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easyJet CEO reviewing business model. Stelios’ onslaught more intestinal than cerebral?

Analysis

easyJet's new CEO, Carolyn McCall, is reviewing all assumptions underpinning the LCC's business model, in order to update investors when full-year results are announced in Nov-2010. Ms McCall is reported to be considering hiring third-party companies to assist with the review. Her focus will be on the airline's pace of growth and resulting fleet requirements. easyJet is the fourth largest European airline, the UK's largest budget airline and one that contests the 'number two LCC in Europe' accolade with Air Berlin.

Similar growth issues led to clashes between the former CEO, Andy Harrison, and the airline's founder and key shareholder, Sir Stelios Haji-Ioannou, who has repeatedly shown concern at further expansion, citing low returns and risks associated with growing the airline's fleet in uncertain economic times. Harrison was the subject of undisguised criticism from some board members that he had squandered GBP2.7 billion on doubling the fleet while failing to pay a dividend or raise the share price.

Sir Stelios' other concerns involve the growth in ancillary services, which he feels could impose on his own, separate, activities in the easyGroup, possibly damaging them. He is still locked in legal dispute on this issue. And, on 12-Jul-2010, he announced he was calling a special meeting of shareholders to challenge the expansion strategy - this time from outside the boardroom.

At the moment Ms McCall, as a former Chief Executive with the Guardian Media Group, takes over, easyJet is facing its most difficult period since its inception in 1995. So difficult in fact that Sir Stelios recently stated that if his dispute with the carrier is not resolved he might withdraw easyJet's brand licence and licence it to another carrier or lease the name to a large online travel retailer, such as Expedia or Travelocity.

The outgoing CEO, who came to easyJet from the motor vehicle services and textiles sectors, admitted the LCC has developed plans for a new name for the carrier but "only as a contingency plan". A judicial decision is due this month.

More modest growth agreed - then not

easyJet had reached an agreement on the pace of growth with Sir Stelios after he had questioned the strategy. The LCC now plans to increase future capacity by 7.5% per annum, following yearly increases of 15% from 2005 to 2008 and will increase its fleet to 207 aircraft by 2012. Sir Stelios declared himself "a lot happier" with the carrier's shift to a "more modest growth strategy" and insisted it was more resilient than that of Ryanair, which cancelled a large order with Boeing in 2009, though it will continue to receive aircraft from previous orders for several years to come.

Then he apparently had another change of heart and resigned from the board in May-2010, again complaining about excessive and over-ambitious growth.

For its part easyJet considers it has sufficient resources, including GBP1,086 million in cash and equivalents as at 31-Dec-2009, to fund future aircraft deliveries through to Jun-2011. The carrier's fleet plans are now as follows:

  • At 30-Sep-2009: Total of 181 aircraft;
  • At 31-Dec-2009*: 187;
  • At 30-Sep-2010: 192;
  • At 30-Sep-2011: 196;
  • At 30-Sep-2012: 207.
  • *Includes four A321 held for sale which are expected to be sold by September 2010

When the row began last year Sir Stelios wanted to keep the fleet size at 170.

37 A320 family aircraft were delivered in 2009. easyJet has since been in discussions with Bombardier about its CSeries aircraft, as an alternative to re-engined A320/B737NGs.

Keeping up with Ryanair

In the 12 months ended 30-Sep-2009 easyJet reported an operating profit of GBP60.1 million (-34%) and a net profit of GBP71 million (-14.4%) on revenues of GBP2,667 million (+12.9%). The passenger load factor rose by 1.4 ppts, while Ryanair's fell slightly in a comparable period. In the following three months to the end of December revenues continued to rise, especially in the ancillary segment (+20.9%), following a 41% ancillaries increase in the full year to September.

Airport charges up by 16.6% reflect main airport strategy. Is it right?

However, in the six month period ending 31-Mar-2010 easyJet declared an operating loss of GBP66.5 million (2008: -GBP115.5 million); and a positive EBITDAR of GBP22.8 million (2008: -GBP40.9 million). Revenues were up by 13.4% (GBP1,171 million); passenger numbers by 10.6% (21.5 million) and fuel costs fell by 14.3% to GBP305.4 million. Interestingly, airport charges rose by 16.6%, reflecting the fact that easyJet operates mainly out of primary airports.

That raises the question of whether Ms McCall, despite the focus on the pace of growth in her review, will also analyse whether the continuing drift towards the provision of 'business services' - including the use of primary airports - is in easyJet's interests. It was once difficult to identify any tangible difference in the operating philosophy of easyJet and Ryanair but while the latter has made cost savings an obsession, easyJet has tended to go the other way, adding value wherever possible.

This has taken the form of selling tickets through GDSs, providing passenger lounges, rapid check-in, no weight limit on hand baggage and providing increased ticket flexibility (e.g. 'Change to an earlier flight home for free'). Its package holiday business, which allows travellers simultaneously to match up flights to more than 15,000 hotels across Europe by combining flights and hotels, has been expanded and cargo is now carried on some flights.

But the shift means the airline has also strengthened its position in key European business markets, such as Paris, London Gatwick, Milan and Madrid, incurring a greater than 10% increase in slots at capacity constrained (mainly primary) airports, rather than utilising the secondary and tertiary airports that Ryanair favours and where it might be virtually the only carrier with just a couple of flights a day.

"Business travel transformed" attracts the corporate trade

The easyJet website has a complete section given over to 'Business Travel Transformed', claiming that while "we may not offer business class flights but we do have business class solutions to all main UK and European airports". An examination of the route map offers only a handful of airports that might be classed as 'low cost alternatives' (e.g. London Luton; Doncaster-Sheffield; Liverpool and Cologne Bonn), though it does operate to primary airports where budget terminal facilities are offered, or will be (e.g. Copenhagen, Brussels, Madrid, Marseille and Bordeaux).

There is however some evidence of cost consciousness. For example easyJet closed its East Midlands Airport base (Manchester Airports Group) completely then started to build up services at the nearby Doncaster-Sheffield Airport (YVRAS/Peel Airports) and has reduced capacity by 20% at London Luton Airport (operated by TBI/Abertis), where the municipal council (which owns the airport), did not take kindly to requests by easyJet that it should lower its charges.

While all LCC operators regularly review their existing model in line with industry developments, this shift looks to have lasting implications, not only sending out a message that growth in a segment that has become mature is finite, but also perhaps that easyJet is set to make a quantum leap across the artificial boundary between LCCs and legacy airlines and might even be able to assume the role of British Airways and other European flag carriers in the short-medium haul European arena.

It is not the only LCC in the world to be looking across the bridge. The attraction of higher yields becomes almost overpowering, especially where the market for a commoditised product becomes crowded.

And, as business travellers have demonstrated an apparently irreversible willingness to forego creature comforts on short-haul flights, if there is frequency and on-time reliability and prices are low, so easyJet's attraction grows.

Fixing a course - and Sir Stelios

So, Ms McCall will not have much time for reading newspapers in her new job.

Issue 1: transforming business travel: This part of easyJet's strategy now appears to be fairly well defined and uncontroversial - even if not yet complete irreversible. But this does involve different decisions on how much premium product to add, while keeping a lid on costs. The cost religion tends to be a top-down phenomenon. Take an eye off it, and it will quickly bite you.

Issue 2: Timing the pace of growth: Ms McCall could be accused of a cop-out if she outsources advice on how fast the airline should grow. But then, she is brand new to the industry; and, more tactically, there is perhaps wisdom in being able to lean on independent opinions to confront any further attacks from the airline's founder.

But insofar as there may be a conflict between the long term best strategy for easyJet and the short term interests of its shareholders, defining the criteria for such a judgment will be crucial; the outcome may also prove less than optimal too, if the CEO subsequently finds her hands tied in a decision she didn't make.

Issue 3: Taming Sir Stelios: Or at least, neutralising his disruptive impact on the airline's day-to-day management. Each of the easyKnight's beefs (growth, ancillaries, brand) may have independently serious foundations. But there comes a stage when it is unclear whether the aggregated onslaught has become more intestinal than cerebral.

Sir Stelios shows some signs now of being embarked on a crusade. If that is the case, logic and reason may not be the best weapons. Ms McCall clearly has a decent armoury. She'll be looking to move as quickly as possible past this first test.

There's plenty to do in the real market.

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