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CAPA Live Transcript: CityJet well positioned for the demand spike

Analysis

Before COVID-19 CityJet had wet lease agreements with five airlines, but four of those evaporated, leaving just SAS, with whom CityJet had a mutual dependency as they were responsible for an enormous proportion of SAS’ regional network.

The airline went through a process in Ireland called Examinership, unique in the EU, which is like chapter 11 except in the US chapter 11 is more creditor-driven; examinership is more possession-driven.

The airline wants to continue with the wet lease model, but could also consider a franchise or quasi-franchise model.

CityJet is looking to obtain a UK AOC to protect against some potential restrictive rules that may be coming in.

Talking at the CAPA Live on 13-Jan-2021, CityJet’s CEO and Executive Chairman Patrick Byrne spoke with CAPA’s Chairman Emeritus Peter Harbison. Some of the key highlights can be found below.

Before COVID we had a wet lease agreement with five European airlines, but since COVID we are just working with SAS.  

“We're probably heading back into biblical times because we will forever more in the industry talk about BC as in before COVID in the Old Testament.

"So in the Old Testament, our business model, we were 100% wet lease with our activities. We ceased to be a scheduled carrier in our own right about two years ago. We went fully into a wet lease with five airlines in Europe, SAS, Brussels Airlines, Air France, Lufthansa, Aer Lingus. Our model was quite simple in so far as we would provide the aircraft and the crew and the maintenance and the insurance, we'd show up and fly, typically, our contracts would be probably four or three years and out as long as six years, not as long as the CPA model capacity provider agreement models in North America, which can be 10, even 12 years. But we were getting there.

“We're trying to emulate the North American model and import that into Europe. So essentially, we would provide our AOC, obviously, for all of our operations, but we would fly as the customer airline. We would have our aircraft liveried in their colours, wear their uniform and deliver onboard their products exactly to the same standards as they would deliver it to their own. And all of that was subject to rigorous monitoring and SLAs and KPIs and bonus payments and penalties. So bonus and penalties for on-time performance and reliability and all of that kind of stuff.

"So we became very much integrated into the customer's operation, but we retained our own independence of operation to their standard. So that essentially had been our model before COVID.

“When COVID came along, we obviously, like the rest of the industry, we headed into unprecedented territory, and most of our contracts, four out of our five contracts literally evaporated because the customers invoked force majeure, because nobody envisaged something like this. SAS did not. Thank God. And because we recognised that we had a mutual dependency on each other because we were responsible for an enormous proportion of their regional network. And that was very important, and we had actually built quite an infrastructure in Scandinavia to service that network."

"So we worked out an arrangement where we obviously did everything to reduce costs everywhere we could, and to try and ride out the storm because we knew that we were going to be parked for a number of months and then ramping up to a small degree and then a progressive degree. And then that has regressed again as more restrictions are biting Europe.

To protect the business we went into a process called examinership in Ireland, which is more debtor-driven. We emerged in August and are a lot lighter than we were, but we survived

“But we are looking forward now to hopefully, by early summer, we do anticipate that there will be an uplift again, number of factors at play there, obviously dependency on vaccine rollout, also at seasonal change, which last time had a big impact in lasting transmissibility of the virus and so on. So high dependency on a number of critical factors, but we are optimistic that we will be getting back to that.

"And then there will be the question of trying to spark other opportunities to rebuild our portfolio, because we have taken quite a pounding. And in all of this to protect the business, we went through a process in Ireland where we're domiciled called examinership, which is unique in the EU. Examinership is like Chapter 11 in the US, except in the US Chapter 11 is more creditor driven, Examinership is debtor in possession driven.

“So it's a much more benign piece of legislation designed to give the company, the airline every chance of finding a solution so that it can emerge from Examinership successfully. And with the very great good will have creditors and lessors, and our main customer and our shareholders, we can show that process. It's a hundred day process. In our case was about 120 days, so you can get an extension.

"We emerged from that successfully in August, a hell of a lot lighter than we were. It had a dramatic impact on us. We lost more than a third of our fleet. We lost nearly 60% of our human resources. So that was difficult, but we survived and we're alive, and we're operating a small number of our aircraft at the moment. Hopefully, progressing on that over the next few months. And we're still in business. And I think that we're one of the few regional carriers in the business and poised for other new wet lease opportunities as they emerge.”

We hope we are in a good position to take advantage of the spike in demand; "..trip costs has got to be the big thing"

“We think we are in a pretty good position. We're pretty confident the gauge of aircraft that we fly, our fleet or the Bombardier CRJ900. We're pretty confident that that size aircraft, that size jet is going to be the one, and that that gauge will be most in demand soonest.

"And again, we look to North America where we see that actually is the case, CRJ 900s, 700s, and E-175s are the aircraft that are back in the air and they're actually very, very busy over there. We believe that's going to happen here because we think that loads will be light as recovery starts. And I think that being able to go back on routes for the main carriers is critical. Being able to secure a frequency to service the market is critical.

“But trip costs has got to be the big thing. So I think that with low loads, I think that recovering airlines have to have a very critical eye on trip cost. And that's where the CRJ900 comes in. It's the right size, can service a lot of those markets. We do think we will be in a very strong position to provide the capacity that we think is going to be needed, because we don't think that the larger aircraft are not going to be deployed too quickly, as long as there's no density in traffic on routes, but airlines will be anxious to preserve slots, they will be anxious to protect market position, they will be anxious to defend routes they previously had. And the tactical weapon for doing that is the regional jet.”

We are going to head into a competitive scenario with a lot of new entrants in the market

“It's going to be very difficult, because free competition thoughts will start to enter into the equation again soon. So it's going to be a balance of are you over protective of those slots? Are you giving an unfair advantage to new start-up airlines who are taking advantage of low lease rates and availability of crew that were laid off or permanently let go by some of the legacy carriers?

"So we're going to head into quite a competitive scenario, I think, where there will be a lot of new entrants into the market as well. So it's going to be quite challenging. And I think there are elements that will emerge that we don't even foresee at the moment. I think it's going to be quite a different place, quite a different market.”

We will continue with the wet lease model, but could also look at a franchise or quasi-franchise model

“At the moment we're firmly fixed in wet lease, having made that big decision to get out of it. Maybe it's worth just looking at why we made the decision in the first place.

"When I set up the airline back in '93, and we started with a franchise with Richard Branson's Virgin. And we were called Virgin CityJet was our airline, but we were using his brand. We then went independent in '96 and we developed our own brand, the CityJet brand. And we had a creeping relationship with Air France where we were doing some wet lease for them and some franchise. And they eventually bought us in 2000 and we went totally wet lease within the Air France group. But then Air France took a decision a few years later to reinstate the CityJet brand as a standalone brand, but still owned by the Air France group.

“And we had quite a success. But when we were no longer part of the Air France group, having a brand of your own and even though you're subscribed to a very strong market value, brand values and everything else, you are always fighting an uphill battle against the reach and the broad distribution of the established brands, and you just cannot make it on your own.

"So I think that it is impossible for a regional brand, unless it has an incredibly protected zero competed niche, and I don't know of too many situations like that anywhere in the world, it is impossible to survive as a small regional carrier with your own brand. However, I do believe that as a companion to wet lease, I think that franchise or quasi-franchise is something that's going to emerge quite soon. And CityJet would certainly look at a situation where we would look at a franchise with a very established brand with good distribution.

“Again, we'd look at all of those things of how competitive the routes we would be going on because it would be our risk. Or it could even be a hybrid between a wet lease and a franchise where there's risk sharing between the franchisor and the franchisee using the franchisor's brand. So I do think that's going to be an emerging model and I think quite quickly that could well emerge. And we would certainly be interested in that type of model, as well as a complement to our wet lease portfolio.”

It's likely that legacy carriers will realise the value of their brand and have to revisit their cost base, so that may well be either a wet lease option or a franchise of some of their activity

“I think that what's going to happen or likely to happen is that as the legacy carriers and many of whom have had to turn to their governments for support, I think what they're going to realise quite quickly is that the most valuable thing they have in the wardrobe is the brand. And they're going to have to really revisit their cost base. And I think that they're going to have to look at that if they want to grow and try and get back to where they were, maybe they need to figure out clever ways of leveraging their brand with a lower operating cost base. And that may well be either a wet lease option for some of their activity or a franchise for some of their activity.

"So I think that they will end up with a mixed portfolio of their own flying, wet lease flying and franchise line. But the brand is the valuable thing that they have.”

We have six CRJs active at the moment and hope to be back up to the full complement of 10 by June or July, but it’s a moving target, and predictions have proved wrong

“At the moment we have six active CRJs. We were up to 10, we have six active at the moment, and we are hoping that we will be back up to pretty much full complement by, we're looking at sort of June, July has been that time.

"But again, I'm not rushing out to buy a lotto ticket because I don't actually know the numbers on the winning tickets. And many people are making predictions and we're all wrong. We don't know. It's a moving target. But we sort of think around that sort of timeframe, that is when we should be getting back to close to full production. But the only thing we have learned over the last number of months is be prepared to be disappointed.

“We've availed of a number of government support programmes where we operate. Our main base of operation now is Copenhagen. I mean, we've gone from having nine bases to now one operational base. That has been the impact of COVID on our business. So we are operating out of Copenhagen and our operation centre is in Dublin, but our actual flight operations, the actual metal is operating in and out of Copenhagen.

"So we're not flying as full a programme even per aircraft as normal, but we do have six active aircraft at the moment. We rotate crew as much as we can, but also we have availed of government support, as I say, in terms of furlough schemes and government support to be able to do that. And we're very grateful for those schemes, they have been of tremendous practical help to a small airline like us.

At the moment BREXIT doesn’t make a lot of difference, although we are looking to obtain a UK AOC

“To us it doesn't really make a lot of difference at the moment. And we don't have operations in the UK at the moment. There are some restrictions. I mean, we do operate some charter business in the UK. We do look to obviously, to provide wet lease to the UK. So we do see some restrictive rules coming in now from the CAA, where they're basically saying that a UK carrier cannot wet lease in a non UK aircraft for more than three days, which would be quite a blocker for a potential business, for somebody like us in the UK. We are however, looking at obtaining a UK AOC. So we would probably go down that road of getting a UK AOC as a complementary AOC to our Irish EU AOC.

“I think a number of airlines are doing that and I think it will be a good thing for us to do as well. Outside of that we don't really see any great impact on Brexit. Supply chains potentially, and we're examining that at the moment.

"It has been again, another moveable feast, and it hasn't been fully understood. We're only getting to the point of really understanding what the... I mean, it's a heap of paperwork. It's more paperwork getting in supplies from the UK now that we don't fly the Avro anymore. So we've retired our Avro fleet, so we're not as dependent on the UK as a parts source. Most of our parts are coming from outside of the UK, but we still do have a dependency for some supplies from the UK. So that just means more paperwork, but all surmountable. Just a bit more work, a bit more processing. But it's not the end of the world.”

CAPA Live January 2021 Highlight: Patrick Byrne CEO & Executive Chairman CityJet

We have no plans to change ownership and our shareholder has been very supportive

“Where we are at the moment is we're very solid with our existing shareholder.

"And there are no plans on the table at the moment for any of that to change. And our shareholder has been very supportive over the last six years now, which is since they came in, and were tremendously supportive when we went through the Examinership process. So we have been through the wars together. I think we understand each other extremely well. And I think as they would say in Hollywood, 'we're good'.”

We did put in a bid for the Aer Lingus regional franchise and are still interested if they want to get back to us!

“We were a bidder for the Aer Lingus regional franchise. The current 10 year franchise ends on 22-Dec-2022. We put in a joint bid with our friends in Spain, Air Nostrum. So Air Nostrum and ourselves put in a joint bid for that business. We were not successful. Conor McCarthy was selected as the preferred bidder. They went into a period of exclusivity for four to six weeks, that's been extended, we think, by a few more weeks."

"So I would presume that that will lead to the awarding of a contract to Emerald. I believe they've applied for an AOC. So aside of that really, I don't know. I mean, I can just imagine that Aer Lingus have made a decision that Emerald as the preferred bidder, that they will prosecute that to contract stage. If they want to come back and talk to us any time they have my phone number. We'd be delighted.”

We’ll see some virtual airlines emerging, but the history of these virtual airlines has not been good. I think we'll see a consolidation of regional carriers like us, rather than a whole host of new entrants

“If I look back again "BC", which seems like a hundred years ago, but yet, it's not even a year yet, but it seems like an awful long time ago for all of us I think in the industry. But if we look back then, there were a lot of new entrants into the market in the wet lease business. And I do not believe that there will be the same number. When the smoke clears there will not be the same number after the event. Yeah. I think that people have been so badly burned, I just do not believe that investment capital will be as easy to attract for that type of business. I don't think so. I really don't."

“I do see a trend of people saying they'll set up a virtual airline, and I think we'll see some virtual airlines emerging and they will wet lease in. But again, the history of these virtual airlines has not been good in the past, and I don't see why it's going to be any better in the future, to be honest. If anything, it's going to be even more challenged."

"And that kind of short-term thing of would we be attracted to fly for a virtual airline? I don't think so. Because you want to have longevity in your contract, you want to be pretty sure it's going to be solid. And you go to a lot of effort to put two or three airplanes into something that could burn out in nine months. And you don't make any money over that, you just lose a lot of money because your upfront investment and getting in crews, converting them, or bringing them over to your OCC course, all that kind of thing. All of that costs money.

“So you have to get a return on that investment. And that means you have to have an expectation of two, three years activity out of that. And I think that the short-term high-risk stuff, I think it's dangerous. From an economic point of view I think it's dangerous.

"So I don't think that we will be flooded with new entrants into the ACMI market. And even if we are, I think that the larger legacy carriers are going to look very, very carefully at who they contract with. They're going to want to make pretty sure that you have staying power, stamina that your balance sheet is in good shape, that you have a strong, solid shareholder standing behind you. I think that's going to become more and more important. If anything, I think we'll see a consolidation of regional carriers like us, rather than a whole host of new entrants, smaller new entrants. I think we'd see a consolidation. I think the large legacy carriers want to know they're dealing with somebody very solid.”

State aid rules have just evaporated. The industry had to be saved, but it does throw into question what are the new rules?

“We look at the landscape now, it's totally changed. When I think about the effort we went to when we announced our intended merger with Air Nostrum two years ago now or more. The amount of effort we had to go to, to get the blessing of the EU on that because of competition. When I even think of the amount of processing we had to go through while we were doing a wet lease, with Aer Lingus we were transferring what was our route on Dublin on the city to Aer Lingus, and then to operate with a wet lease. The amount of money we had to spend with lawyers, the amount of time it took to deal with the UK authorities on that, was all to do with competition.

“And now in one fell swoop, competition has been thrown out the window, because all of the state aid rules just have evaporated. And that's going to be a really interesting conversation very, very soon as to, well, what are the new rules? I mean, do we even need a DG4 anymore? I'm being slightly facetious, but why do we have the competition authority when suddenly, anything goes now really? I mean, I'm not saying that it was a wrong thing at all. No, not at all. But the industry had to be saved. Absolutely had to be saved. No question about that. And I'm delighted that the industry has been saved. But it certainly throws into question, what are the new rules? And we pick up the paper every day and we see an Air France looking for more money and Lufthansa got a ton of money and on and on it goes. And they're huge telephone numbers that we're talking about.

“And then people like Michael O'Leary will be jumping up and down and saying, "Well, hang on a second. I don't get any state aid', and whatever. But he has his own way of responding. I think he just is great at the land grab and he will do very well. I have no doubt about that. I'll put my money on him.

"But I think it's an interesting question. And how is it going to be unwound? The industry is notorious for going through, as we all know, cycles. And it'll come up and go down and whatever. I would imagine that the airlines themselves who've got the state aid, will want to unwind that state aid just as quickly as the governments who've given it want it to be unwound as well.

“So I think that everybody is kind of uncomfortable with it, but accepting that it's a necessary thing for now. So I would think that the industry will not want to be supported by state aid into the future. And I think that it's a bit like when the banks got bailed out after the 2008 crisis. I think eventually the governments got paid back. I think it's important that the governments do get paid back and that the airlines have true independence again. I think that's in everybody's interest. And I think that's what's going to regularise competition, if you like, again. It's going to balance it. It's going to take a few years though. I can't see it happening in the very short term. It's a five-years plus thing, I think.

“We never say never, but we think we're kind of impregnable now, because I think we've taken so many body blows. But having gone through the process we've gone through, and it's been very tough on a lot of the people who are not with us now, and the people who are, I mean, they've gone through very tough times. But I think we're very strong, we're very determined, we have a huge appetite to grow again, and we're not going to let a little bugger from China beat us. That's for sure.”

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