14-Feb-2013 3:47 PM

TAP Portugal privatisation. Will TAP be back in the shop window soon?

Analysis

The Portuguese government's decision in late 2012 to reject the only second round bid it had for TAP Portugal cast doubts over the future for the loss-making and indebted Portuguese national airline group.

The government reportedly said it had a 'Plan B', involving shutting down and re-launching the airline after assuming its debt. German Efromovich, owner of Synergy Aerospace (the rejected bidder) has said that he remains interested until the end of 1Q2013 and there have been some suggestions that the government may be planning to re-start the privatisation process.

While a number of major airlines were reported to have considered bidding for TAP in the early phases of the process, including IAG, Air France-KLM, Lufthansa, Turkish Airlines, Qatar Airways and LATAM Airlines, none did so.

TAP's strengths on routes to Latin America (in particular Brazil) and Africa should appeal to prospective bidders, but the group's financial position may continue to offset this without some restructuring. Moreover, growing LCC competition in Europe may eventually undermine all-important feed into its key long-haul niches.

TAP Group is weak financially

The TAP Group has not reported a positive annual net result for several years, (its website shows results only as far back as 2008).

TAP SA, the main subsidiary of the group, contains the Air Transport segment, the Portugal-based maintenance segment and TAP Servicios (which provides support services, such as finance, HR and logistics, to other group companies).

TAP SA does not include the loss-making Brazilian maintenance segment or the 'Holdings and others' segment, which is also loss-making. TAP SA has been more profitable than the group in recent years, but, in 1H2012, it recorded a net loss of EUR112 million, while in the seasonally stronger 3Q2012, it saw a net profit of EUR102 million, suggesting a nine-month cumulative loss of EUR10 million.

The consolidated group did not report its result for the first half, but it did report group net income of EUR90 million for 3Q2012. Given that group results are typically weaker than those of TAP SA, which saw a loss for 1Q-3Q2012, this suggests that the group may have also generated a cumulative net loss for the first nine months of 2012. Given also that Q4 tends to be loss-making, this points to a likely loss for the full year 2012.

TAP Group and TAP SA net result (EUR million): 2008-2012*

Group net debt at the end of 2011 was EUR1.1 billion, excluding operating leases, or around EUR1.6 billion if operating leases, capitalised at eight times annual payments, are included. The precarious balance sheet was further burdened by negative equity of -EUR343 million at the end of 2011. TAP did not report its net debt or equity at the half year or Q3 point of 2012, but the balance sheet is likely to have deteriorated further by the end of 2012.

TAP Group net debt 2008-2012*

This combination of group losses, high debt and negative equity make the group unattractive from a financial standpoint. The Portuguese government and the management of TAP could consider selling or closing the heavily loss-making segments as this would improve the group's profitability, but, given that virtually all the debt is attached to the air transport segment, the weak balance sheet would remain a challenge.

TAP Group net income by business segment (EUR million): 2010 and 2011

TAP and the Portuguese government have different priorities

For TAP, a crucial priority for the privatisation process is to ensure a capital injection to repair the balance sheet, to fund future capex and to reduce the annual interest burden on its earnings. For the government, it is important to generate cash for the state coffers.

Under a EUR78 billion European Union bailout package for Portugal, the government agreed in 2011 on a privatisation programme to pay off public debt, including the sale of TAP. The Synergy bid was reported to have consisted of a EUR316 million capital injection into TAP, the assumption of TAP's EUR1.2 billion of debt and a payment of just EUR35 million to the Portuguese government.

TAP Portugal projected delivery dates for aircraft on order direct from manufacturers as at 11-Feb-2013

While it has been reported that the reason for the government's rejection of the bid related to Synergy's failure to provide sufficient financial guarantees, it seems reasonable to assume that Portugal was also unhappy with the proposed contribution to its own funds. This tension between the needs of the company and the needs of the state is likely to trouble any future attempts to restart the privatisation.

The Synergy bid represented a very full valuation

On an enterprise value basis (equity plus net debt, including capitalised operating leases), the Synergy bid valued TAP Group at a little over EUR2 billion. Based on its 2011 EBITDAR (earnings before interest, tax, depreciation and rental payments on aircraft operating leases), this represents a multiple of 12.5 times. It is difficult to envisage other, listed, airlines justifying such a high multiple to their shareholders.

With interest payments of around EUR55 million to service its existing debt, repayments of at least EUR170 million in each of the next three years in respect of maturing debt and an aircraft delivery programme of 12 Airbus A250s to fund from 2015 to 2018, the strain on TAP's balance sheet and, more importantly, its cash flow could become unbearable unless a solution can be found soon.

TAP Group debt repayment schedule as at end 2011

Could the state assume TAP's debt?

The Portuguese government's Plan B, which involves assuming TAP's debt, could fall foul of European Union rules on state subsidies into airlines, since the market economy investor principle would require the government to demonstrate that it is investing on the same terms as a private sector investor would. Moreover, the assumption of TAP's debt would not fit with the aims of the privatisation programme agreed with the EU.

An alternative may be to allow TAP to go bankrupt, which would have the effect of writing off its debt, but would also see most of its fleet revert to lessors. It may also be possible to separate out the more profitable parts of the group and sell these to a bidder, with the government retaining the loss-making parts (similar to the Alitalia restructuring) and/or for the group to sell or close all non-core business units and downsize the core business.

Political and union opposition to privatisation

It is not just the differing goals of TAP and the government that makes the process difficult. Lined up against government plans to re-start the privatisation stands the National Union of Civil Aviation Flight Personnel and the TAP Workers Committee. Moreover, the opposition Socialist Party welcomed the suspension of the privatisation process, arguing that the process had been opaque and that, if conducted properly, additional potential buyers could likely be found.

The government may prefer to continue with the suspension of the process in order to attempt to resolve the political challenges surrounding it.

Who might bid in the future?

If the government does re-launch the privatisation process, it is debatable whether there will be any more serious bidders than there were last year (i.e. one), but there are some that may possibly take another look, based on TAP's strengths on routes to South America (particularly Brazil) and Africa.

TAP Portugal international capacity share (% of ASKs) by region: 11-Feb-2013 to 17-Feb-2013

TAP Portugal top 10 international routes by capacity (ASKs): 11-Feb-2013 to 17-Feb-2013

Europe to sub-Saharan Africa* by capacity (seats): 11-Feb-2013 to 17-Feb-2013

Airline group	Seats
Air France-KLM	97,033
IAG	47,620
Lufthansa Group	24,564
Brussels Airlines	17,128
TAP	14,472
South African	14,258

Synergy is still the most feasible option

A sale to Synergy, the owner of Avianca Brazil, may still be the most feasible option. Its owner German Efromovich expressed surprise and disappointment at the rejection of his bid in December, saying that he had all the necessary bank guarantees lined up for the proposed contract signature date of 27-Dec2012, rather than for 20-Dec-2012, the date that the government decided on the bid.

This deal would reinforce the Portuguese carrier's leading position in the Europe-Brazil market and meet Synergy's goal to expand into the Europe-Brazil and other long-haul markets. Avianca Brazil is a significant and fast-expanding domestic player in Brazil, but has no widebody aircraft and has no international routes.

Avianca Brazil could replace TAM as TAP's partner for connecting flights in Brazil. TAP will likely need to find a new Brazilian partner anyway as TAM is expected to leave the Star Alliance to join new sister carrier LAN in oneworld. A TAP-Synergy combination would be a positive outcome for Star as it would ensure the Portuguese carrier and its valuable Europe-Brazil network stays in Star.

But, whether Synergy will retain its interest in a deal beyond the end of 1Q2013 remains to be seen.

Top 15 airlines Brazil to Western Europe by capacity (seats): 11-Feb-2013 to 17-Feb-2013

Rank	Airline		Total Seats
1	TP	TAP Portugal	30,144
2	JJ	TAM Airlines	24,854
3	AF	Air France	16,610
4	IB	Iberia	10,598
5	LH	Lufthansa	9,732
6	AZ	Alitalia	8,668
7	KL	KLM Royal Dutch Airlines	7,744
8	BA	British Airways	7,348
9	LX	SWISS	3,066
10	UX	Air Europa Lineas Aereas	2,392
11	SQ	Singapore Airlines	1,668
12	DE	Condor Flugdienst	1,494
13	CA	Air China	1,088
14	I9	Air Italy	1,060
15	S4	SATA International	444

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Major European airline groups may be reluctant

Despite initial interest from several European companies, no European airline firmed up these intentions in the first round of bidding. All three major airline groups - Air France-KLM, Lufthansa and IAG - are stock-exchange listed and are concentrating on restructuring their own operations.

Of the three, IAG openly expressed the greatest initial interest in bidding for TAP, but this weakened mid-way through 2012. As the number one carrier between western Europe and Brazil, where it has 10 destinations, TAP would complement IAG member Iberia's leading position overall on routes between Europe and Latin America. Iberia has 17 destinations in Latin America, but only two in Brazil, while only one of TAP's 11 Latin American destinations is outside Brazil (Caracas). TAP's African network would also give IAG a strong footing in the Europe to Africa market, where it has been trying to expand, although it would remain a distant second to Air France-KLM on Europe to sub-Saharan Africa.

A combination between IAG's Iberia and TAP may however run into opposition from European competition regulators and, moreover, the Portuguese government may not relish the prospect of the likely transfer of operations from Lisbon to Madrid.

IAG CEO Willie Walsh said during its 1Q2012 results presentation: "Our interest in TAP largely related to the network that it had in Brazil. But things are developing; the merger of LAN and TAM, [and] our acquisition of slots through the acquisition of BMI at Heathrow gives us opportunities that look more interesting to us. So our interest in TAP is significantly less today than it would have been 12 months ago". Certainly British Airways appears to be increasingly focused on markets to the east, rather than westwards.

A future bid from Lufthansa or Air France-KLM is only likely as a defensive move if IAG were to bid. Lufthansa would be keen to keep TAP in Star, but would probably still prefer Synergy (owner of Star member Avianca Brazil) to make the bid. In recent years, Lufthansa has consistently resisted buying indebted, loss-making companies that are not profitable unless they have already taken significant steps to restructure (e.g. SWISS), the seller has contributed towards debt reduction (e.g. Austrian) and the price is very favourable.

TAP's Latin America and Africa routes could be of interest to Air France-KLM, but the Franco-Dutch group is currently focusing on its own restructuring and, in particular, conserving cash. Mr Walsh also said he "can't see Air France-KLM doing anything in relation to TAP. I can't see Lufthansa doing anything. And quite honestly I can't see LATAM doing anything. So I think the interest in TAP will be very weak and that you should include us in that list."

One less obvious Star member, Turkish Airlines, 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 two destinations in Latin America.

Non-European airline interest

LATAM Airlines Group, now the fourth largest player in the South Atlantic market (behind IAG, Air France-KLM and TAP), also considered a bid in the earlier phases of the process. TAP would instantly more than double LATAM's trans-Atlantic network and build its presence in Europe, particularly since the LATAM group does not currently serve Portugal. Moreover, Caracas, TAP's only Latin American destination outside Brazil, is also one of the few major cities in South America which does not have a LATAM hub. It is likely, however, that LATAM will continue to focus on growing its transatlantic operation organically by exploiting synergies from the recently completed merger.

Qatar Airways, which was in talks to take a stake in Spanair before the Barcelona-based airline collapsed in Jan-2012, may regard TAP as a superior substitute for Spanair. Qatar also has the funds and ambitions to pursue overseas acquisition, but there are limited network synergies as it only serves two destinations in Latin America. It is unlikely TAP would remain in Star under Qatar, which is to join oneworld.

While Emirates and TAP signed a codeshare agreement in December, Emirates is a very unlikely equity partner.

Etihad expressed interest in the first round of bids for TAP, but CEO James Hogan was reported to have said in Oct-2012: "We are code-share partners with TAP. However strategically, we do not see any value in investing in TAP."

LCC and other short-haul competition

Although penetration by LCCs of routes from Portugal to western Europe stabilised in 2012, they accounted for 37.6% of seats for the year. At Lisbon, TAP has a 63.6% share of seats and easyJet has 10.2%, while at Porto Ryanair now has a leading 35.7% share, just ahead of TAP on 34.1%, and easyJet with 12.3%.

Although the position at TAP's Lisbon hub is still fairly strong, low-cost carriers have come from nowhere over the past 10 years and Ryanair's strength at Porto could help it to become better established in Portugal as a whole. Any further erosion of TAP's position at its long-haul hub could threaten its ability to feed its crucial Brazilian and African networks.

Portugal LCC capacity share (%) of total seats: 2001 - 2012

TAP's future is unclear and risky

TAP Portugal has operational and strategic strengths in the shape of its Brazil and Africa routes, but it faces an assault on short-haul from LCCs. Moreover, the group is unprofitable and its balance sheet is stretched, even if its air transport segment may be returning to profit. Meanwhile, TAP faces challenges in generating cash to service debt obligations and to fund its 2015-2018 aircraft deliveries.

There was a notable lack of bids from major carriers in 2012's aborted privatisation process and it is difficult to see this situation changing in the future, unless the government takes the politically difficult steps of accepting lower proceeds or finding a way to assume TAP's debt; or unless TAP significantly improves its financial performance through restructuring and a market upturn.

The suspension of TAP's privatisation may buy time for the government to address the political obstacles and may also give the group more time to improve its financial results, including considering an exit from the unprofitable Brazil-based maintenance business and other loss-making holdings, and to restructure its debt.

On the other hand, airline mergers and acquisitions are increasingly giving way to a trend whereby the strong just allow the weak to wither and die: Portugal should be wary of TAP becoming another statistic in this growing form of consolidation.