Lufthansa’s unenthusiastic embrace of BMI is a sign of the times

ON JULY 1st Lufthansa finally took control of BMI, the second-biggest carrier at Heathrow airport. But the only person celebrating was Sir Michael Bishop. A fortnight earlier the 67-year-old entrepreneur had forced the German airline to honour a decade-old put option to add his 50% stake to the 30% it already held, albeit at a lower price: £223m ($368m) rather than £292m.

That the deal had to be imposed on Lufthansa, almost literally on the steps of the High Court in London, was a sign of the times. Until quite recently, the chance to acquire BMI's 11% share of take-off and landing slots at Heathrow would have been enviable. In 2007 American airlines, eager to take advantage of new “open skies” rules, were paying up to £25m for each pairing of slots. But these days, faced with one of the most savage downturns in the history of a notoriously cyclical industry, Lufthansa is desperately trying to conserve cash and cut capacity to match plunging demand.

The airline recently warned that without fierce cost-cutting measures it would fail to make even an operating profit this year. In the first four months of 2009 its premium traffic fell by 15%, while traffic within Europe dropped by 37%. Blair Pomeroy, of Oliver Wyman, a consultancy, points out that the last thing Lufthansa needs just now is to spend precious money and management time trying to sort out a struggling, sub-scale airline such as BMI.

It shows just how bad things are if even Lufthansa, one of the world's most powerful airlines, cannot see how to make money by bulking up at Heathrow, one of the most coveted bits of real estate in aviation. According to IATA, the trade body that represents most of the world's airlines, the industry is on course to lose $9 billion this year. Although passenger volumes appear to have bottomed out and freight recently recorded a small increase, IATA's boss, Giovanni Bisignani, fears that the worst is yet to come and that once the summer holidays are over the crisis will intensify.

The problem, according to Brian Pearce, IATA's chief economist, is that “fares and yields are still collapsing” in most of the world because capacity cuts have yet to catch up with the fall in demand. Deliveries to airlines that ordered new planes near the top of the cycle are running at a rate of about 100 a month and will continue at that pace well into next year because the penalties for late cancellation are so high. It is also hard for airlines to mothball planes they are still paying for. American majors were able to slash capacity much faster than their European and Asian counterparts because many of their elderly planes were fully depreciated. In just a few months last year, United Airlines grounded nearly 100 of its elderly Boeing 737s.

Another anxiety is the price of jet fuel, which has risen by nearly 50% since the beginning of the year and by over 30% since early May. Mr Pearce says that his forecast assumes oil at $65 for the rest of the year—five dollars below the level it reached this week. Each extra dollar adds $1.6 billion to the airlines' costs.

If cash continues to evaporate at its present rate, even the strongest airlines will need to raise money. But the price they will pay for it could cripple them for years. Even airlines with healthy balance sheets, such as American and Southwest, are having to pay 10-11% on secured debt. United offered a yield of 17% on $175m worth of debt issued last week.

Sir Richard Branson, the founder of Virgin Atlantic, has mischievously suggested that his old rival BA could go bust. Aviation analysts think that unlikely. But its chief executive, Willie Walsh, admits it is facing a “fight for survival”. In the last financial year, BA recorded its worst-ever loss: £401m, £331m of which was chalked up in the first three months of 2009. The airline was getting through £2.7m a day in February and had cash reserves of less than £1.4 billion at the end of March.

Usually, about 65% of BA's profits come from its routes across the North Atlantic, most of it from passengers paying a £4,000 business-class fare to New York. So far this year, BA's premium traffic is down by about 17%—hardly surprising when much of it used to come from deal-chasing bankers. Mr Walsh is right to be fearful, particularly if unions balk at his plans to cut 3,500 jobs and opt to launch a summer of strikes.

IATA's Mr Pearce sees some signs of recovery in Asia. But he expects only a long, hard grind for airlines in Europe and America. European regional airlines, squeezed on one side by low-cost rivals like easyJet and Ryanair and on the other by the big network operators, such as Air France-KLM and Lufthansa, are especially vulnerable. Although overstretched by the acquisition of BMI and two smaller airlines, Lufthansa is strong enough to weather the storm better than most. But not as well as Sir Michael, who realised some time ago that the best way of making money from the airline industry was to leave it.

Capt Shekhar Gupta
CEO
Asiatic International Aviation Corp.
Mission To Canada
# 108 AMBIKAPURI EXTN,
AIRPORT ROAD,INDORE 452005,
Madhya Pradesh, INDIA
www.MissionToCanada.co.in
shekhar@missiontocanada.co.in

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