Airline ownership & control. Why might Europe uphold something its officials call "stupid"?
In Apr-2014, the European Commission began an investigation into "certain non-EU investments in European airlines". These include Delta Air Lines' 49% stake in Virgin Atlantic, Etihad Airways' 29% stake in airberlin and 33% stake in Darwin Airlines (now renamed Etihad Regional), Korean Air's 44% stake in CSA Czech Airlines and HNCA's 35% stake in Cargolux. Any investment by Etihad in Alitalia might also fall into this category.
It is intriguing that the EC is bothering to investigate ownership and control of airlines at all. Europe has done more to liberalise restrictions in this area than any other region in the world. Within the European Union, there are no restrictions, as long as airline and investors are EU nationals. Moreover, Commission officials often publicly state their opposition to the concept (even calling the restrictions "stupid" and "outdated and harmful").
What has motivated these investigations, what are the points of interest in each case and what are their similarities and differences?
Competition concerns versus ownership and control concerns
Although there does not appear to have been an official statement from the European Commission on the investigations, Dow Jones reported on 4-Apr-2014 that the EC had asked the member states concerned “to provide further information on how these investments comply with the rules on ownership and control of European airlines”, quoting a commission spokesman. According to the newswire, the official said foreign investments are welcome in EU airlines, particularly if they expand connections between regions. “But if it’s a Trojan horse and reduces competition, that’s another thing.”
This latter comment is intriguing. Rules on ownership and control of airlines and competition concerns are two different things. Competition authorities tend to focus on cooperation that distorts or reduces competition, whether it takes the form of a commercial agreement (including a codeshare, for example), or a merger.
In each of the cases currently subject to investigation, the European Competition Commission has jurisdiction to approve, investigate, or block cooperation between the respective airlines, as appropriate. The commercial partnerships between the airlines could only proceed on the basis of approval from the competition authorities.
According to a Reuters report on 5-May-2014, Etihad views its strategy of buying stakes in European airlines as bringing fresh competition. "We are bringing competition in the market," Etihad CEO James Hogan said.
An investigation into the ownership and control position between the respective airlines is something else. It would be possible even for an outright acquisition to be approved on competition grounds, but not to be approved on the grounds of ownership and control if the acquirer were not an EU national.
Ownership is easier to define than is control
The restrictions on ownership and control have two strands. First, the easy part: ownership of an EU airline by a non-EU national must be limited to 49.9%, leaving majority ownership in the hands of EU nationals. All of the above transactions comply with this, based on the percentage of voting shares owned by the investor airline.
The concept of control is less clearly defined as it is not always possible to express numerically the level of influence that an airline (or other) investor has in the management of an airline in which the former has invested. Of course, factors such as entitlement to appoint directors are taken into account, but this is not always clear cut. Just because an investor is only entitled to appoint a minority of the directors, it does not necessarily mean that the influence of that minority is always less than that of the majority of directors.
In the past, there were many instances in the airline industry of minority stakes being taken by an airline in another airline of a different nationality, but where the effective control was never questioned. In such cases, the equity investment was relatively passive, even if it was accompanied by a codeshare or other form of commercial cooperation.
The transactions that are part of the EC investigation all have a commercial cooperation agreement at their core. They also include language suggesting a deeper relationship involving joint procurement and cost synergies in addition to the revenue synergies habitually claimed by global alliances and other cooperation models. When sealed by an equity investment, particularly fresh equity, it is possible to see how the suggestion arises that the question of de facto control is at least worthy of some further investigation.
HNCA's 35% stake in Cargolux
In the case of freight carrier Cargolux, Henan Civil Aviation Development and Investment (HNCA) agreed to buy the Luxembourg Government's 35% stake in Jan-2014.
The commercial cooperation agreement between Cargolux and HNCA includes the development of a dual-hub strategy centred on Luxembourg’s Findel Airport and on Zhengzhou’s Xinzheng International Airport. HNCA also agreed to participate in a capital increase in Cargolux.
Korean Air's 44% stake in CSA Czech
Korean Air agreed to buy a 44% stake in CSA Czech Airlines in Apr-2013 from state holding company Czech Aeroholding, which said the relationship would positively impact CSA's cost structure, due to the synergies available in purchasing services, technology and other items.
Korean Air chairman and CEO Cho Yan-ho said the investment in CSA would strengthen its presence in the Eastern European market, noting: “We are expecting to create a synergy effect through the partnership with Czech Aeroholding, which has a long business experience in the Europe and Asian markets. The deal will help boost the business of the two carriers and also cooperation between the two countries” (Korea Times/Joongangdaily, 11-Apr-2013). Korean also has a representative on CSA's supervisory board.
Korean Air said at the time that it did not plan to take part in the managing of CSA, but the language surrounding the transaction certainly suggests a deeper relationship than that of a more typical commercial cooperation, or even of a passive equity stake. Subsequently, Czech charter airline Travel Service agreed to take a 34% stake, alongside the 20% still held by Czech Aeroholding, and this may help to counteract any suggestion that CSA is not both owned and controlled by Czech nationals.
Etihad's 33% stake in Darwin Airline (rebranded as Etihad Regional)
Etihad Airways acquired a 33.3% stake in the struggling Darwin Airline in Nov-2013 and the Swiss regional carrier was rebranded as Etihad Regional Airlines from Jan-2014. Under the commercial agreement between the two, European travellers would be able to connect from the Darwin network through Abu Dhabi to Etihad destinations worldwide. In addition, the new Etihad Regional network would be linked into hubs of other Etihad Equity Alliance partners, such as airberlin and Air Serbia.
Etihad also parachuted a new CFO into Darwin Airline, appointing Shelley Cole from Air Seychelles where she was CFO on secondment from Etihad Airways. Darwin Airline CEO Maurizio Merlo welcomed her to the Darwin executive team, saying: "She brings to our growing business a depth of financial management experience that will help guide the next phase of its development and in particular, its new membership of the Etihad Airways equity alliance.”
Switzerland’s Federal Office of Civil Aviation (BAZL) was reportedly ready to approve Darwin Airline’s codeshare agreement with Etihad Airways for routes from Geneva to Belgrade, Rome and Zurich, as well as from Zurich to Dusseldorf and Linz, but was expected to review the planned codeshare on routes to Abu Dhabi from Geneva and Zurich.
Talk of cost synergies, the cooperation between Etihad Regional and other Etihad alliance partners, the appointment of a key executive and the significant minority stake held by Etihad all contributed to a perception that the relationship closely mimics an acquisition. On top of all that, the rebranding of Darwin as Etihad Regional Airlines appeared to be a challenge that the authorities could not ignore - even if the goal is to enhance marketability.
In Mar-2014, the Swiss civil aviation authority launched an investigation into Etihad Regional’s ownership structure. Spokesperson Urs Holderegger said: “We will examine whether the so-called ownership-and-control conditions are met and if the company is still in Swiss hands.” (Tribune de Genève/Air-Journal.fr/Basler Zeitung/24heures.ch, 18-Mar-2014).
Although the Swiss investigation is separate from the subsequently initiated European Union investigation, the fact that the Swiss authorities have approved the codeshare agreements (at least in part), but are investigating ownership and control, highlights the distinction between competition concerns and ownership/control issues.
Of course, an investigation does not necessarily mean any contravention. Etihad Regional's CEO Maurizio Merlo told CAPA TV in Apr-2014 that the authorities are doing "exactly what they are allowed to do". He added that there was no concern regarding management and control of the company. "Except the chief financial officer - it's a person from Etihad joining us - the rest is the same. I'm the chief executive since 2012. I have my chief commercial officer as before, we have a board of directors with three persons representing the shareholders of Darwin and we have two of Etihad. As you can see, they are in the minority. We are very comfortable that there is no stop on the transaction."
Even if Mr Merlo is right to be comfortable and the Swiss and European authorities do not prevent the transaction, there are other signs that the new Etihad Regional is not welcome everywhere in Europe. Previously Darwin had operated Public Service Obligation (PSO) routes in the domestic Italian market, but Italy’s L'Ente Nazionale per l'Aviazione Civile (ENAC) recently prevented it from bidding to renew such contracts.
Etihad Regional CCO Christian Schneider reportedly attributed this decision by ENAC to an unspecified airline or alliance (ch-aviation.ch, 24-Apr-2014). Mr Schneider said: “It seems that a European airline/alliance is trying to prevent us from satisfying the needs of European travellers.”
Etihad's 29% stake in airberlin
Etihad's 29% stake in airberlin dates from Dec-2011, since when it has also acquired a majority stake in topbonus, the German airline's frequent flyer programme and provided debt funding. The relationship includes a codeshare agreement, joint sales operations, an agreement under which Etihad has taken on airberlin pilots and cooperation over supplier contracts including engine procurement on their 787 programmes.
In Apr-2014, Etihad provided a further EUR300 million to airberlin in the form of a subordinated perpetual convertible bond. This is treated for accounting purposes as equity, but Etihad did not increase its stake in the voting equity of airberlin and so it did not contravene the limit on foreign ownership.
A more conventional equity increase subscribed by Etihad would have taken it well over the 49.9% limit. Having provided airberlin with more than EUR800 million in various forms of funding, there is no doubt that Etihad has single handedly rescued it from oblivion.
The EC investigation to consider whether or not it might contravene regulations on non-EU control was already under way before this new cash injection, which only added to the external perception that airberlin is an Etihad subsidiary in all but name. At what stage is the value of a passive commercial relationship overtaken by the need to exercise control of that company?
Nevertheless, airberlin told analysts on a conference call in Apr-2014 to discuss the 2013 results that it did not expect a negative outcome from the EC investigation.
See related reports:
- Airberlin: still in need of a cap that fits, although 1Q2014 operating loss narrows slightly
- Airberlin: Etihad to the rescue after another loss in 2013. Meanwhile codeshare partners are booming
Delta's 49% stake in Virgin Atlantic
Delta announced its trans-Atlantic joint venture agreement with, and acquisition of a 49% stake in, Virgin Atlantic Airways (VAA) in Dec-2012. The equity purchase was concluded in Jun-2013 following regulatory approval from the US and the EU.
The joint venture, under which the two airlines coordinate their schedules and pricing on flights between the US and the UK, was granted antitrust immunity by the US Department of Transportation in Sep-2013. This is the only one of the arrangements described in this report where a substantial overlap exists between the operations of the purchaser and the purchased. Nearly two thirds of Virgin Atlantic's seats are flown on North American routes. The other acquisitions deal essentially with operational complementarity.
Again, there was separate approval of the equity stake and the commercial cooperation.
VAA is now 51% owned by the Virgin Group, which appoints four of the nine board directors, and 49% owned by Delta, which appoints three. The two remaining directors are from the management team. Overtly, therefore, there is no evidence that Delta has either majority ownership or majority influence on the board.
Virgin Atlantic CEO Craig Kreeger is clear that Delta does not control the UK airline. He told The Financial Times (24-Apr-2014) that such concerns were "rubbish", saying he was certain that investigators would find nothing wrong with the way the business is managed. The UK authorities had to satisfy themselves that ownership and control limits had not been breached when they approved the joint venture between Delta and Virgin in 2013.
Mr Kreeger has also been adamant that the two airlines have, and will continue to have, distinct brands. He told The Sunday Telegraph (18-May-2014) that "Virgin Atlantic will be Virgin Atlantic, and Delta will be Delta."
Delta's 49% stake was previously owned by Singapore Airlines, but this was very much a passive equity stake and nobody ever questioned whether SIA controlled VAA. There was not the same level of cooperation between SIA and VAA as there now is between Delta and VAA and perhaps the JV gives the perception that control has to some extent been ceded to Delta.
Unlike the Etihad and HNCA investments, Delta has not provided fresh equity to VAA. The latter is more clearly having to find its own solutions to restore profitability, rather than to follow any path preferred by an external financial saviour.
See related reports:
- Virgin Atlantic Airways sees more than a little red, but things were much simpler 30 years ago
- Virgin Atlantic’s track record of losses: Delta should help, but what about SkyTeam?
Why is the European Commission undertaking these investigations?
The restrictions on ownership and control surely cannot be the number one issue confronting the European Commission, even in the area of air transport. Indeed, shortly after news of the EC investigations emerged, the EC's director of aviation and international transport policy, Matthew Baldwin, told CAPA's Airlines in Transition Summit in Dublin in Apr-2014 that the restrictions were "stupid" and should be changed. He added that this was "one of the reasons why this inherently global industry is not normal".
Mr Baldwin's is not a lone voice in the Commission on this issue. Speaking at the EU-ASEAN Aviation Summit in Singapore in Feb-2014, the EU Commissioner for Transport, Siim Kallas, called restrictions on ownership and control of airlines "outdated and harmful".
Why is the EC investigating this issue? On the surface at least, there is no evidence to suggest a contravention – each of the transactions respects the numerical limits on ownership of voting shares and on board composition. Moreover, the EC does not really seem to have any objection to the concept of foreign ownership.
Perhaps there is some truth in the suggestion that Europe's airline establishment has sought to influence the Commission in mounting these investigations. Etihad's Mr Hogan seemed to think so when he said: "Some legacy carriers are using the European Commission to challenge us rather than challenge us through competition" (Reuters, 5-May-2014).
Perhaps, too, given the apparently progressive views within the European Commission, the investigations are being conducted so that it can be seen to have addressed the concerns of these legacy carriers, while finding no contravention.
There is also the more legalistic point that, while restrictions on non-EU ownership and control are in place, the Commission is probably obliged to investigate any situation where there might be a contravention. Moreover, as Mr Baldwin said, it would not be wise for the EU to dismantle the external limits on ownership and control without negotiating similar concessions with other parts of the world. "Change multilaterally is best", he told CAPA's Airlines in Transition conference, "unilateral change may be attractive at some level, but is stupid".
CAPA has argued many times before that global restrictions on ownership and control are the major barriers to the airline industry's ability to cover its cost of capital.
If the current investigations throw the spotlight onto this archaic regulation and add even slightly to the pressure for liberalisation, they are to be welcomed (regardless of the individual outcomes).
See related reports:
- IATA raises its airline profit outlook, but the cracks are still clearly visible under the surface
- CAPA's Airlines in Transition: limits on ownership, legal knots, labour and long haul