17-Jan-2014 5:27 PM

Airberlin receives a vote of confidence from Etihad, but how will the relationship evolve now?

Analysis

Wolfgang Prock-Schauer and James Hogan, respectively the CEOs of airberlin and Etihad Airways, held a joint press conference in Berlin on 13-Jan-2014. At the conference, they reviewed the progress of their codeshare agreement since 2012 and outlined plans for its development in 2014.

In addition, Mr Hogan took the opportunity to reinforce the rationale behind Etihad's equity alliance strategy ("Global reach is beyond the capability of any single airline"). He also reiterated his airline's support for airberlin ("We are confident that airberlin is on the right path back to profitability and the next phase in the airline's proud history").

The announcements led to an 11% increase in the share price of Air Berlin PLC on the day as investors were cheered by Etihad's vote of confidence in the loss-making German carrier. Nevertheless, the closer co-operation signalled by the two airlines stopped short of what some observers had expected. Further developments cannot be ruled out, however.

Summary

The codeshare agreement between Etihad Airways and airberlin has seen a significant increase in common passengers and revenues in 2013.
The two airlines plan to further expand their joint network in 2014, adding new routes and increasing frequencies.
Airberlin plans to add more US frequencies in 2014 and complete the retrofit of its long-haul fleet with Etihad's business class product.
Etihad Airways' equity alliance strategy aims to build a global network through organic growth, codeshares, and minority equity investments.
Etihad has reiterated its support for airberlin and its commitment to the long-term strategic investment.
The two-year lock-up period for Etihad's 29% stake in airberlin is expiring, raising questions about the future of their partnership and potential ownership and control limits.

Common codeshare passengers and revenues grew sharply in 2013

The codeshare agreement between Etihad and airberlin has carried almost 900,000 common passengers in the two years since it came into being. In 2013 the number was 563,000, which was an increase of 74% on the 2012 figure of 323,000. Common revenues generated by the codeshare increased from EUR100 million in 2012 to EUR200 million in 2013. Airberlin carries the Etihad EY code on 66 routes, compared with 33 Etihad routes carrying the AB code.

Airberlin and Etihad joint codeshare passenger numbers ('000): 2012 and 2013

Further expansion of the joint network is planned for 2014

The two carriers currently operate 42 weekly flights between them on routes connecting Germany and Abu Dhabi. In Feb-2014, a second daily Munich flight will be added, taking the weekly total to 49 flights. Airberlin announced the addition of new routes for the joint network in 2014. These include destinations in India, South Korea and Australia.

The two will also expand their joint sales operations, adding to the 17 joint sales offices around the world that represent them in more than 50 markets.

Airberlin's Mr Prock-Schauer, said: "The comprehensive commercial partnership with Etihad Airways has brought many benefits to airberlin, including our shares of joint revenues of EUR200 million, which is an integral part of our turnaround program." He also referred to the benefits to airberlin passengers of being able to offer additional destinations and improved services as a result of the partnership.

Airberlin and Etihad joint codeshare revenues (EUR million): 2012 and 2013

Airberlin to add to US frequencies in 2014

In other indications of its plans for 2014, Mr Prock-Schauer said that airberlin will add to its US network, where it serves five destinations from Berlin and Düsseldorf, by increasing frequencies on its services to New York JFK and Chicago. In 2014, airberlin will fly 45 weekly frequencies to the US, where its oneworld partner American Airlines offers a significant number of additional destinations. It also has nine tourist destinations in the Caribbean.

Its new business class retrofit of the long-haul fleet is expected to be complete by the summer 2014 schedule. This new product is based on Etihad's business class. WiFi will be added to the entire fleet over the next three years.

Airberlin's US and Caribbean destinations

Europe frequencies to grow by 8% on average

From its main hubs in Berlin and Düsseldorf (it is the leading carrier in both of these airports), airberlin's focus in Europe is on the 10 largest airports in Germany, in addition to Vienna and Zurich, while it also has a significant presence in Spain (it is number one in Palma de Mallorca) and Greece. In 2014, it plans to increase frequencies by an average of 8%.

Airberlin's network from Berlin

Airberlin's network from Düsseldorf

Airberlin's network from Palma de Mallorca

Airberlin's network to Greece

Three strategic elements for Etihad to build a global network

Etihad Airways' James Hogan said that Etihad's business model was "about partnership", referring to the "traditional alliances" as being "fractured". Etihad was very focused on how to "build from Abu Dhabi a global network that reaches all parts of the globe".

Its strategy to achieve this includes three elements: organic growth, codeshares with a range of airlines and Etihad's 'Equity Alliance', of which Mr Hogan said airberlin was a "foundation member".

Etihad's equity alliance investments are 'for the long term'

He explained this latter element in further detail: "The Equity Alliance partners enable us to stretch our network globally and these investments aren't for the short term, they're for the long term. They are part of a very clear strategy over the next five, ten, fifteen, twenty years to build a network, where the guest… can link into a network."

Each of Etihad's equity partners provides it with access to new markets. In addition, members of Etihad's equity alliance are increasingly co-operating with one another. The number of codeshare routes is also increasing across the Equity Alliance. For example, airberlin now offers 41 combined codeshare routes with Air Serbia, Virgin Australia and Air Seychelles.

Etihad Airways equity partners

But Etihad is seeking more than just network benefits. More than any other carrier that has made minority equity investments in the airline sector, it seems that Etihad is attempting to derive the benefits of outright acquisition with its equity partners. Mr Hogan even used the word "Group" when referring to Etihad's equity partners, as if he views them as a single Group of companies.

One of the key benefits of successful acquisitions is that they can achieve cost synergies that are much deeper than those achieved by commercial partnerships. Mr Hogan is aiming for such benefits: "…The key to success isn't about buying brands; it's about all the carriers within the Group moving to sustainable profitability and we achieve that through scale.

"When we sit down with Boeing and Airbus, our discussions are about 500 aircraft. When we discuss with General Electric and Rolls Royce, the type of deals we are able to achieve as a group become better, because it's about volume and it's about unit cost. The flip-side is that we also achieve higher productivity."

Equity Etihad Airways partnership benefits

Why Etihad invested in airberlin

Mr Hogan recalled the reasoning that led to his carrier's investment in airberlin, which he described as "one of Europe's leading business and leisure airlines". A key attraction for Etihad was Germany, which is Europe's largest outbound market. Airberlin is the number one carrier in Berlin and Düsseldorf, through which it provides Etihad with additional gateways to the German market beyond its Frankfurt and Munich services (although Etihad also serves Düsseldorf).

"We invested in airberlin because we obviously saw the potential. What appealed to us in airberlin - they in fact carry more passengers than British Airways - [was] the size of the market, the scope of the business in Europe. [It] was a no-brainer for us to enter in to the partnership. The airline is well positioned. The connectivity that we bring strengthens both airlines."

Etihad reiterates its support for airberlin

Significantly, Mr Hogan reiterated Etihad's support for airberlin as it continues to implement its Turbine restructuring programme: "…airberlin's new business strategy has made great progress and Etihad Airways continues to place its full support behind the airline and its management." He added that "airberlin is making outstanding progress in a tough aviation market and being here [in Berlin] today is our endorsement of the airberlin business model".

Mr Hogan described Etihad's commitment to airberlin: "Quite simply, it's a long term strategic investment. We are going nowhere. We are here to work with the management team of airberlin. … The long term goals we see very clearly. As an airline, as a partnership we continue to develop into each other's network the passengers that we expect. We see the growth…. The benefits from a revenue perspective have been exceeded."

Etihad has provided more than EUR500 million to airberlin

Mr Hogan stated that it had cost his airline USD105 million to acquire its 29% stake in airberlin and that this sum was recouped in the first six months through revenue generation and cost savings resulting from the closer cooperation. Setting aside the question of whether, and how much of, the benefits could have been achieved without an equity investment, there is more to the full picture when it comes to the sums invested by Etihad in airberlin.

In fact, the funds supplied to airberlin by Etihad go well beyond this transaction, which amounted to EUR73 million. Etihad also acquired 70% of topbonus (the airberlin FFP) and provided EUR156 million in debt financing and a further EUR40 million through a convertible bond issue. In addition, airberlin's 2012 annual report made reference to EUR58 million of funds provided by Etihad in connection with a joint procurement programme and indemnity income.

Funds provided by Etihad Airways to airberlin since Jan-2012

	EUR million
29% of airberlin equity	73
70% of topbonus	184
Debt financing	156
Convertible bond	40
Receipts re joint procurement	32
Indemnity income	26
Total	511

These items no doubt have their own rationale and pay-back horizon, although it seems unlikely that the total sum of EUR511 million has been recouped in such a short timeframe. This is groundbreaking investment territory in an industry in transition and while there are undoubted risks associated with the purchases - which need to be appropriately weighted in the reward equation - the potential upside in financial and strategic terms is extraordinary.

For example, the investment in topbonus mirrors Etihad's investment in Jet Airways' FFP, JetPrivilege and raises some intriguing questions about how - and when - synergies can be exploited; each of the programmes is profitable in its own right, a positive start. Joint purchasing, the shadow cast by the "Group" and simply the ability to grasp a significant strategic role in the group airlines should deliver benefits in making the arrangements so attractive for the equity acquisitions that they will be unlikely to want to leave.

Joint livery A320 unveiled for marketing campaign

Prior to the press conference given by Messrs Prock-Schauer and Hogan, there had been some speculation that a major re-branding of airberlin was going to be announced. Darwin Airlines, which is Etihad's most recent investment, is being re-branded as Etihad Regional and some had envisaged a similarly radical move might be on the cards for airberlin.

Mr Hogan explained the rationale for the Darwin re-branding, saying that the Etihad Regional brand "gives an opportunity to develop small, niche carriers, where the brand is unknown, into a network."

This clearly does not apply to airberlin and such a high profile re-branding might have drawn more attention from any critics that already feel that Etihad's interest in airberlin, while not breaking non-EU ownership limits with a 29% shareholding, is approaching a grey area in terms of limits on control exerted by non-EU nationals.

Wolfgang Prock-Schauer and James Hogan with cabin crew of airberlin and Etihad unveil an Airbus A320 in joint livery

The two CEOs did announce a new joint marketing campaign, under the slogan "Moving Forward" and unveiled an Airbus A320 in joint airberlin/Etihad livery. This stopped well short of the possible closer integration that had been rumoured in some quarters, but is perhaps more realistic. Nevertheless, the two may have to confront the ownership and control limits at some point in the foreseeable future.

Two year lock-up expires in Jan-2014: what next?

Etihad invested the EUR73 million in airberlin through a capital increase in Jan-2012, thereby taking its stake from 3% to 29%. At that time, it committed to hold the shares for two years, but also not to increase its stake and not to make a public takeover offer for Air Berlin PLC. With that two year lock-up period now all but expired, Etihad is able to choose whether to sell the stake, to increase it, or to maintain the status quo.

Mr Hogan's very clear commitment to airberlin rules out selling the stake. Maintaining the status quo beyond the short term looks unlikely too.

In Nov-2013, at the time of airberlin's 9M2013 results, it warned that its targets to restore profits and to lower net debt were slipping. In our analysis of the results, we suggested that an additional fund-raising may be a possibility.

If a new fund-raising were to take the form of equity capital, which seems likely (airberlin had negative equity at the end of Sep-2013 and cannot increase its debt indefinitely), and if other shareholders were reluctant to participate, Etihad could find its stake increasing above 30% and this could trigger a requirement for it to make a public takeover offer.

In turn, this could lead it to hit against the 49% limit on holdings in EU airlines by non-EU nationals, a scenario that has not really been tested in the past. With this in mind, it is not clear how Etihad's apparently open-ended commitment to airberlin will evolve, if it carries the Catch 22 risk that it could be blocked by ownership and control rules.

The need for airberlin to improve its finances without significant additional outside investment becomes more than just desirable in these circumstances.