Merger Market
* JVs with Chinese partners seen as priority
* JV with European low-cost airline may attract merger partners
* Stake sale to Gulf airline would only bring cash to the table
Air France-KLM [EPA:AF] could seek further JVs to combat mounting competitive pressure from low-cost European carriers and fast-growing Gulf airlines, two union sources and a lawyer and banker with knowledge of the company said.
AF-KLM is now focused on restructuring and is in ongoing negotiations with trade unions on labour costs. It will need to sort these issues out before considering any major M&A operation.
But, in order to cope with the fierce competition from Gulf companies in long haul flights and low-cost airlines in Europe, a JV with airlines offering access to an untapped local network outside Europe is an option, the lawyer and banker said.
The group is looking to strengthen existing JVs and develop new ones primarily in China and to a lesser extent India, the first union source said. A JV is a wonderful growth tool and AF-KLM will keep on strengthening ties with its Chinese partners, CEO Frederic Gagey told the French Parliament Assembly on 4 November.
In September, AF-KLM announced it strengthened its JV with China Southern Airlines through a new partnership (cargo domain agreement) between Air France KLM Martinair Cargo and China Southern Cargo.
Other Chinese airlines, China Eastern and Xiamen Airlines are already part of the SkyTeam alliance of which Air France-KLM is also a member. An alliance enables airlines to share one or several flights’ codeshare to facilitate passengers transfer in a given route but does not translate into costs or profits sharing, a lawyer with knowledge of the company explained.
AF-KLM is looking east but could also consider strengthening its position in North America and in Latin America through its JV with Delta Air Lines [NYSE:DAL], the first company source said. This JV covers routes between Canada, the US, Mexico and Europe and generated revenue of USD 13bn in 2014, according to the group’s website.
The Gulf airlines' success is based historically on the development of airport hubs serving passengers flying from Europe to Asia. So far, it does not have a competitive advantage in the Americas and Africa, the lawyer noted.
A second option would be to aim for a JV with a significant European low-cost airline and then attract the interest of worldwide airlines, both union sources said.
This was the route followed by Iberia, which merged its low-cost subsidiary Click Air with Spanish low-cost carrier Vueling in 2008. The significant network developed by the low-cost JV then attracted the interest of British Airways, which merged with Iberia to form IAG [LON:IAG] in 2011.
But, one obstacle to this is that AF KLM low-cost subsidiary Transavia had to stop its European development in 2014 as negotiations with the trade unions over pilots’ wages stalled, both union representatives pointed out. The issue attracted global media attention on 5 October when Air France’s HR director got his shirt ripped off during a works council meeting on restructuring and potential job cuts.
The union sources referred to the growth strategy of Easy Jet [LON:EZJ] as a model to follow for Transavia’s development. But, the longer the negotiations with trade unions last, the less attractive AF-KLM will be for an airline interested in a JV, the second union source argued.
Compared to its main listed peers Air France-KLM is the worst performer, mainly due to higher social costs and comparatively high pilots’ wages. It has a LTM net income margin of 0.7%, compared to 6.6% for IAG, 4.5% for Lufthansa [ETR:LHA] and 11.7% for Easy Jet, according to Dealreporter analytics.
It reported net losses of EUR 1.83bn for FY13 and net losses of EUR 198m in FY14. Despite losses of EUR 158m in 9M15, LTM (last twelve months) net income was positive as of 3Q15 at EUR 177m due to a strong performance in 4Q14.
As of 30 September, cash in hand amounted to EUR 3.2bn with a net debt of EUR 4.33bn, giving the company an adjusted net debt to EBITDAR leverage of 3.4x.
Should the group want to finance a small acquisition or invest in upgrading its services, it can sell some of its shares in Spanish travel information technology company Amadeus IT Holding [BME:AMS].
The French airline still has 9.9m shares in Amadeus. The shares were entered into a hedging agreement on 25 November but no details of the transaction have been provided. In January, AF-KLM sold 9,857,202 Amadeus shares for EUR 327m. On 9 December Amadeus shares were trading at EUR 37.77.
Potential tie-up with Gulf airlines seen as unbalanced
But, should AF-KLM not manage to swing into profitability in two to three years time, it may have to consider a strategic investor, probably from the Gulf, to survive, one analyst said.
UAE-based airline Etihad is seen as a potential bidder for a minority stake in Air France KLM but, unlike Chinese airlines, which would offer access to their fast growing domestic network and market, Gulf companies would only bring money to the table.
A JV between AF-KLM and a Gulf airline would not be balanced, the union sources and lawyer said. The Gulf airline would benefit from AF-KLM’s dense European network but AF-KLM would not find much upside in the Gulf routes network, they argued.
There will be neither a stake sale nor a sale to Ethiad, deputy CEO Pierre-Olivier Bandet told Mergermarket on the sidelines of the French Parliament hearing.
According to EU competition law on foreign ownership, non-EU investors cannot hold more than 49% in a European airline and control of the company must remain within the EU. Furthermore, the French state has a 19% stake in Air France KLM and would be able to block the entry of potential bidders due to the new double voting law, the first union source said.
From 2016, the Florange law will automatically give double voting rights in French listed companies to long-term shareholders (more than two years) unless two-thirds of shareholders vote against implementing the law.
AF-KLM market cap (circa EUR 2bn) is low compared to its two main European competitors, Lufthansa (circa EUR 6.5bn) and IAG (circa EUR 16bn). So, size would not be an issue for a Gulf company willing to acquire a 49% stake, the first union source said.
Qatar Airways acquired a 10% stake in IAG for around EUR 2bn. This amount would have been sufficient to buy AF-KLM, he pointed out.
But, the union sources see the Dutch government seeking greater influence in AF-KLM as a more likely scenario. AF-KLM is the Netherlands’ first employer.
According to previous Dutch press reports citing Dutch Finance minister Jereon Dijsselbloem, the Dutch government is willing to take an equity interest in AF-KLM, if this proves necessary to implement the planned reorganization of the airline.
The Dutch government, which holds no shares in AF-KLM, has a 6% stake in KLM and 50% of the voting rights. The Dutch state, which upgraded its interest in KLM to strategic in October, could convert this interest into a majority holding of 50.1% in KLM NV in certain circumstances.
KLM NV is a subsidiary of AF-KLM and is run independently and headquartered in Amsterdam.
AF-KLM’s shares were trading at EUR 6.64 on Thursday morning, giving it a market capitalisation of EUR 1.95bn.