Mergers and Alliances Istanbul Technical University Air Transportation Management, M.Sc. Program Aviation Economics and Financial Analysis Module 12
Outline A. Trends in M&A Activity B. Factors Affecting M&A Activity C. Overview: Mergers and Alliances 2
A. Trends and M&A Activity
Global Airline Industry Performance (old slide 18) Airlines have the lowest returns in the aviation value chain, well below that of travel agents and CRSs Airline returns are well below their cost of capital Source: McKinsey & Company for IATA, 2011 4
Trends in Global Mergers and Alliances (old slide 14) Key airline industry trends: Rapid expansion of alliances and increased incidences of mergers. A deepening in the scope and depth of airline cooperation Airlines are seeking cooperation beyond traditional codeshare and joint marketing agreements. Metal-neutral joint ventures are a new form of super alliances. Increased liberalization of international skies facilitates the growth of alliances. The growth of international airline alliances and domestic airline mergers raises strong competition concerns. 5
Trends in Global Mergers During 2001-2012 there was a total of 677 airline M&A transactions with a total value of $98 billion. Top markets by transaction volume: United States ($30 billion), Australia ($11 billion), China ($9 billion), Japan ($5 billion), Brazil ($4 billion). Source: Bloomberg data, InterVISTAS analysis 6
B. Factors Affecting M&A Activities
Factors Affecting M&A Activity Airline yields have been decreasing or remained stable in real terms Real average domestic fares and yields have decreased after industry deregulation increased competition from Low Cost Carriers in domestic markets further erodes real yields and net profits for Full Service Network Carriers U.S. Domestic Net Income Per Available Seat-Mile Source: Borenstein (2011), US DOT BTS P-12 data 8
Factors Affecting M&A Activity U.S. Airline Industry Passenger Yield (CPI Adjusted): 2004-2010 Source: U.S. Department of Transportation 9
Operating costs keep surging The industry is facing higher operating costs, in particular due to increases in fuel costs which currently account for 25-40% of airline operating costs. Main cost drivers: Fuel; Labour; Depreciation, amortization and rent; Maintenance, materials and repairs; Landing and terminal fees; Other Source: IATA 10
Jet Fuel Historical Prices Source: U.S. Energy Information Administration 11
Jet Fuel Post Recessionary Prices Source: U.S. Energy Information Administration 12
Bankruptcies Airlines benefit from larger networks cost advantage due to economics of scale and scope higher demand due to better connectivity, greater range of destinations and increased service frequency High incidence of bankruptcies in the airline industry following deregulation continuing trend among major carrier to restructure under bankruptcy protection E.g. United Airlines bankruptcy was the longest and most expensive in aviation history lasted 1,150 days cost $400 million in consulting and legal fees 13
Major Airline Bankruptcies 14
C. Overview: Mergers and Alliances
Airline Industry Consolidation Mergers United Continental Delta Northwest Ryanair buzz Gol Varig Air France KLM US Airways America West Caribbean Air Jamaica Air Berlin LTU EasyJet go British Airways British Midland Southwest AirTran Sun Country Arrow Air Mesa Air Lufthansa Swiss Austrian Brussels British Midland Champion Air JetsGO Sterling Oasis Hong Kong SkyBus Comair EOS ATA Zoom MaxJet SkyEurope Aloha Big Sky Failures
Airline M&A in the United States (old slide 17) Source: U.S. GAO, Airline Mergers: Issues Raised by the Proposed Merger of American Airlines and US Airways, GAO-13-403T, June 19, 2013. After deregulation in 1978: After 9/11: 162 bankruptcy filings as of 2005 Most failing airlines were small new entrants But 24 airlines had more than $100 million in assets 17 Bankruptcy filings by airlines including Sun Country, ATA, Vanguard, Atlas Air/Polar Air Cargo, US Airways (twice), United, Hawaiian, Aloha, Northwest, Delta, American, Midway, etc.
What is an alliance? (old slide 20) An alliance is an agreement between two or more airlines that enter into a form of cooperation global alliances (Star, SkyTeam and oneworld) bilateral or multilateral alliances (marketing alliances, joint ventures, codeshare, etc.) Alliances are subject to regulatory approval US regulators may grant anti-trust immunity to international alliances EU regulators may grant anti-trust immunity to international alliances Both the US and EU will consider whether or not there is a signed Open Skies Agreement with the foreign carrier s government May be passenger or cargo (the two can overlap) Source: ICAO (2013) Antitrust Immunity for Airline Alliances 18
Why alliances? Foreign ownership rules Many countries prohibit or limit ownership of domestic airlines. International or cross-border mergers are rare. Instead, the benefits of a merger can be achieved through an alliance. Restrictions on cabotage rights Countries generally restrict foreign airlines from operating domestic service. There are exceptions (e.g. the European Union). Access to a larger global network Airlines can increase service frequency and number of destinations served by participating in an alliance. Increased connectivity may improve load factors. 19
Why alliances? Marketing cooperation Frequent Flyer Programs Codeshare Agreements Lounge Access etc. Cost synergies Shared airport facilities Joint scheduling Reciprocal sales arrangements Increased buyer power Decrease in competition Airline alliances have a potential to diminish or exclude competition. Pro- and anti-competitive effects will be discussed in Module 13. 20
Passenger vs. Carrier Priority (old slide 16) The Passenger Wants: The Carrier Wants: CHO ESB CHO Gateway C Gateway ESB Minimum Time Increase global access for passengers Lowest Fare Seamless travel and brand awareness Predictable Quality Increase frequent flier loyalties Maximum Frequent Flyer Credit Lower costs and increase revenues
Types of alliances (old slide 23) 100% JOINT VENTURE Alliances and Strategic Partnerships COORDINATION (prices, schedules, facilities, capacity, etc.) Integration Level FFP & LOUNGE ACCESS CODESHARING INTERLINING 0% Integration Level 22 100%
Global alliances: Star Alliance Star Alliance 23
Global alliances: SkyTeam SkyTeam 24
Global alliances: oneworld oneworld 25
Trends in airline alliances Many major airlines have joined a major alliance grouping (Star, SkyTeam or oneworld) Over 50 carriers are members of one of the three major alliances These carriers represent two-thirds of industry s ASKs LCCs begin to join global alliances In 2012, airberlin joined oneworld There is a tendency towards seeking deeper cooperation by airlines via bilateral and multilateral alliances metal neutral joint ventures are a form of a super-alliance which is very similar to a merger. Several major carrier that have deliberately avoided alliances seek increased cooperation on a bilateral basis (e.g. Emirates) 26
Emirates and Etihad s Strategic Partnerships Sample of selected strategic partnerships of Etihad and Emirates Both Etihad Airways and Emirates have codeshare partnerships in place that penetrate all three airline alliances 27
Traffic Paradigm Shifts The emergence of Gulf/Middle East carriers has caused a paradigm shift in global traffic flows across major connecting hubs are depicted above. 28
If you can t beat them. QANTAS Before Emirates Partnership: 5 One-Stop Destinations in Europe (via QF operations or codeshares) No service to Middle East/North Africa QANTAS After Emirates Partnership: 32 One-Stop Destinations in Europe & 31 One- Stop Destinations in Middle East/North Africa via DXB Revised service to SIN/HKG/KUL for better connectivity to Asia 29
Select Recent Mergers and Joint Ventures A++ 30
Metal-neutral joint ventures Metal-neutral joint ventures High degree of integration The most intensive form of an airline alliance Revenue & profit sharing Joint setting of prices and schedules Similar to a merger but no ownership transfer Metal-neutral joint ventures in major aviation markets Transatlantic Star A++ (Lufthansa Group, Air Canada, United/Continental) SkyTeam Joint Venture (Air France / KLM, Delta and Alitalia) Oneworld Joint Venture (American, British Airways / Iberia) Transpacific Star Joint Venture (United / Continental, ANA) Delta/Virgin Australia Joint Venture American / JAL Joint Venture 31
Passenger Traffic Forecast 2013 Travel Forecast to/from North America (millions of passengers) 30.3 54.2 +98% 60.2 78.2 +50% 62.2 77.3 +61% Source: FAA Aerospace Forecast Fiscal Years 2013-2033. 32
Passenger Traffic Forecast 2033 Travel Forecast to/from North America (millions of passengers) 48.7 54.2 +61% +98% 92.7 78.2 +54% +50% 99.0 77.3 +59% +61% Source: FAA Aerospace Forecast Fiscal Years 2013-2033. 33
North Atlantic Market Share Non-Aligned Alliance Annual Seats (millions) 25% 75% 25% 75% 23% 77% 22% 78% 16% 84% 17% 83% 18% 82% 19% 81% 19% 81% 19% 81% 19% 81% 20% 80% 17% 84% 83% 16% 12% 88% Source: U.S. DOT T-100 34
North Atlantic Alliance Structure July 2013 Market Shares (Frequency)* Joint Venture Other Alliance Non-Aligned U.S. Europe 78.5% 14.3% 7.2% U.S. U.K. 94.5% 3.5% 2.0% U.S. London LHR 96.4% 3.1% 0.4% U.S. Paris CDG 90.3% 4.2% 5.5% U.S. Amsterdam 94.4% 3.0% 2.6% U.S. Frankfurt 81.8% 12.1% 6.1% Note: Virgin Atlantic included in Sky JV * Based on monthly flights Source: Diio Mi July 2013 Schedule Data 35
What makes an alliance successful? Factors that affect success of an alliance: Aligned expectations Win-win financial provisions Cultural compatibility (corporate and national) Consistent quality and other customer relations Network fit Well-coordinated IT systems E.g. WestJet-Southwest failure Smooth airport interfaces Coordinated selling and distribution Source: AirLearn (2013) 36
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