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Delta’s Virgin Atlantic 49% purchase prises open the valuable London Heathrow hub - for SkyTeam?

12-Dec-2012

Delta’s purchase of Singapore Airlines’ 49% share in Virgin Atlantic for USD360 million continues the massive US airline’s international expansion and opens up a major front in the battle for Heathrow’s valuable traffic flows. For Virgin, it once again means the airline has been saved from decline and even oblivion. The previous saviour, Singapore Airlines, paid almost three times as much, but had no prospect of leveraging the deal in the way Delta potentially may.

Almost since the day it acquired the stake for GBP600 million, Singapore Airlines has been trying to sell out of its barren partnership with Sir Richard Branson’s Virgin Group. It has been a long and painful – not to mention embarrassing – saga. SIA has long since stopped trying to leverage its relationship.

Delta meanwhile is in global expansion mode, growing organically at home and investing in Gol and Aeromexico over the past year, as it sees a window of opportunity in the evolution of world aviation. The mega-airline is also expanding through metal neutral agreements on the Atlantic and the Pacific. This is a time when seemingly anything is now possible, where Air France can combine with one of the despised Gulf airlines, Qatar Airways can join oneworld and Emirates can team up with arch rival Qantas.

Delta is making a play to be one of the first movers.

The next step is for Air France-KLM to link into the deal and perhaps bring Virgin into SkyTeam. That will not be quite as simple as it sounds.

The Delta-Virgin Atlantic joint announcement stresses the proposed metal neutral joint venture across the Atlantic and the combined 31 joint services between the US and London, with nine of those between London Heathrow and New York’s JFK and Newark airports.

But, apart from providing a lifesaver for a floundering Virgin Atlantic, a central issue for Delta – and perhaps for its SkyTeam Alliance – is gaining a major alternative European foothold in one of the world’s most valuable premium markets, Heathrow. However difficult partnering with the Virgin Group may be, Delta has both size and timing on its side and, although Sir Richard Branson has stressed that Virgin will still make all its own decisions, Delta will undoubtedly have ring-fenced a number of key options to preserve the value of its investment.

Who wins, who loses? Virgin Atlantic is the biggest winner by a country mile, at least in the short term

Poised on the edge of a difficult environment, spurned by Star Alliance, an impossible member of oneworld, apparently not a candidate for investment by one of the Gulf carriers, bereft of short-haul connectivity, moving into financial red ink with a shaky outlook, the outlook was not good for Virgin Atlantic.

Fortunately, Delta’s interests happened to coincide at the right moment. Not everybody’s idea of the perfect partner, Sir Richard’s team has again pulled the airline back from the brink, almost as he did (in much more tortured times) when he sold down to SIA.

Now Virgin’s future is more or less underwritten, partnered with the world’s biggest airline and in a position to issue more than rhetoric in conversations with near neighbour Willie Walsh.

Delta also wins

The mega-airline cements a partnership which gives improved access to Heathrow and the valuable business flows between New York and London. It prevents someone else from moving on Virgin and creating a competitor – perhaps the reason that Delta decided to spend a few hundred million on an insurance policy, rather than merely seeking a metal neutral codeshare without making the equity investment.

Equally – and this is not necessarily something that anyone will be talking about publicly – it gives Delta a foothold in Europe that leaves it less reliant on a deeply troubled Air France to deliver its feed.

It also gives Delta two major hubs in Europe. While Delta has for some time been the largest carrier between the US and Europe (although it has seen its market share drop in recent years as service to several secondary markets have been discontinued), it is only the fifth largest carrier in the US-UK market. According to Innovata data, Delta currently accounts for only 8% of seat capacity in the US-UK market, putting it behind American (14%), United (16%), Virgin Atlantic (21%) and British Airways (37%).

United States to United Kingdom capacity by carrier (seats per week, one-way): 19-Sep-2011 to 02-Jun-2013

As a late arrival on the scene, Delta was also the poor cousin among the US majors at Heathrow and this will help restore some balance. Delta currently operates only 56 weekly frequencies from Heathrow compared to 110 for United and 105 for American, according to Innovata data. Virgin Atlantic operates 150 weekly frequencies from Heathrow, including over 90 to the US. 

It’s just a pity for Delta that the idea had not occurred last year towards helping Virgin with a handful of millions to outbid BA for the bmi purchase, something that would have delivered a swag of Heathrow slots and regional connections.

SkyTeam should be a winner?

The next move should be for Virgin to enter the SkyTeam Alliance.

Sir Richard has made warm noises in this direction recently as other options faded. There is almost certainly very substantial upside in membership. However, his negotiating position is, paradoxically, made much stronger now that he has The Force on his side.

And, not renowned for his generosity, Sir Richard’s style does not have a great deal in common with the Gallic temperament.

Virgin would allow SkyTeam to nearly double its share of seat capacity at London Heathrow to 12%, according to CAPA and Innovata data. But SkyTeam would still remain the smallest alliance at Heathrow. oneworld members currently account for over half of all seat capacity at Heathrow and Star carriers account for about a 20% share while SkyTeam accounts for less than 7%.

London Heathrow capacity share (% of seats) by alliance: 10-Dec-2012 to 16-Dec-2012

It is hardly a coincidence that Star, the same day the Delta-Virgin tie-up was announced, unveiled plans to co-locate at Heathrow. The 23 Star carriers that serve Heathrow, including SIA, will move to Heathrow's new Terminal 2 in phases starting in 2014.

SkyTeam carriers have already been co-located at Heathrow's Terminal 4 since Oct-2009. (Virgin Atlantic uses Terminal 3). While it is the smallest alliance in the key UK market, SkyTeam carriers have always made an effort to work closely at Heathrow. Air France, for example, recently made available some of its excess Heathrow slots to Aeromexico, allowing the Mexican carrier to launch service to the airport.

Air France watches hopefully, but with some understandable concerns

Although the deal is in the family and Air France and Delta maintain a strong relationship backed by mutual interest, the French flag carrier is in the midst of a painful transition that should cause any partner to want to have options. If the French icon does not achieve the restructuring (ie cutbacks) it needs over the coming winter, its future looks increasingly bleak.

See related article: Air France-KLM restructuring to continue as 3Q earnings fall sharply

It is inconceivable that Delta and Air France would have omitted to talk through the implications and possibilities of a Virgin purchase; undoubtedly it had also crossed the minds of Air France management to buy it themselves. However, spending several hundred million euros on a British airline would have been a red rag to the militant French unions when their membership is being asked to make sacrifices.

But now the deal is done, and will most likely be approved by all competition authorities involved, Air France is inevitably moved a little further from the central position in its SkyTeam constellation. There will be those in Paris headquarters today who feel a little bit more nervous about the future.

And, despite talk of Air France perhaps taking a minority share in Virgin to give SkyTeam members control, Sir Richard and his merry band were not born yesterday. Another 3% or so would be enough to swing the balance. But unless there is an unannounced parallel agreement that this be done at a reasonable price, a measly 3% would cost a great deal more than the 49% that Delta has just bought. And Air France simply does not have the political capital to be making a sizeable offshore investment right now.

Aer Lingus – a leprechaun pops into the frame

A day before the Delta-Virgin media announcement, the creative little Irish airline (perhaps not) coincidentally announced that it had reached a “preliminary agreement” to wet lease four of its A320s “to operate certain short-haul routes for Virgin” for an initial period of three years, beginning 31-Mar-2013. The aircraft, painted in Virgin livery, will connect Heathrow with Manchester, Edinburgh and Aberdeen.

Virgin Atlantic in Nov-2012 announced plans to launch Edinburgh and Aberdeen with wet-leased aircraft, after being awarded 12 Heathrow slots that BA was required to divest as part of its acquistion of bmi. Aer Lingus had also submitted a bid for the slots.

Virgin Atlantic first unveiled plans in Aug-2012 to launch London Heathrow-Manchester service starting 31-Mar-2013, using wet-leased aircraft. But the carrier did not initially reveal a source for the wet-leased aircraft.

See related article: Flybe pulls Gatwick to Aberdeen route, adding spark to the London-Scotland connectivity debate

The Delta arrangement with Virgin does limit Heathrow onward feed – at this stage – to domestic UK points. Virgin itself only operates long-haul routes, so Delta will be grateful for the opportunity to connect to these three points, which also occupy the bulk of British Airways’ domestic capacity. They also provide extensive feed for Delta’s US competitor American Airlines.

Aer Lingus is also the proud possessor of just over 5% of Heathrow’s peak slots according to Innovata data, far more than Virgin. The seeds of a wider partnership may be there for the former oneworld, but now non-aligned, Irish carrier.

(The deal gained a ringing endorsement from Aer Lingus’ arch rival and part owner, Ryanair; the LCC’s spokesman Stephen McNamara said “this latest wet lease deal with Virgin is yet another sign that Aer Lingus has no viable commercial strategy, a mismanaged and fading brand and no independent future.”)

This onward restriction is undoubtedly to soothe any concerns of conflict with Delta’s use of the Charles de Gaulle hub. But that does not prevent the potential for other options in future.

While almost 70% of Virgin's seat capacity is deployed to North America and the Caribbean, the carrier has been focusing on growing markets to the east. Virgin Atlantic now serves Dubai, Delhi, Mumbai, Hong Kong, Shanghai and Tokyo (with the Hong Kong service continuing to Sydney). Dubai, Delhi and Mumbai (the latter was recently launched) would be potential markets for the new Virgin-Delta joint venture if it was not for overlap in the joint venture with Air France-KLM.

Lufthansa was not a buyer but sees its position diluted

The Star Alliance leader famously tried and failed to gain a foothold at Heathrow through Lufthansa buying bmi and its slots. But that deal fell through as the inter-airline synergies were not sufficient to cover the British regional carrier’s financial haemorrhaging.

Instead the German flag carrier sold out to the highest bidder, British Airways, while Virgin could not match the bigger carrier’s bid. Star had already decided that buying Virgin would only cannibalise the services of Lufthansa and United, so, despite possible benefits to lesser Star members, there was no deal to be done.

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Nonetheless anything that strengthens the hand of its opposition, especially where none of the European flags has been able to establish a foothold at the others’ hubs, is a negative.

Lufthansa is arguably now the only European leader which does not have a senior growth partner. IAG/BA has Qatar, Air France is with Etihad; the German major has indicated closer links with Turkish, which, although it is a powerful and expansive operation, may not be enough to solve a growing list of challenges.

See related article: Turkish Airlines tie-up could give Lufthansa the solution it needs as profits continue to fall

Singapore Airlines is quietly putting a brave face on the deal

 – along with a resounding sigh of relief for escaping at last from its long ordeal.

Despite paying more than GBP600 for the share in the 1990s and recouping a bit over a third of that amount from the sale, it had written down the value to such an extent that it will now book a profit from the sale. Its original purchase justification, to gain access from London to the US via the Atlantic, soon disappeared once those rights became directly available to SIA.

Since then the investment has never delivered one penny in dividends. Early rumours of a secret deal for the Singapore carrier to gain de facto control for its investment was abruptly scuppered by the majority owner, leaving SIA with a minority share that had neither strategic nor financial value.

At last that nightmare is ended. Today SIA is investing – with a much more strategically likely outcome – in another Branson partnership, Virgin Australia. At least Virgin Group has only a minority share there; still uncomfortable bedfellows, but not taking up the central part.

For SIA, focusing on investments in the Asia-Pacific region, starting with Virgin Australia, is more logical. SIA has a limited presence on the trans-Atlantic and no longer has an interest in the UK-US market. SIA is more interested in cementing its position in Asia through potential new investments, particularly in China.

In a statement announcing the sale of its 49% stake in Virgin Atlantic, SIA pointed out it "had been evaluating strategic options for the stake for some time, as the investment has not performed to expectations and the synergies the parties originally hoped for have not materialised". It added that "commercial arrangements between Singapore Airlines and Virgin Atlantic, encompassing codesharing, frequent-flyer programme ties and reciprocal lounge access, are expected to remain in place after the divestment".

SIA uses Virgin Atlantic to access markets in the US it does not serve, such as Boston and Washington Dulles. Having feed beyond London, where it now has four daily flights including three with A380s, to US markets still provides some value to SIA. But it's not strategic and does not warrant investment or even a joint venture. Should Virgin Atlantic under Delta ownership be compelled to drop the rather limited tie-up with SIA, the latter should be able to easily find alternatives for offline access to the affected North American markets. 

British Airways, undoubtedly the biggest loser, but remains dominant

Given its highly privileged position at Heathrow, as well as on the key trans-Atlantic routes to New York and Boston, BA was always going to have to suffer some downside once Virgin found a partner. It will still retain substantially better positions than a combined Delta-Virgin in each of these places (something that will make anti-trust approvals easier), but will immediately feel dilution. The addition of domestic feeder services to Virgin’s offering will cause further inroads.

The Delta-Virgin combination is still much smaller than BA/American’s share in the US-UK market of over 50%, but the accent on an improved London-New York offering will undoubtedly hurt BA’s premium market there.

The IAG team is being dragged down at present by the weak Spanish market and the resulting poor performance of Iberia. This further competitive attack comes at an unwelcome moment.

Delta-Virgin Atlantic deal: the key points

According to the joint announcement, the key points of the agreement are that it entails:

  • A fully integrated joint venture that will operate on a “metal neutral” basis with both airlines sharing the costs and revenues from all joint venture flights;
  • A combined trans-Atlantic network between the United Kingdom and North America with 31 peak-day round-trip flights;
  • Enhanced benefits for customers including cooperation on services between New York and London, with a combined total of nine daily round-trip flights from London Heathrow to John F. Kennedy International Airport and Newark Liberty International Airport;
  • Reciprocal frequent flyer benefits;
  • Shared access to Delta Sky Club and Virgin Atlantic Clubhouse airport lounges for elite passengers.

Indications are that the UK, EU and US DoT competition approvals will be forthcoming. The partners expect that all of the pieces will be in place by the end of 2013. SIA expects the transaction with Delta to close in 4Q2013.

Delta’s Virgin Atlantic purchase delivers an alternative European hub at London Heathrow

Delta, like most of the US majors, still retains its historic fixation with the North Atlantic. This is understandable, especially as managements have striven for so long to gain a strong foothold in London’s leading airport.

Of all the major hubs none is more valuable than London’s Heathrow, even though British Airways does not quite have the same stranglehold on its base as Lufthansa and Air France have at home.

Lufthansa currently holds 55% of the peak hour slots at Frankfurt and 73% of peak hour slots at its secondary German hub, Munich.

Frankfurt Airport share of aircraft movements by carrier during peak hour: 03-Dec-2012 to 09-Dec-2012

Air France-KLM at the Paris Charles de Gaulle hub holds almost two-thirds of slots during peak periods.

Paris Charles de Gaulle Airport share of aircraft movements by carrier during peak hour: 03-Dec-2012 to 09-Dec-2012

British Airways has a still-healthy 55% of peak hour slots at London Heathrow, but its strength is apparent from its premium seating profile, with 13% of all seats (not including premium economy). This is double the world average.

Charles de Gaulle premium seating accounts for 7.7% of the total, although Frankfurt is a stronger 11.3%.

London Heathrow Airport share of seats by class: 03-Dec-2012 to 09-Dec-2012

London Heathrow share of aircraft movements by carrier during peak hour: 03-Dec-2012 to 09-Dec-2012

Lufthansa’s failed invasion of Heathrow with bmi

None of the big three European airlines has yet managed to establish a substantial foothold in a competitors’ home hub. And one major assault on Heathrow has already been rebuffed.

As noted above, Lufthansa made a bid to make London its offshore home when it acquired the right to buy bmi and its extensive slot portfolio; unfortunately as it turned out it also acquired the subsequent obligation – in the form of a put option – to buy the airline at a by-then greatly inflated price.

Lufthansa had already bought SAS’ 20% share in 1999, as SAS began its long saga of fire sales to generate cash flow. The sale brought with it a commitment for bmi to join the Star Alliance.

The canny half owner of bmi, Sir Michael Bishop’s timing in selling his 50% share was immaculate, as the airline’s fortunes declined rapidly once his deal with the German flag carrier was concluded in 2008.

Although it operated a useful variety of short-haul services in Europe and North Africa, the British airline was scarcely likely to become a valuable acquisition in its own right; but it possessed the rare asset of around 17% of Heathrow’s scarce slots. These were the times for “strategic” acquisitions as the new world began to emerge and the big guns lined up. However as the financial crisis closed in and bmi’s losses accelerated, reality replaced strategy and Lufthansa hurriedly sought a way out.

Its short and failed attempt to stem bmi’s haemorrhaging provoked a fire sale in which there were only ever two serious airline buyers: British Airways and Virgin Atlantic. BA outbid Virgin’s GBP50 million bid by a factor of 100% and Lufthansa was only too keen to exit, licking its wounds. Perhaps surprisingly, Virgin’s appeal to regulators that this arrangement would entrench its bigger rival’s power at Heathrow was rejected; they considered that there were other, bigger, competitive forces at play.

Virgin was increasingly in need of an ally – or two. But will need to be a whole lot more reasonable than in the past

The bmi sale to British Airways was also painful to the purely long-haul Virgin because it deprived it of a neutral partner to deliver it short-haul feed. Part of the approval conditioning required BA to provide substitute short-haul access, but it is less than an ideal situation to be relying on your major competitor to carry your passengers (and in doing so to learn all about them).

See related article: Fiercely independent Virgin Atlantic struggles to attain profitability

The Delta deal will be great cause for celebration at Virgin Group. The airline is not out of the woods just yet, but it could hardly have hoped for a more satisfactory saviour.


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