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Stelios goes, easyJet grows. What is uneasyJet’s best strategy? What would Sun Tzu do?

21-May-2010
easyJet Founder, Sir Stelios Haji-loannou
easyJet Founder, Sir Stelios Haji-loannou

CAPA looks at the battle between founder Sir Stelios and the easyJet board over the airline’s expansion – or not – strategy. And seeks advice from the author of the Art of War, as two Knights face off.

Carolyn McCall would have been hoping for a more stable platform from which to operate when she takes over as CEO in Jul-2010. But, although Sir Stelios Haji-Ioannou’s resignation from that board on 14-May-2010, along with his nominee Robert Rothenberg, could make board meetings a little more harmonious, having the lion on the outside promises to make life even more difficult for management.

Outgoing chief executive, Andy Harrison, has already been chastised by Sir Stelios as “overrated”, despite being pretty much admired by observers for his performance since taking over from the founding CEO, Ray Webster, in 2005.  Ms McCall should be pretty thick skinned, coming from the media business; and she will need to be, once Sir Stelios embarks on his new crusade from the other side of the fence.

She is no stranger to controversy, leaving behind her a drastically restructured Guardian Media Group, where she was operating in a world every bit as challenged as the airline industry.

But now it looks as if last year’s highly public debate over the airline’s growth planning will provide plenty of newsfeed for several months to come.

Strategy #1: Divided boards are not good strategy, that’s for sure – not when the dissenter controls nearly 40% of the voting stock

Sir Stelios is used to getting his way. And there will undoubtedly be that strong feeling that this is still his baby. After all he conceived and founded the highly successful airline. He now argues for pulling back on growth. In some ways he may be perfectly justified in seeking to enhance his takeout from easyJet, a company which has not paid monetary dividends – although he has generated considerable income from the IPO, as well as from royalty payments.

In this respect, his argument against further expansion only stacks up if a more static fleet would convert into immediate dividends – and would continue to deliver under Sir Stelios’ slow growth strategy.

He has presumably done his homework, so believes he (and other shareholders) would be the winners, if not in the long term, at least in the coming months. So far however he appears to be still in the minority, as the airline continues to perform. If a public campaign follows – as now appears likely – this will surely be disruptive. A public war is not what any airline needs. The  business is tough enough as it is.

The board, and the airline’s CEO, insist however that the growth programme had been agreed unanimously prior to Stelios’ alleged change of tack – presumably due to the straitened circumstances.

So, in response to the noise around Sir Stelios’ departure, the Chairman, Sir Michael Rake, in a letter to shareholders on 18-May-2010, said: “The Board is both surprised and disappointed to find itself in a public debate over strategy as Sir Stelios and I had agreed principles of engagement in May 2009 specifically to avoid such situations. In the view of the Board there are simply no grounds for a dispute.”

Sun Tzu: “If your enemy is secure at all points, be prepared for him. If he is in superior strength, evade him. If your opponent is temperamental, seek to irritate him. Pretend to be weak, that he may grow arrogant.”

Strategy #2: To corner market share – or play it safe (and pay dividends)?

Sometimes a cautious approach to serious challenge can guarantee failure. Or at best it can mean that opportunities are missed in capitalising on strengths, where others may be failing. Alternatively, battening down may be the only safe approach if the goal is to be profitable. After all a number of airlines – notably some of the US full service airlines – shrank considerably over recent months and became profitable as a result.

The past two years – the first, 2008, characterised by strong economies and unimagined high fuel prices, then, starting later that year, the massive downturn into the global financial crisis of 2009 – have been unique in their double whammy impact. This environment presented every airline management with massive challenges and, in some cases, opportunities.

This was in other words a one-off. Getting it right could establish a great platform for the future; a wrong step could mean missing a major opportunity to secure a stronghold – or, at worst, getting into serious trouble.

During this time, easyJet was attacking the very markets from which Europe’s full service carriers were withdrawing – and gaining market share with ease. This was mostly profitably – even if the year on year levels have been declining:

easyJet operating margin vs net margin: 1HFY2006 to 1HFY2010

As it was, easyJet did actually slow its expansion in 2009 from what was originally planned. Although the carrier still grew, it did not chase the sort of market size that its main competitor, Ryanair continued to achieve (even if easyJet would disagree on who is its main competition).

In 2008/09, easyJet made a clear break with the pattern of almost one-for-one expansion that it had previously followed with Ryanair. Until mid-2008 the two went more or less toe-to-toe in fleet size, but Ryanair surged ahead over the past year, as easyJet eased back, before also flattening out.

The past five years’ expansion, from a fleet of 95 aircraft to 169 (173, if stored aircraft are included and not including the GB Airways’ fleet) imposes massive management pressures, but the carrier has made creditable progress, remaining profitable through most of that period.

easyjet fleet expansion trend: 2005 to 2009

The fleet is made up of A319/20/21 family aircraft, along with a handful of B737NG, the remnants of the original fleet.  Another 57 aircraft are in the pipeline for delivery over the next five years.

easyJet’s  fleet current fleet: May-2010

Manufacturer

Aircraft Type

 In Service

In Storage

On Order

Grand Total

Airbus

A319

135

0

43

178

Airbus

A320

24

0

13

37

Airbus

A321

3

1

1

5

Boeing

737 (NG)

7

1

0

8

Total

 

169

2

57

228

The bulk of these are currently scheduled to arrive in the next 18 months, by the end of 2012. That is, 53 new aircraft are due to arrive during that period, most of them A319s - an average of one new arrival approximately every 18 days.

Total aircraft delivery schedule: 2010 to 2015

That is undoubtedly a large meal to swallow, off a base of a 169-aircraft fleet, even allowing for any retirements (of near-new aircraft). But then again, if the market turns, or if the full service airlines continue to contract on European routes, there may well be scope for their use. There are still many city pairs in Europe which are underserved, by US domestic standards.

Was there agreement on the expansion programme now being followed?

According to Sir Michael’s 18-May-2010 letter, “In 2005 and 2007 the Board approved the conversion of purchase rights granted under the Airbus contract to the status of firm orders. Further details are set out in Appendix B. These decisions were made with the agreement of the entire Board including Sir Stelios. No aircraft have been ordered from Airbus since June 2007.”   

Moreover, the letter continues, “At the request of Sir Stelios, in spring 2009 the Board took extensive legal advice which allowed it to evaluate the possibility of renegotiating our arrangements with Airbus. Subsequently, the Board was able to gain some additional flexibility in our fleet planning arrangements.

“easyJet's stated medium term growth rate of 7.5% in seats flown per annum was approved by the Board in June 2009. The Board minutes from that meeting show unanimous agreement.”[1]

With the exception of the gruesome first half of FY2009, this rate of growth has been exceeded.

easyJet passenger numbers and growth rate: 1HFY2006 to 1HFY2010

Aircraft manufacturers have a habit of being fairly hard to budge when it comes to cancelling or delaying orders. In good times, when there is a queue of eager operators, it is even possible to sell a production slot; but when the going gets tough and the aftermarket softens, the cost of slipping can be extremely high. There is no fixed equation for this cost, as it depends on the power of the airline to negotiate a deal.

In easyJet’s case, where the airline clearly gained a good deal from Airbus in making a large order while switching from a Boeing fleet, the manufacturer’s margins would have been thin –  and the conditions of sale relatively fixed (a little bit like the cost of rebooking a budget, no-frills fare, as compared with changing a full fare, flexible ticket). The carrier will not be keen to book a lot of cancellation charges of this nature right now either.

In other words, there isn’t a lot of room for the parties to move.

Strategy #3: Licensing brands from a shareholder

There is only a handful of airline brands that come with a branding premium – and even fewer that come with a royalty payment. easyJet is one.

And here too the carrier is in dispute with its brand owner, Sir Stelios. In this case it is over the volume of ancillary charges easyJet may levy using the easy brand. That matter is to arrive in court in the next couple of weeks, just to add a little spice to the debate and to ensure that the dispute is kept squarely in the headlines. Judgment is not expected until the Autumn.

There doesn’t seem to be much room for compromise here either. Sir Michael’s letter again: “The Board has been proactive in trying to achieve a commercial settlement of the dispute within the limits of what we believe would be reasonable to our institutional shareholders. As you will be aware the view of our professional advisers Herbert Smith is that the Company's interpretation of the brand licence is well-founded and therefore the Board does not feel it is right, in the interest of all shareholders, to offer material concessions to easyGroup.”

One possibility which has been mooted is that the airline relinquishes the “easy” brand, thereby avoiding future conflict in this context. That would have the added virtue of allowing the carrier to cultivate its own brand, independent of its founder.

easyJet has made much of its green credentials, so perhaps a name like jetGreen would go well – although the last airline with that name (in Ireland in 2004) lasted a little over a week. It described itself as “the world’s first ‘low-cost’ First Class service”, but not for long. And its colours were red, white and blue – and orange – not green.

Then there is the brand that the carrier has already captured for itself, with similar connotations: ecoJet. Changing the brand colour from an orange hue to a shade of green would perhaps suit well and certainly be distinctive, not to mention making Ryanair feel more edgy.

So that may be a practical outcome. After all, the airline has evolved from its original low cost format into something more professional-oriented. So taking a big breath and shifting a gear might not be altogether silly. It would also reduce one front on which the war is being waged.

Sun Tzu: In the practical art of war, the best thing of all is to take the enemy's country whole and intact; to shatter and destroy it is not so good.

Strategy #4: Watching the share price

As with many healthy airline stocks, easyJet’s does little more than track the economy, and that is mostly what it has done over the course of the past decade. Mr Harrison would probably not claim all of the immediate post-2005 improvement as his own – although he was obviously doing something right. Nor would he take all of the blame when 2008 fuel prices drove profitability down, followed hard by the financial crisis in 2009.

But easyJet has been performing relatively well of late. The carrier’s shares last week reached their highest level since Nov-2007, nudging GBP5. 

easyJet share price growth: 2000 to 2010 (GBP, pence)

And, to contrast the recent performance of Ryanair – which has now cut back strenuously on capacity expansion, it would seem that the market still prefers easyJet’s results. The following indexed performance comparison suggests that there is actually a perception of a better outlook for easyJet.

Comparison of easyJet and Ryanair indexed share price: 2001 to 2010

So, even if dividends are not on the horizon, the company looks to be reasonably well positioned to prosper. It has moved successfully into a low cost/higher yield niche market, where probably only Air Berlin will be a serious challenger. And with continuing slow economic growth and cost sensitive business travellers, that does seem a good place to be.

What would Sun Tzu have done?

And we offer the last words from the author of the immortal “Art of War”, as the sides prepare to do battle:

Sun Tzu: “The supreme art of war is to subdue the enemy without fighting.”

Both sides will be looking for a negotiated solution.

But Sir Stelios probably feels he has less to lose – so his position will be more rigid. That should keep Ms McCall on her toes over coming months.


[1]  easyJet’s Interim Management Statement issued on 29 July 2009 noted that,  "As part of the annual strategy process, the Board has agreed that the fleet plan set out below will enable easyJet to deliver prudent growth and take advantage of the substantial opportunities to take market share in European short-haul aviation whilst maximising margins and delivering positive cash generation beyond the Boeing replacement programme. It is anticipated that easyJet's average annual growth rate over the medium term measured in seats flown will be around 7.5% per annum.”


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