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British Airways/IAG with bmi looks to re-establish world leadership – and long term survival

IAG Group CEO, Willie Walsh
IAG Group CEO, Willie Walsh

It can be a fine line between survival and success, just as the blowtorch of a threatened existence provides a powerful motive to pursue ambitious goals.

Last month’s International Airlines Group (IAG)/British Airways move on bmi is only one more piece in the strategic kaleidoscope opening out in front of the Group Chairman, Willie Walsh. The world is his oyster at present. Answering a question following the bmi purchase announcement, Mr Walsh said that despite the uncertain economic environment that Europe’s politicians have created, this was a time of opportunity. His airline is well placed now to capitalise and, as bad news for others spells bargains in the marketplace, the time could well be ripe. In the process, London Heathrow Airport is firmly in the spotlight as Virgin Atlantic also remains a sale possibility. Yet for BA and all of its major rivals, the elephant in the room remains how to service shorthaul network connections profitably.

The “opportunity” for British Airways is not a modest one; it is to establish the carrier and Iberia as the world’s leading airline group. From British Airways’ precarious position just two years ago, as union pressures to preserve the status quo threatened to shut the airline down, the now-merged carrier is once again poised for greatness. 2012 will be a defining year for IAG.

It will not be a simple mission. For one thing, neither Spain’s nor the UK’s pilot unions is easily convinced about any new strategy that might threaten the status quo. And it is formidably easy to make mistakes in the minefield of cross-border minority equity investments. Airline history is littered with examples of failed attempts. It is not so long since British Airways invested, in Jan-1993, USD300 million in US Air as part of a partnership deal; that ended in tears and in court. Mr Walsh just has to look over the fence into Virgin Atlantic, where Singapore Airlines has had over a decade to rue its equity “investment” in the Virgin stable.

Times are changing however. And British Airways, as part of the new entity of International Airlines Group, IAG, is sufficiently well positioned to be able to influence the way that change occurs.

The immediate driver is the purchase of bmi, whose 56 daily slot pairs at London Heathrow will increase IAG’s share by 8.5ppt to 56%. IAG has so far laid a clear-cut two phase plan to integrate bmi. The first phase calls for the existing bmi operation to reach break-even in the medium-term via relatively minor network and aircraft changes before the more extensive and long-term phase of using the bmi slots for long-haul services.

The machinations of IAG's broad strategy highlight two other possibilities, each real and with potential strategic significance: one shorthaul, the other longhaul.

(1) The short-haul strategy

British Airways/IAG needs a lower cost short-haul operation

One priority for British Airways is the need to secure its shorthaul future in Europe. This is essential to long-term network success. The three major European groups (Air France-KLM, IAG and Lufthansa) are living on borrowed time, operating mostly loss making short haul spokes, competing on those routes with very low cost point-to-point operators like Ryanair and easyJet.

“On the short and medium haul the big challenge we have is just that it isn’t profitable,” Rafael Sanchez-Lozano, CEO of BA sister carrier Iberia recently remarked, echoing sentiments from other carriers. “The industry has transformed in Europe on how short haul is flied and we need to adjust and do a complete change to what we do.”

The major European carriers have a high short haul cost base, and the aggregated CASKs below are flattering to the big three as they do not separate out the much lower per ASK unit cost of their longhaul flying.

Selected European Carriers' RASK and CASK: Quarter ended 30-Sep-2011

Although IAG does have a lower base than Air France-KLM and Lufthansa, it is still well above the independents and unable to extract sufficiently higher yields to counteract the cost differentials.

Lufthansa’s CASK is nearly 20% higher than airberlin’s and, despite a powerful position in the large and high yielding German domestic market, operates only on the slenderest of margins. Air France’s desperate cost position is flattered by being measured along with KLM’s lower CASK and, although able to command higher yields than its competitors, is heading rapidly towards a most-unwanted crunch time for its shorthaul services – something its decentralisation strategy will do little to help. IAG meanwhile enjoys the best margin and the lowest CASK, but it still has a long way to go to be competitive with the aggressive easyJet and Ryanair which compete in so many of its markets.

bmi does not offer anything like a full solution to BA’s needs in this respect and the lower-cost bmi baby is expressly not part of the purchase package. Here Mr Walsh will be walking on eggshells with his unsympathetic pilots unions, anxious to ensure that any future growth will use their members at their higher pay scales. Although the British pilots’ union, BALPA, has been slow to comment formally on the bmi purchase, its principal negotiator John Moore has added his voice in Spanish media to those of the Spanish pilots' union, Sepla, likening the bmi threat to Iberia’s proposed use of a new low cost subsidiary, Iberia Express – over which the Spanish pilots are planning a series of strikes.

The UK’s Unite union group, which covers flight attendants and others, has however been explicit: "We will be looking to meet with IAG in the immediate future to press for guarantees on jobs and terms." But there must surely be job cuts, adding to the already sensitive airline industrial scene in the region.

Any new IAG lower cost operation – inevitable in one form or another in due course – would therefore eat up at least some of the bmi slots, even if they are merely kept warm with other operations for the time being. Iberia’s part-owned hybrid, Vueling, offers part of the answer for IAG, but there is a lot of tactical manoeuvring to be done in the coming year to get the group where it needs to be.

Cost restructuring underway elsewhere in Europe

Part of the problem is that the trend of the past decade has been to reduce intra-European service, both in terms of routes and frequencies, diminishing the value of the network offering. Between 2007 and 2011 Iberia, for example, decreased its short- and medium-haul available seat-kilometres by 30%.

A European hub carrier cannot survive with progressively diminishing short haul spokes, especially when long-haul capacity is increased (which Iberia did, by 15% in the same period). Unlike the hubs of Gulf airlines, Europe does not possess the geographic centrality to allow reliance on longhaul-to-longhaul connections, although European carriers including the IAG group are tapping into America-Asia connections. IAG is also keen to develop Asia-Latin America connections when the time is right, but European hubs compared to Gulf hubs have not only a labour disadvantage but a tax disadvantage, especially in the UK with the ever-increasing Air Passenger Duty. So British Airways must be able to offer good connections within Europe, both for its own services and to cater to its partners’.

(Virgin Atlantic is the exception, operating only longhaul, which is underpinned by Heathrow’s high yield US profile, with half of its total capacity dedicated to that market. But even then, Virgin has partially relied on bmi codeshares to provide intra-Europe connections, making that loss to arch-rival British Airways even more painful.)

Fundamental restructuring of intra-European costs and service arrangements, like partnerships, is a priority that must be resolved within the next two years, and is already on the agenda elsewhere in Europe. Iberia later this year plans to launch Iberia Express, having recognised that its shrinking short-haul network was unsustainable; at its Madrid hub, 70% of passengers are connecting. “There is a need for short-haul. We cannot just cut it as we have done in the past,” Mr Sanchez-Lozano said. The challenges today are greater: network feed is coming from more start and end points than before. “It is not that we can get four or five routes…We need to fly to quite a few places. So that is why we thought there is no way to escape that. We need a short-haul model.”

There is also continued restructuring at SAS to regain lost passengers to LCC Norwegian Air Shuttle, and Lufthansa plans to make its first major inroads in Berlin, which it previously left to lower-cost competitor airberlin.

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Prior to this current wave of restructuring was the merger of historically loss-making Alitalia with Air One into the “new” Aliatalia, which briefly posted profits until oil wreaked global havoc on balance sheets. The vestiges of Air One serve as Alitalia’s lower cost subsidiary, a hybrid operation with some free perks.

Addressing the festering wound of shorthaul networks is what is needed, and will be aggravated by a slowdown in European growth. Carriers recognise the cross subsidy from less competitive longhaul routes is not a sustainable strategy.

Preventing further access to foreign longhaul operators like the Gulf carriers is helpful, and Germany is pursuing that path, but it is no more than a temporary bandage. Although Emirates made no remarks about why it selected the Berlin airshow in 2010 to announce in the presence of the Chancellor an order for 32 A380s, the hint was that Emirates could contribute to Germany’s aerospace economy only if Emirates had destinations to fly the aircraft to. Etihad, a competitor to Emirates but still one of the menacing Gulf carriers in the eyes of Europe’s legacies, is now shifting the balance of aviation and attempts of protectionism with its increased stake in airberlin.

See related article:  Etihad moves on Air Berlin and the world’s aviation axis shifts. What will Willie do next?

Fending off the Gulf network carriers is also merely a bandage on a bigger and growing problem, for example as Europe is invaded by Chinese airlines too.

Unlike Air France-KLM and Lufthansa, British Airways has a notable foreign exchange advantage in that it has two large short-haul markets on different currencies: its domestic market in British sterling, and most of Europe on the euro. That can influence the balance of O&D Heathrow traffic versus traffic connecting from elsewhere in Europe. When the Euro strengthens, BA’s connecting fares become more competitive in the Eurozone and can be greater promoted over O&D fares, as BA did in 2009. “The switch into what would normally have been perceived to be a weaker yield market was a positive development for the group,” Mr Walsh recently remarked. But absent long-term forex shifts, capacity must be planned ahead of currency fluctuations, requiring BA to maintain a short-haul network and focus on improving profitability, especially during the inevitable down cycle.

British Airways needs a base in continental Europe as well

Japan Airlines, a vital oneworld partner of British Airways in Asia, has floated the idea of entrenching its longstanding and very valuable bilateral partnership with Air France to secure better access to the continental European market. This highlights BA’s current disadvantage as a hub partner in accessing many of the popular markets. At present all roads lead to and through congested and often unattractive Heathrow.

It is the highest value hub of all, but it doesn’t give direct access to Europe for travellers coming from the east, something that is exploited by alliance members. oneworld partner Finnair for example promotes its speedy access from Asia to Europe while most airlines overfly Helsinki en route, then backhaul their passengers into Europe, as Qantas does.

The Australian carrier has been heavily criticised at home for only serving two points in Europe: Heathrow, which creates that circuitous routing when making onward connections, and Frankfurt, where Qantas lacks adequate onward feed. Still, the carrier is resolute that the benefits of its joint-service agreement with BA outweigh the losses, which Emirates happily takes up. Emirates reports 86% of its Australian-European traffic – just over one million annual passengers in 2010 – was to points other than Heathrow and Frankfurt. That traffic represents lost opportunity for BA, too.

Madrid offers something of a counterpoint, but its southern position and Iberia’s weak links to Asia do not offer a solution for that large growth market, nor to Africa. A possible purchase of TAP when the airline is privatised offers a strengthened presence in Latin America and Africa – but is not a European solution either.

So British Airways has a readily exploitable weakness where both of its biggest competitors are well provided: Lufthansa through its various hubs and satellites and Air France, with plenty of capacity at its hub and a strong joint operation with KLM, which dominates Amsterdam.

Soon to be oneworld member airberlin is a strong candidate to support BA’s continental presence, but Etihad, by raising its holding in the German hybrid airline to 29%, also raises some question marks. This has been widely seen as shutting BA out of an airberlin option, but things are probably not as clear-cut as they seem.

So ruling an airberlin solution out, just as its home base blossoms into a substantial hub, with the opening Berlin’s new Brandenburg Airport in mid-2012, is clearly premature.

The potential for some arrangement between IAG and a Gulf carrier remains a real prospect and Etihad is almost certainly an interested player in that respect. Qatar Airways too offers a formidable option for IAG. All concerned recognise what a massive upheaval to global aviation such a partnership would deliver; such a combination would be well en route to becoming the most powerful grouping in the world. But finding the right balance of power in any such deal is a challenge.

There are also many small, ailing nationally owned flag carriers in eastern Europe looking for a buyer. Although they come burdened with issues, an IAG presence would strengthen it against Lufthansa’s strong presence there. But that would be a solution for eastern Europe and CIS, not east Asia. Other than establishing its own subsidiary on mainland Europe, BA has an issue – and one that must be resolved soon. Organic expansion in well-defended territory is unlikely. The airline needs a northwestern European partner (or two), with low costs and useful hubs.

(2) The long-haul strategy

British Airways will be buying/partnering with long-haul airlines

It is widely assumed that the value to be extracted from bmi’s slots is enhanced if longhaul, widebody aircraft replace bmi’s short haul usage. This is broadly true and helped BA place a higher value on bmi than Virgin was able to (although strategic values of enhanced shorthaul feeder operations cannot be underestimated either). There is plenty of scope for longhaul partnering in a declining market, with lots of opportunities for Mr Walsh to find bargains.

Over the past year the IAG Chairman has been expansive in his list of potential airline partnerships and equity purchases. From specific suggestions of a Japan Airlines investment, an “Indian airline” (the Indian government only now seems to moving towards allowing up to 49% foreign ownership of its airlines), to Gulf carriers and, potentially other Asian airlines, the shopping list is extensive. By spreading the word widely – and having more to offer than merely an investment – Mr Walsh is creating a buyer’s market at a time when buyers are few. That is not to discount AF-KLM and Lufthansa being forced into action, or quiet interest emerging from Gulf carriers or even Turkish Airlines. It is only a matter of time before IAG moves to expand again and 2012 will see IAG move to become a global force again. Indeed, after Mr Walsh addressed a number of questions about the bmi acquisition, he was asked about interest in buying TAP. His response was that a purchase would depend on TAP’s privatisation process, effectively placing the matter in the hands of the Portuguese government.

Asia is British Airways’ biggest global priority

The biggest gap in British Airways’ network coverage is in the market with the biggest potential: Asia. Although India faces government inertia for airlines to achieve closer foreigner partnerships or equity stakes, Mr Walsh recently downplayed an urgency to make a move, pointing to the five Indian cities BA serves directly from Heathrow, with potential to open new points if demand warrants. “We don’t need a strong alliance partner in the Indian domestic market because we have high seat factors on our Heathrow-India flights anyway. We see Kingfisher strengthening oneworld within India. It is nice from a BA point of view to have a partner in India, but it was more a oneworld issue than an IAG or BA issue.”

The big yawning hole, or at least one of them, is in China. To be absent from the Middle Kingdom, redolent with opportunity, is not acceptable. Aside from the recovering, but downsized post-bankruptcy JAL (complete with its Air France allegiance), representing the oneworld team is an ambivalent Cathay Pacific and aggressive Finnair, which is now turning to secondary Chinese cities. But they do not offer the same opportunity as a mainland carrier.

Although SkyTeam lacks a Japanese member since All Nippon Airways is firmly Star-aligned, it does have reprieve in Delta’s fifth-freedom intra-Asia network from Tokyo Narita that Delta inherited from merger partner Northwest Airlines. Although it is a limited network with respect to destinations and frequency, it covers the basics.

Elsewhere in Northeast Asia, SkyTeam has done well, outpacing Star for market share. SkyTeam has Korean Air and prized access to the mainland Chinese domestic market via members China Eastern/Shanghai Airlines and China Southern Airlines, and member-elect Xiamen Airlines. The Air France-KLM/Delta team also has Taiwan’s China Airlines and Vietnam Airlines.

The only other “government” airline, Air China, is firmly in Star, leaving one or more of the Chinese independents as candidates. Hainan has a lot to offer, but new airlines are spreading their international wings too. BA badly needs a friend in China, and the carrier has not shied away from that acknowledgement. “The absence of a Chinese domestic carrier in oneworld is probably the only real weakness that I would see in the oneworld alliance today,” Mr Walsh remarked in Nov-2011 at the carrier’s Capital Markets Day. “I have been to China several times in the last year, visiting a number of different Chinese carriers. We remain confident that we can get domestic partners in China for the benefit of oneworld.” But a holistic oneworld benefit will negate Cathay Pacific, whose possible opposition to a mainland carrier joining could cause a riff. China must be a priority for Mr Walsh, but he will need to consider ramifications, such as if Cathay would leave oneworld to join part-owner Air China in Star.

Southeast Asia also beckons, and was largely a gap until Malaysia Airlines in Jun-2011 announced its intention to join oneworld. The region is very much a Star stronghold, anchored by the massive Singapore Airlines and to a lesser extent Thai Airways. Not to be forgotten, although not a oneworld member, is Qantas’ Jetstar subsidiary in Singapore, and a smaller one in Vietnam. SkyTeam is making inroads, most recently through Garuda Indonesia (to join in Mar-2012), in one of the region’s more understated, but potentially massive single country markets. There, non-aligned Lion Air, with a massive order of more than 350 Boeing 737s, dominates the domestic market and has major aspirations for short-to-medium haul operations in the region. Its potential is almost unimaginable and its value to a future partner substantial. (Another airline in this category is India’s IndiGo, the only profitable carrier in that country, also sitting on a massive aircraft order, for 225 A320s)

More intimate ties to Malaysia Airlines give some insight into the agenda that Mr Walsh is seeking to address. After inviting the Malaysian flag carrier into oneworld, the prospect of an equity purchase loomed. Local LCC, AirAsia has bought 20% of its former Goliath-like opponent, again making for a potentially intriguing extended family.

AirAsia also has many attractions as a partner when it comes to gaining access internally within Asia, as it has bases in Thailand and Indonesia and, soon, the Philippines and Japan (the latter in partnership with ANA). It too has an astronomical order book, of over 280 A320s. It also has a longhaul low cost operation, AirAsia X. A disadvantage for British Airways in this mix is Virgin’s presence in the longhaul operation and AirAsia’s Tony Fernandes’ tight relationship with Virgin founder, Sir Richard Branson.

But, unlikely though this may sound, Malaysia Airlines could become a very useful sixth freedom partner into southeast Asia and the South Pacific, also helping deliver customers directly into and from Amsterdam, Frankfurt and Paris.

Long term partner Qantas has less to offer these days, at least in the low yield Australia-Europe market and despite the very helpful Joint Services Agreement, similar to metal neutral antitrust immunity. But the Australian flag carrier’s medium term value to British Airways and Iberia may prove to be an established network in Asia, as its Jetstar brand – and potentially a premium Qantas brand – spreads across the region. Mr Walsh said that although he sees it is “early days” in Asia, IAG’s growth opportunity will be to and from Asia and not intra-Asia, as Qantas is proposing to establish.

Middle East/Africa is a weak spot too for IAG and oneworld

Aside from BA’s minority investment in South African franchise Comair, IAG is relatively weak across the whole Middle East-Africa zone. Royal Jordanian carries the flag for oneworld in the Middle East, but SkyTeam and Star especially are much better positioned, especially in the small but burgeoning African resource-driven markets. bmi’s network does offer some support in these markets.

The high value/high growth Gulf region is not IAG territory either. The Saudi government has announced a quasi-open skies for domestic establishment, but despite possessing the largest domestic Middle East potential, Saudi Arabia’s still-conservative policies place a ceiling on expansion.

An Etihad (or Qatar) partnership in one form or another would provide considerable presence in each of these markets for IAG and each of those carriers is rapidly exploiting the growing links between Asia and the mines of Africa.

Eastern Europe/Central Asia is underdone and offers upside

There is only so much investment – in time and money – that IAG can expend, but even if a deal is in the offing with airberlin, the airlines are not well positioned to take advantage of the upside in the mineral rich areas to the east of western Europe, even though the German carrier does have access, albeit very limited. Also, the new Brandenburg Airport would lend itself well to expanding services to the east, including possible codeshare opportunities.

Mr Walsh has not ruled out the possibility of an investment in a low cost carrier (indeed, part of airberlin consists of the former dba, a locally established low cost cross border joint venture operation set up by British Airways as Deutsche BA in 1992. It had a chequered career and was eventually acquired by Air Berlin group in 2006). Several LCCs in the region could be of interest in an expansionist strategy, even in the turbulent Russian market.

See related article: Avianova bankruptcy spotlights instability in alluring emerging markets

The US market is well covered – assuming American Airlines emerges from Chapter 11 in healthy condition

British Airways has a strong position on the North Atlantic, with New York well covered in its own name and a very valuable metal neutral status with American Airlines. Although the once-largest airline finally succumbed to bankruptcy in late 2011, the perverse outcome of Chapter 11 provisions is for most others to suffer after the airline emerges with a lower cost structure and better equipped to fight. American has made clear that it will place high priority on its alliance relationships as it goes through this process, citing the great value it gains from oneworld – notably on the North Atlantic under the antitrust immunity regime – and, by implication, from its main partner, British Airways.

(The anti-trust benefits may be skewed with American’s passengers appreciating the alliance more than BA’s. BA commercial director Drew Crawley remarked the largest growth on BA trans-Atlantic flights is from American’s frequent flyers taking BA-coded and BA-operated flights, essentially bypassing American except to earn frequent flyer miles. The largest growth for AA, however, is from BA selling codeshares on American-operated flights, indicating BA customers are still making BA their first point of call to book flights. Explanations could be that American’s passengers are finally availing themselves of BA’s more extensive US destinations – before ATI they could not earn frequent flyer miles on BA’s US-UK flights – and/or they prefer BA’s service.)

BA should expect no serious threat from that angle, with little change expected, other than a downsizing - possibly substantial - of American’s domestic services as it grounds its geriatric fleet of MD80s and others. An opportunity may present itself if American wants to reduce North Atlantic routes, some of which are reportedly unprofitable. Rather than have American decrease capacity, BA could pull off, thus handing American its passengers while BA frees up a precious long-haul aircraft and Heathrow slot pairs.

An investment in American is unlikely too, in the context of the US airline unions’ nationalistic posturing, as it would appear to offer little to BA/IAG. American does however remain underdone on the US west coast, a regional market that might be attractive for investment.

Star Alliance-dominated Canada lacks a oneworld distributor behind British Airways’ gateways, but the country’s healthy domestic LCC, Westjet is moving towards being a more useful connection point for non-Star carriers. However, the slow growth Canadian market is unlikely to attract equity interest from across the ocean.

Latin America is likely to be very well served, assuming LATAM remains in oneworld

Oneworld is already particularly well positioned in the fast growing and profitable Latin American market. LAN is a dominant presence on the continent, a position that will only grow as the merger/acquisition with Brazil’s TAM is consummated. And LAN would not be keen to see IAG investing on its turf, unless perhaps it is on a joint basis. The high probability is that LATAM will remain in oneworld.

See related article: oneworld favoured with more at stake than Star in LAN-TAM alliance decision

Meanwhile, Iberia has a lucrative hold on Central America, oneworld partner American Airlines is the stronges south of the border, British Airways itself has a reasonably valuable system, and acquiring TAP – if that occurs - would complete a near-stranglehold on the Europe-Latin America market. But a TAP purchase would involve more short than longhaul services, and TAP’s big disadvantage is that its short sighted government failed many years ago to provide for expansion at Lisbon Airport.

Rationalising Gatwick operations may come into the reckoning

Back at home, the bmi acquisition must surely also provoke a more pressing need to rationalise British Airways’ London Gatwick strategies, potentially delivering some still-nascent valuable synergies. The operation was formed originally and largely around the former British Caledonian Airlines network bought by BA in 1988.  As the bmi fleet is progressively displaced by widebody aircraft using Heathrow slots, the potential to regroup a scaled down BA operation at Gatwick, with the more tourist oriented point-to-point services also using the lower cost facilities of that airport. This gives British Airways more options to servicing a varied market profile, somewhat similarly to germanwings’ role for Lufthansa.

For Lufthansa, a “significantly negative” outcome

Forced into the bmi purchase under the terms of a put option signed when times were different, Lufthansa has been an unenthusiastic owner of bmi and its offspring. The German flag is now left with a need to sell the regional and low cost units of bmi, both left out of this package, already bearing a heavy loss on the sale and, further, having to commit to taking on bmi’s pension scheme liabilities, as well as paying the high cost of bmi’s exit from the Star Alliance.

It is little wonder Lufthansa described the bmi saga as “significantly negative”. Whether the experience will whet the appetite to target the oneworld stronghold or deter it from any further attempts will become clear as 2012 progresses. The original interest in bmi was prompted by a belief that a Heathrow presence was essential. Now that British Airways/IAG’s position there is even more entrenched and this is a time for greater austerity, the prospect would have to appear more remote.

Virgin Atlantic now needs a partner more than ever, keeping Heathrow in the spotlight

At the same time as British Airways entrenches its position at Heathrow – arguably a positive for the airport and the UK industry – a successful future of Virgin Atlantic could also generate even greater value for the hub. The right partner/purchaser could deliver another valuable combination, ideally involving Star or SkyTeam. Virgin is unabashedly keen to join Star, but Lufthansa is still keeping mum on that.

Without the opportunity to leverage bmi’s slots, long a basic strategy for the carrier, Virgin Atlantic must be very much in sell-down mode. Sir Richard will continue to oppose the bmi sale to his larger competitor, but recognising that is unlikely to achieve anything of great value to Virgin. He has reiterated loudly and often that his predominantly North Atlantic long haul carrier needs a partner (or simply a buyer); the crystallisation of the BA-bmi acquisition makes that need even more poignant.

Virgin is now captive to its prickly and demanding posture in partner negotiations, making partial acquisition difficult for any would be buyer. The increasingly endangered British carrier is already 49% owned by Singapore Airlines, an arrangement almost as unwelcome today to that airline as bmi was to Lufthansa. But Virgin can be expected to extract as much as possible in concessions for the removal of SIA from its registry – effectively a pre-condition to another foreign airline buying in. With such a high level of foreign ownership already on its books, Virgin Atlantic offers little to any buyer, so SIA must presumably be cleared off the register before anything else happens.

SIA has made clear that it will happily sell its interest in an airline that has delivered little joy since a misjudged UKP600 million splurge bought it what it thought would be de facto control almost exactly 12 years ago. The “unique global partnership” which was to be created never materialised, at least not in the way SIA intended.

Virgin does not possess the Heathrow slots attraction of bmi, holding only a little under 3% of Heathrow’s total. Though these are not insignificant, their upside value, unlike bmi’s, is fully exploited in terms of use as longhaul operations, so leave little room for adding value. At 3%, they scarcely offer a basis for an airline to establish a new hub and there are only a limited number of airlines to which the slots would be useful. Etihad, for example, prior to last month’s cementing of a piece of the European marketplace with its well-timed (for all concerned) purchase of airberlin, expressed interest in Virgin. Despite remaining coy, Lufthansa continues to be linked romantically in the tabloids.

For the time being that is a story for another day, but the passage of time is unlikely to enhance the price of Virgin, so in the absence of a keen contest for the carrier, there is no rush to buy. The downside for the company appears greater than the upside as we enter 2012.

Meanwhile, stemming bmi’s red ink is not optional, but it will not be easy

Aside from the big picture strategy, IAG has to do something about bmi in the short-term. The airline currently operates some domestic routes, short haul, often niche, European services and routes to the Middle East, Central Asia and throughout Africa. It is haemorrhaging cash. In Lufthansa’s group accounts for the three months to 30-Sep-2011, bmi (including bmi baby and the regional operation), albeit in holding pattern, made an operating loss of EUR154 million; this was against a group net profit of EUR288 million. Understandably Lufthansa was keen to see it gone.

The bmi purchase will come directly from IAG funds. UKP60 million is to be paid in four instalments to Lufthansa prior to completion. By 2015, the operation should be adding EUR1.5 billion to group profits. As Mr Walsh told Bloomberg, “We believe we can turn this around within two years. It’s going to require some effort on our part and some investment on our part, but we’re confident that we have the skills and capability to do that.”

Loss reduction will not be possible without eventual downsizing of the bmi operation. That much is clear, at least to management. Undoubtedly, in a climate of contraction at home, British unions, especially pilots, can nonetheless be expected to oppose most measures. There does not appear to be a great deal of additional value to IAG in bmi’s operation, except perhaps in northern Africa and the eastern fringes of Europe. If Lufthansa cannot find a buyer for bmi baby before 31-Mar-2012, IAG will take custody of that negative asset as well. A hefty reduction in the agreed sale price would be some compensation, but it would also create more headaches.

Mr Walsh’s goal will be to achieve the maximum cost reduction, with the minimum damage to industrial relations and impact on the existing services. IAG does not need a strike at this stage, let alone a coordinated attack on the whole concept of introducing a means of providing lower cost shorthaul feed for the group. One carrot should be the prospect of actual expansion of the IAG group as it becomes a bigger world force, with greater opportunities for staff. That in turn will depend to some extent on the nature of the new acquisitions and partnerships upon which IAG embarks in 2012.

2012 now becomes the defining year for IAG’s long term future, as opportunities abound

However this intriguing story evolves, 2012 will be the defining year for IAG/BA/Iberia’s long term fortunes.

That is a steep challenge, but as the ever-optimistic Mr Walsh sees it, opportunities abound. He could be right. He has perhaps the greatest chance in commercial aviation’s short history to create a major global force for the long term. There are plenty of potholes along the way, but he might just have the momentum to ride them.

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