financial crisis had a disastrous impact on air traffic demand as well as the local economy. Since then airberlin has been struggling to find a strategy. It last recorded a profit before tax in 2006; since then it has lost a total of €1.8bn.

Arabian rescue

In 2011 Etihad pumped in €73m and increased an existing small stake to 29% of the equity. Since then it has effectively been bankrolling the airline — with an additional €300m perpetual convertible, a €250m rolling debt facility and buying 70% of the frequent flier programme topbonus for €200m.

In September this year Etihad used its newly granted A-rating from Fitch to raise $500m on the international debt markets (since increased to $700m by popular demand) for Etihad Airways Partners IBV — the vehicle through which it (possibly) owns its stakes in airlines and other non-consolidated assets. (Fitch in its rating summary carefully avoided controversy by stating that the rating was entirely independent of the Sovereign rating of Abu Dhabi). Of the sum raised 20% each is earmarked for airberlin, Alitalia and Etihad Airport Services, 16% for Jet Airways and the remainder for Air Serbia and Air Seychelles.

Restructuring Plans

For airberlin this additional loan injection should allow it to cope with bond repayments due before the end of the year, but is unlikely to do anything to improve its dire financial position. Since the 2008 financial crisis the company has introduced a series of cost reduction and restructuring programmes — none of which have been particularly effective.

The number of passengers carried peaked in 2011 at 35.3m; the 2014 numbers were 10% below this at 31.7m. Over the same period it has pushed up the length of haul (in part by adding connections to Abu Dhabi) and ASKs and RPKs last year were respectively only 5% and 6% below the peak. Revenues likewise have stagnated at just above €4bn a year — on which since 2011 it has achieved an average negative operating margin of 6%.

At the end of December 2014 net assets on the balance sheet stood at a negative €(416)m. By June this year this had declined further to €(575)m. If we deduct intangibles (mainly airport slots) the net asset position would sit at just under €(1)bn. At the end of June net debt stood at €727m — which increases to €5.2bn when taking into account capitalisation of lease rentals. At the same time the gross cash position stood at 6% of annual revenues. Clearly this is not sustainable.

At the beginning of 2015, the company appointed its fourth CEO in as many years — Stephan Pichler (formerly Lufthansa, Thomas Cook, Virgin Blue and Fiji Airlines) — who has introduced yet another restructuring programme. He stated: “Our company strategy is clear: we are a European multi-hub airline with four major advantages over our competitors: we produce with lower unit costs than other network carriers, a lead we want to further extend by consistent revenue management; we have a strong touristic sales organization; we have an expandable position in strong catchment areas and we can count on our employees and their loyalty and excitement.”

The focus of the “new” programme appears to be in three phases:

  • Management and leadership (by Sept 2015). KPIs and incentives for senior management; realignment of the corporate structure; review of network strategy, scheduling and revenue management; staff engagement.
  • Market segmentation and capacity adjustments (by March 2016). Cut winter capacity by 5%; new revenue management strategy to improve yields; withdrawal from non-strategic markets and build market shares in its hubs and on strategic target markets; focus on core business.
  • Profitability and growth (from Apr 2016). Developing multi-hub strategy and new long haul routes; “platform growth” strategy, outsource non-core activities; improve IT infrastructure as a basis for future growth.

Not entirely convincing. But Pichler appears to be aiming for profitability by the spring of 2016. “We can’t wait for 2017 to be profitable,” he is quoted as saying. “We need to follow a clear corporate strategy. We can’t wait for the new airport to open in Berlin. We have multiple hubs now in Düsseldorf, Stuttgart and Vienna. They’re in strong catchment areas. Within 120 minutes drive of Düsseldorf Airport there are 37 million people, unfortunately we are only getting 34% market share there. We need to grow that... We will focus on point to point... Some 65 percent of our revenue comes from touristic sales. We have long standing relationships with more than 100 tour operators. We need to establish a fair distribution of risk and opportunity.

Unfortunately for airberlin the market conditions in Germany are changing. Lufthansa has moved its point-to-point non-hub services to its (slightly lower cost) Germanwings putting pressure on airberlin in direct competition (but at the same time increasing the acceptance of low cost airline operations to the conservative German consumer); while its plans to build its new (even lower cost) Eurowings will squeeze it even more.

Other LCCs are also taking advantage. Ryanair has announced a significant increase in operations in Germany — with its new “friendly” face it is looking to build from the current 4.5% market share (less than half the share it has throughout Europe) and this month re-entered the German domestic market with 30 weekly frequencies on the Köln/Bonn-Berlin route. While O’Leary is quoted as saying that “the legacy carriers’ model in Europe is over”, it is likely that Lufthansa will aggressively respond to protect its back garden. As Lufthansa CEO Carsten Spohr says “Lufthansa won’t be squeezed out of its home market”. Although Lufthansa may not actually want airberlin to fail, if anything the “cosy duopoly” that it and airberlin may have enjoyed no longer exists.

Possible outcomes

  • Turnaround.
    It is conceivable that airberlin is successful in its plans to restore profitability. It seemingly has a long way to go, and restructuring its balance sheet will take a great deal of effort. Ignoring yield developments, a 20% reduction in non-fuel unit costs might allow it to break even at the operating level; a 30% reduction give it a net return (and perhaps make it competitive with the new Eurowings). A 50% reduction may give it a chance of competing with Ryanair. Given the competitive pressures developing it may be able to do very little on the revenue side.
  • Status quo.
    It could be that Etihad — seemingly without the pressures of public shareholders — may be willing to continue to support the finances of a loss-making operation to fulfil its ambition of catching up with its Gulf rivals in access to worldwide markets. Lufthansa may even be happy to retain a weak but supported competitor to help it against the Ryanair onslaught — in much the same way that it and SAS supported bmi for many years.
  • Porchi volanti.
    Etihad pushes its two larger European associate airlines — Alitalia and airberlin — into merger. Although the overlap is small, and the two are developing code share routes linking their respective networks, it is difficult to conceive of any convincing corporate strategy.
  • Exit.
    Having put so much money and effort into its minority investment in an airline over which it can have no official control, Etihad may find it difficult to stomach, but could walk away.

airberlin may be in ill health, and in a position redolent of many smaller legacy flag carriers. However, it is still a favoured airline for sun-seeking German tourists to head for holidays in Spain and the Balearics no matter how much Etihad pays them to get there.

Total 169 170 155 140 149 149
2010 2011 2012 2013 2014 6/2015
A319 19 11 8 8 9 9
A320 46 46 43 39 44 50
A321 11 14 16 16 17 22
A330 13 14 14 14 14 14
737-700 27 26 21 11 9 8
737-800 38 42 36 35 34 27
Q400 10 10 10 10 16 17
E190 5 7 7 7 6
Saab 2
€m June 2015 Dec 2014
Equity and reserves 619 523
Retained earnings (1,508) (1,248)
Equity due to Etihad 313 309
less Intangible assets (409) (409)
Net Assets (985) (824)
LT Debt (700) (730)
ST Debt (286) (333)
Cash 259 402
Capitalised Leases (4,524) (4,384)
Net Debt (5,251) (5,046)
Cash % revenues 6.3% 9.7%
Source: Company reports
AIRBERLIN SHARE PRICE Produced by GNUPLOT 5.0 patchlevel 0 1.00 1.50 2.00 3.00 4.00 5.00 7.50 10.00 15.00 20.00 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 EUR(log scale) AB1.F
AIRBERLIN FINANCIAL RESULTS (€M) Produced by GNUPLOT 5.0 patchlevel 0 -400 -300 -200 -100 0 100 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E 1,000 2,000 3,000 4,000 Operating result Net result Revenues Operating result Net result Revenues

Source: Company reports, Aviation Strategy analysis, HSBC forecasts.

AIRBERLIN GROUP TRAFFIC Produced by GNUPLOT 5.0 patchlevel 0 0 10 20 30 40 50 60 70 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 75% 80% 85% ASK RPK Load Factor Pax ASK (bn) RPK (bn) Load Factor Passengers (m)

Source: Company reports. Note: 2015 extrapolated from first half results.

WINTER SEASON LCC SEATS SHARE Produced by GNUPLOT 5.0 patchlevel 5 0% 5% 10% 15% 20% 25% 30% 35% 40% Berlin D#xFC;sseldorf Munich Hamburg Stuttgart Cologne airberlin Ryanair airberlin Ryanair easyJet Vueling Eurowings airberlin Ryanair easyJet Vueling Eurowings airberlin Ryanair easyJet Vueling Eurowings airberlin Ryanair easyJet Vueling Eurowings Winter 2014 Winter 2015 FR FR15-16 U2 U215-16 VY VY15-16 EW EW15-16

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