18-Jul-2012 8:45 PM

TAP Portugal’s privatisation is moving slowly as potential bidders keep their interest subdued

Analysis

The Portuguese Government remains reticent on providing detailed progress reports on the privatisation of TAP Portugal, underlying a likely reluctance to sell its cherished national carrier. But the sale is required under a 2011 agreement with the EU and several airline groups from Europe, the Middle East and Latin America will be ready to participate once the sale process finally begins. More than a handful of airline groups will likely participate at least in the initial stages of the bidding process as TAP despite its small size and challenging local market remains a relatively strong carrier with powerful positions in two key emerging markets - Latin American and Africa.

The European Council, European Central Bank and the International Monetary Fund agreed last year to a EUR78 billion bailout package for Portugal providing that it intensified its austerity measures and introduced a comprehensive privatisation programme that includes the energy and insurance sectors, media industries and transport. The latter comprises Aeroportos de Portugal (ANA), Portugal's airports operator, and TAP.

The 3-May-2011 "Troika" memorandum stated that the Portuguese Government was "hopeful that market conditions will permit the sale of TAP by the end of the 2011", yet this has not materialised. In fact, Portugal has stretched the timeline of the airline's privatization more than once, despite official and non-official interest by several parties including British Airways and Iberia parent International Airlines Group (IAG), the Lufthansa Group and new LAN and TAM parent LATAM. Turkish Airlines and Qatar Airways have also reportedly expressed preliminary interest in the carrier while TAP CEO Fernando Pinto recently indicated that Avianca-TACA could be a potentially interested party as its recent membership in Star Alliance has strengthened ties between the two companies.

The most recent reports in local media indicate that the privatisation process at TAP may finally officially launch within the next few days. Given the later than expected start to the process, the sale process reportedly is now not expected to conclude until 2013.

TAP's privatisation has been on and off the Portugal's agenda since the 1990s

Plans to re-privatise TAP date back to 1990, and the Portuguese government took initial steps in 1991 - when the flag carrier was reorganised as a Sociedade Anónima, or a public limited company with the Portuguese state holding most of the shares. The necessary laws to allow the privatisation of TAP were passed in 1998 and in Feb-2000 the government concluded an agreement with SAirGroup to sell an initial 34% shareholding. However, in Feb-2001, SAirGroup withdrew from the agreement and one year later the Swiss airline conglomerate filed for bankruptcy.

TAP's privatisation plans have been lingering on the Portuguese political agenda since the SAirGroup debacle, but they have now been firmed up under pressure of the Troika. The government in May-2012 selected Credit Suisse Group, Barclays PLC, Citigroup and Banco Espirito Santo Investment to run the airline sale. The four banks have also been retained to oversee the privatisation of ANA. TAP is valued at approximately EUR1.2 billion, based on a multiple of eight times EBITDA (earnings) in 2011, while Aeroportos de Portugal SA is valued at EUR1.6 billion (using the same calculation), but could achieve an enterprise value of EUR2 billion.

See related article: Portugal Airport privatisation moving forward

Mr Pinto told CAPA in Jun-2012 on the sidelines of the IATA AGM in Beijing that the Government initially imagined a faster process for the planned sale but it "took longer than expected". He said it has been decided that TAP and the airport will now be privatised at the same time. Two different owners will be sought to avoid a repeat of the situation in Qatar, where the airline and airport are part of the same entity.

As recently highlighted by CAPA, the outcome at TAP could impact the value of ANA because if IAG bids for TAP and is successful it may, post-acquisition, look to partially disband the carrier's Portuguese hubs in favour of concentrated operations at Madrid. Moving large amounts of TAP traffic out of Portugal would dent ANA's appeal, although the national airline's weight in the country's total airport passenger throughput has gradually declined over the years due to the rapid expansion of foreign low-cost carriers.

LCCs have taken a bite out of TAP's short-haul market

TAP Portugal is still the country's largest carrier, accounting for about 46% of system ASKs, according to current Innovata data. However, in terms of capacity measured in seats TAP only has a 37% share and a 35% share when considering only seat capacity deployed on international routes.

Europe's two largest LCCs, Ryanair and easyJet jointly have a 30% share of international seat capacity in Portugal. On domestic routes, which represent about 13% of Portugal's total seat capacity, TAP is still the dominant carrier with about a 50% share of the market.

Portugal capacity share by carrier (% of seats): 16-Jul-2012 to 22-Jul-2012

At Lisbon Portela Airport, the country's busiest airport, TAP Portugal has managed very well to keep its leading market position and the carrier has developed a successful hub-and-spoke operation there under the leadership of Mr Pinto, who joined the carrier as chief executive in Nov-2000. Mr Pinto, who was President and CEO of Varig S.A between 1996 and 2000, has used Portugal's geographic location at the most southwestern tip of Europe to link the continent with Latin America, particularly Brazil, and Africa.

TAP Portugal capacity share at Lisbon Airport: 16-Jul-2012 to 22-Jul-2012

	System	International	Domestic
Seats	60%	57%	76%
ASKs	66%	66%	67%
Frequency (to/from)	64%	62%	77%

TAP also has a smaller hub at Porto in north Portugal, where it operates four long-haul routes and serves several European destinations (including with regional jets inherited from its acquisition of smaller Portuguese carrier Portugalia in 2006). TAP only operates domestic flights from Portugal's third major airport, Faro in Portugal's Algarve region (a population beach destination), where LCCs currently account for about 87% of total capacity.

TAP Portugal capacity share (% of seats) at Portugal's three main airports: 16-Jul-2012 to 22-Jul-2012

	Passengers 2011	TAP capacity share	TAP seats per week
Lisbon Airport	14.8 million	60%	254,632
Porto Airport	8 million	29%	50,394
Faro Airport	5.6 million	3%	5,388

Brazilian and African networks are TAP's prime assets

Mr Pinto continues to believe that TAP's strength in the South Atlantic and African markets will make the carrier an appealing target. TAP now has about 70 weekly frequencies to 10 Brazilian airports and also has about 70 weekly frequencies to 13 African destinations.

Before Mr Pinto joined TAP the carrier only had 18 weekly flights to Brazil. The carrier now has about a 30% share of the growing and lucrative Brazil-Western Europe market, which brings value to a potential strategic investor.

In terms of point of sale Mr Pinto says 26% of TAP's revenues now come from Brazil. Roughly 73% of its sales are outside Portugal, which is viewed positively as it helps insulate TAP from the current economic situation in Portugal. The country's GDP fell 1.5% in 2011 and is expected to contract by 3.3% in 2012, according to the IMF. Unemployment stood at 13% in 2011 and it is forecast to reach 15% this year with youth unemployment (those aged 15-34) exceeding 35%.

Brazil to Western Europe capacity by carrier (seats per week, one way): 19-Sep-2011 to 6-Jan-2013

TAP is the largest operator between Europe and Brazil, currently offering about 17,000 one-way seats.The second largest operator is Brazi's TAM with approximately 12,000 one-way seats per week. TAP and TAM are both currently members of the Star Alliance. Three other Star carriers Lufthansa, SWISS and Turkish Airlines - deploy over 9,000 additional one-way weekly seats in the Europe-Brazil market, giving Star a dominant share in this market.

Star does not want to give up this leading position in a fast-growing market, certainly not to a member of a competing alliance such as IAG, which has confirmed its interest in TAP. Hence the recent statements from Lufthansa Group CEO Christoph Franz that the group is also considering a bid for the Portuguese airline come as no surprise. "TAP is one of the larger carriers who manage the gateway to Latin America, and that is clearly a good reason to at least listen if your colleagues [at TAP] are giving you a phone call," Mr Franz was quoted as saying to the Financial Times.

Lufthansa serves only six destinations in Latin America, of which two are in Brazil: Rio de Janeiro Galeao and Sao Paulo Guarulhos. Its Swiss subsidiary has only Sao Paulo Guarulhos in its Latin American network while Austrian Airlines and Brussels Airlines do not operate to Latin America.

Traffic to Brazil keeps growing but TAP's European network also important

While the strongest components of TAP's network are Africa and Brazil, the short-haul market also remains an important part of the carrier's business partly because a large portion of its Brazilian passengers connect in Portugal to the airline's short-haul network. Almost 70% of TAP's seat capacity is deployed within Western Europe, according to Innovata data.

TAP Portugal international capacity (seats) by region: 16-Jul-2012 to 22-Jul-2012

The airline this year has not added any long-haul destinations (the last new transcontinental route was launched on 6-Jun-2011 to Miami) and growth has been focused on Europe in spite of the prevalence of LCCs for travel to/from Portugal. LCCs have a near 40% share of capacity in terms of seats on international routes, according to OAG data. However, they have not established a strong foothold at TAP's hub in Lisbon Portela airport, where FSCs still account for about 84% of weekly seat capacity. easyJet is the largest no-frills airline at Lisbon and has about an 11% share of capacity.

TAP launched a thrice weekly service to Bucharest on 30-Jun-2012, expanding its European network to 51 destinations in 22 countries. TAP also added Turin on 30-Jun-2012 and began operating six weekly flights between Lisbon and Berlin Schoenefeld on 5-Jun-2012.

easyJet also operates the Lisbon-Berlin route. Berlin is TAP's fifth destination in Germany joining Frankfurt, Hamburg, Munich and Dusseldorf. TAP operates up to 60 weekly flights to Germany this summer, including 21 weekly flights to Frankfurt, 14 to Munich, 13 to Hamburg and seven to Dusseldorf.

Mr Pinto says about 50% of TAP's traffic is on routes to France, Germany and the UK. Paris Orly and London Heathrow are the airline's two largest routes as measured by seats offered. He points out the short-haul European business is holding up well this year despite the dire economic situation with traffic up 7% in the first four months of 2012. TAP's German routes recorded a year-on-year 10% rise in passengers during the first four months of 2012.

TAP Portugal top ten largest international routes by capacity (seats per week): 16-Jul-2012 to 22-Jul-2012

TAP carried 5.79 million passengers on its European network in 2011, an increase of 9% over the previous year. Total enplanements rose 7% in 2011 to 9.8 million, a record, and load factor increased 1.8ppt to 76.3%. The airline reported a EUR3.1 million profit in 2011 and total revenue rose 4% to EUR2.3 billion, while fuel costs increased 37% to EUR717 million. The airline posted a net profit of EUR62.3 million for 2010 and net income of EUR59 million in 2009.

Financial results for the TAP Group for 2011 have not yet been released, but it is widely expected they will show red ink owing to losses in the ground handling division, Groundforce Portugal, and MRO unit. TAP is now in the process of finalising the sale of Groundforce Portugal. It is not yet clear if the MRO unit, which has large maintenance operations in Portugal and Brazil, will also be sold separately or remain part of TAP Group as TAP itself is sold.

TAP's privatisation has sparked "great interest" including from IAG

Mr Pinto has repeatedly stated that TAP's the privatisation is generating "great interest". IAG has consistently shown interest until recently when it suggested its interest had waned - although perhaps this is a negotiating tactic for a more favourable price. The group reportedly has hired JP Morgan as its advisor.

TAP's Brazilian network is complementary to Iberia's Latin American network, which comprises 17 destinations but only includes two destinations in Brazil. On the other hand, only one of TAP's 11 Latin American destinations is outside Brazil - Caracas.

TAP's vast African network would also give IAG a strong footing in the Europe to Africa market, where it has been trying to expand. But European regulators would take a deep look at the market power of a potential Iberia-TAP combination on the Iberian Peninsula.

While TAP's cost structure is lower than Iberia's the benefit of having two hubs in close proximity catering to Latin America may also not be rationale. The possible - or plausible - transfer of operations from Lisbon to Madrid, which is underutilised, might not sit well with TAP's seller, which is also the seller of ANA.

Latin American groups LATAM and Avianca-TACA eye TAP

New LAN and TAM parent company LATAM Airlines Group is also considering a bid for TAP. The Portuguese carrier would help LATAM grow its presence in the South Atlantic market, where it is now the fourth largest player behind IAG, Air France-KLM and TAP. Adding TAP to LATAM's portfolio of carriers (assuming it can get around EU ownership restrictions) would allow the new airline group to instantly more than double its trans-Atlantic network and build its presence in Europe with TAP's short-haul network feeding flights to Brazil and potential new flights from Lisbon to other LATAM hubs throughout South America.

The LATAM and TAP networks are highly complementary as none of the LATAM subsidiary or affiliate carriers currently serve Portugal. Caracas, TAP's only Latin American destination outside Brazil, is also one of the few major cities in South America which doesn't have a hub from a LATAM carrier.

"As the TAP process evolves we will look at that and see if it's an opportunity for us or not. It's not that clear the timing [or] who is involved," the head of LAN's international operation, Damian Scokin, told CAPA in Jun-2012 during the IATA AGM.

While LATAM will likely take a serious and detailed look at TAP, Mr Scokin says for now the new airline group is focusing on growing its trans-Atlantic operation organically by exploiting synergies from the recently completed merger. Since first agreeing to merge in Aug-2010 Chile-based LAN and Brazil-based TAM have talked up the prospects of more flights to Europe as their combined networks should be able to support new trans-Atlantic routes and additional capacity on existing routes. Their merger was completed last month, allowing the two groups to finally start examining network and cost synergies.

"We have a relative small market share from Latin America into Europe," Mr Scokin said, pointing out how LATAM's market share in the Latin America-US market is roughly double its share of the Latin America-Europe market. "We clearly see a growth opportunity for LATAM as a whole getting into Europe."

Another Latin American airline group, Avianca-TACA, is significantly smaller than LATAM but would potentially be interested in acquiring TAP to accelerate its plan for expanding into the long-haul market from Brazil. Avianca Brazil (formerly known as OceanAir) only has about a 5% share of the Brazilian domestic market and currently operates just one international route to Bogota. But the carrier's owner, Synergy Aerospace, has big ambitions and for several years has been planning to expand into the long-haul flights including to Europe and Africa. Back in 2009 Synergy ordered 10 Airbus A350s to support planned expansion of Avianca Brazil and while these aircraft could potentially be allocated to sister Colombian carrier Avianca the intention of Synergy and Avianca-TACA chairman German Efromovich for now remains to use the A350s in the Brazilian market.

Synergy owns all of Avianca Brazil and Brazilian cargo carrier Variglog and is the majority owner of Aviaca-TACA but ownership of Avianca Brazil is expected to eventually transfer to Avianca-TACA. Overseas acquisitions are considered the likely next step in expanding the Avianca-TACA/Synergy portfolio, as well as the portfolio of larger LATAM. But TAP management and the Portuguese government may favour a sale to Avianca-TACA as Avianca, El Salvador-based TACA and TACA Peru are now members of Star while Avianca Brazil is expected to also later join the alliance. TAM is also now currently in Star but needs to switch to oneworld or, less likely, become non-aligned within the next 24 months as part of a anti-trust requirement related to its merger with oneworld member LAN.

A potential sale to the Lufthansa Group or Turkish Airlines would also allow TAP to remain in Star. But a sale to Avianca-TACA could be more likely given Lufthansa's general reluctance to pursue further acquisitions. Lufthansa is likely to only bid for TAP as a defensive move to counter a possible bid by rival IAG or Air France-KLM. If Avianca-TACA is willing to front the attempt by Star to keep TAP in the alliance, Lufthansa would be happy to give way to its Latin American partner.

Turkish and Qatar purchasing TAP is possible but less likely

Star member Turkish also has the funds and ambitions to pursue overseas acquisitions but there are more synergies in a potential deal with Avianca-TACA or Lufthansa. Turkish currently only has one destination in Latin America with a second to be added later this year. Culturally and economically there are also stronger ties between Portugal and Brazil or Germany than Turkey.

Qatar Airways is another potential suitor. Qatar Airways holds a 35% interest in Cargolux International Airlines and was in talks to take a stake in Spanair before the Barcelona-based airline collapsed in Jan-2012. TAP, whose airline operations are profitable, is a superior substitute for Spanair.

Like Turkish, Qatar has the funds and ambitions to pursue overseas acquisition but there are limited network synergies (although limited network synergies didn't prevent Etihad from acquiring a minority stake in Aer Lingus earlier this year). Qatar only serves two destinations in Latin America. It is unlikely TAP would remain in Star under Qatar, which is currently unaligned but has been looking at joining oneworld.

TAP is a relatively small player in the European market, but it has a profitable operation, it dominates the important Europe-Brazil market and it has an extensive network into fast-growing Africa. The carrier would be a good fit for several network airline groups. In the end, the government will have to balance which potential buyer offers the best long term growth prospects for the Portuguese economy.