01-Oct-2015 3:39 PM

Etihad's first joint financing with equity partners further tests archaic airline ownership rules

Analysis

Etihad continues to implement new forms of cooperation with its equity partner airlines, pushing beyond the limits of other partnerships not involving a controlling stake. The Etihad equity alliance goes beyond codesharing and revenue-generating activities to also seek cost synergies, which partnerships and alliances have seldom managed to achieve.

Etihad is now moving from specific operational synergies (crew resources, aircraft) to macro financing across the group via a USD700 million joint bond financing transaction in the capital market. The allocation of the funds is nearly 20% each to Etihad, Etihad Airport Services, airberlin and Alitalia; 16% to Jet Airways; and the remainder to Air Serbia and Air Seychelles. This is the first time that Etihad and its equity partners have raised funds together and may be the first such joint financing anywhere in the airline industry.

Etihad's equity alliance consists of non-controlling stakes. Nevertheless, as the airline itself said in a release on 21-Sep-2015, the partners collaborate "through measures which otherwise would only be available through mergers or takeovers". Etihad Airways Partners is looking and feeling more and more like a consolidated group of companies under common ownership and control.

Summary

Etihad Airways is implementing new forms of cooperation with its equity partner airlines, going beyond traditional partnerships to seek cost synergies.
Etihad and its equity partners have raised funds together through a joint bond financing transaction, the first of its kind in the airline industry.
The Etihad equity alliance is moving towards a consolidated group of companies under common ownership and control.
The cost synergies achieved through the Etihad equity alliance go beyond what is typically achieved through traditional airline alliances.
The recent joint bond financing transaction provides funds to each airline partner for capital expenditure, fleet investment, and refinancing existing debt.
Etihad's equity alliance demonstrates the redundancy of archaic aviation regulatory frameworks and the need to remove ownership and control restrictions.

Etihad Partners seeks to deliver on cost savings in addition to revenue growth

Although Etihad does not label Partners as an alliance, the cost synergies appear to go beyond what is achieved through the traditional airline alliances, whose benefit is strongest in revenue growth.

In the major alliances, cost saving initiatives have often been dogged by the member airlines failing to agree to a common platform. The role of Etihad as a shareholder to the airlines in Partners provides direction. (Although all members of Partners have equity from Etihad, the grouping has said it is open to carriers not affiliated with Etihad.)

The benefit seems tilted towards Etihad's invested airlines, which may not have the profile or security to attract financing on the presumably favourable terms Etihad has been able to. The collective size of the partners is an advantage, as too is Etihad's backing. Although the invested airlines may benefit, their strength in turn impacts Etihad as a shareholder. It is a very nice mutual benefit model.

Funds to each airline are modest, but expect more in the future

Etihad says the sum was increased from an initial USD500 million, due to the strength of demand. It was raised through a 'special purpose vehicle' named EA Partners IBV. Nevertheless, with 40% of the funds raised going to Etihad and its airport services division, the sums flowing to its equity partners are not huge.

According to our calculations, the 20% share of the proceeds going to each of Alitalia and airberlin equates to around USD140 million (although a press release from Alitalia on 18-Sep-2015 stated that it would receive USD122 million; Alitalia also recently raised a EUR375 million bond in its own right). Jet Airways' 16% share equates to USD112 million, while Air Serbia and Air Seychelles will share the balance of USD28 million.

To put these sums into some kind of context, at list prices USD140 million would buy roughly one and a half Boeing 737-800s or Airbus A320-200s and USD112 million is just more than the price of a Boeing 737MAX-8. Etihad, its airport services business and the five airline partners will use the funds for capital expenditure and investment in fleet, in addition to refinancing their own existing debt, depending on their needs.

The increase in the total size of the Etihad bond appears to suggest investor appetite and that further such financings can now be expected.

Spreading the risk is a valuable ingredient

The bond issue was completed in the week before the CEOs of the six Etihad Airways Partners airlines (airberlin, Alitalia, Jet Airways, Air Serbia, Air Seychelles and Darwin Airline, which trades as Etihad Regional and did not participate in this financing) gathered in Rome on 21-Sep-2015 for a meeting chaired by Etihad CEO James Hogan. Their purpose was to "identify and progress collaborative initiatives designed to cut the carriers' costs, increase their revenues, and expand sustainable choice for their customers".

The partners already engage in joint procurement and insurance of assets, IT pooling and collaboration over the training and deployment of human resources. The new bond extends the search for cost synergies from the domain of operating costs into finance costs.

The terms of the financing were not disclosed by Etihad in its statement on the transaction, although Reuters reported (15-Sep-2015) that the bond would pay investors interest at 6.875%. For the participating airlines, the main benefit is to provide funds at more attractive terms than they would be able to achieve on their own.

Lenders will see such an arrangement as less risky than an investment in any one individual airline, in particular those with weak balance sheets and/or a track record of losses. Since risk is seen as a trade-off against reward, investors in a bond with lower risk are happy with a lower reward and so will accept a lower interest rate.

Etihad equity alliance (date of investment on far left, ownership share on far right): 4Q2014 (includes Aer Lingus)

Etihad itself is not adding to its previous investments in the partner airlines

For Etihad, an additional benefit is that, unlike previous funding into its equity partners, this most recent financing is not provided directly from its own balance sheet. In particular, it ensures that its partners receive cash without Etihad's level of ownership increasing (which would result from a fresh equity investment) and without Etihad itself having to borrow money to lend on to the other airlines.

Etihad has previously invested considerable sums in the five airlines that will now benefit from the new financing from the special purpose vehicle. These past investments by Etihad have included a combination of direct equity investments in the airlines and, in some cases, in their frequent flyer schemes, in addition to shareholder loans and convertible bonds. Some of these have effectively been used to limit Etihad's ownership stake increasing. These are reviewed below.

Etihad's total investment in airberlin reaches EUR800 million

Etihad's biggest overall investment has been in airberlin. After taking a 29% equity stake in the German airline for EUR73 million and a 70% stake in its frequent flyer programme topbonus for EUR184 million in late 2012, Etihad subsequently participated in a range of further funding transactions in 2013 and 2014.

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These included the provision of a EUR156 million loan, subscribing EUR40 million to a convertible bond and injecting EUR300 million into airberlin through a perpetual subordinated convertible bond. This latter instrument is treated for accounting purposes as equity, as it has no maturity date and is convertible into shares, but carries no voting rights and so did not raise Etihad's ownership beyond the 29% level that it already held.

Etihad has additionally helped airberlin with funding through various other means involving smaller sums. In total, although a precise figure is hard to determine, airberlin had received EUR800 million or more from Etihad one way or another, prior to this most recent transaction. This compares with airberlin's 30-Jun-2015 balance sheet figures of total gross debt outstanding of EUR987 million and net debt of EUR767 million (and a negative book equity balance of EUR416 million).

Although not a direct investment by Etihad, airberlin would not have received the USD140 million (around EUR125 million) without Etihad's involvement.

Etihad provided EUR560 million to Alitalia

In addition to taking a 49% stake in Alitalia for EUR387.5, Etihad acquired a 75% stake in Alitalia Loyalty, the company that runs Italian airline's loyalty programme Millemiglia, for EUR112.5 million in cash. Etihad also provided other financing facilities to take its total investment in Alitalia to EUR560 million.

Alitalia has not published details of its balance sheet, including debt levels, although it did report a net loss of 1H2015 of EUR130 million. Under its strategic plan agreed with Etihad, Alitalia aims to post a profit in 2017 (which would be its first positive result this century).

At the time of Etihad's investment in Alitalia at the start of 2015, the Abu Dhabi airline's CEO James Hogan said, "we have made a commercial investment that must deliver a commercial return". He also suggested that Alitalia should not view Etihad's pockets as bottomless: "There are no free kicks. We don't have an endless reserve on cash."

The new special purpose vehicle has given Alitalia access to fresh funds, presumably at lower cost than it would achieve through its own balance sheet, while allowing Mr Hogan to honour these words.

Jet Airways received USD750 million from Etihad in total

Etihad has also invested heavily in Jet Airways, injecting cash of INR20,580 million (USD380 million) for a 24% equity stake and INR8,590 million (USD150 million) for 50.1% of Jet's frequent flyer programme JetPrivilege in 2013. Etihad also provided Jet Airways with a USD150 million loan and USD70 million in a sale and leaseback transaction for Jet's three pairs of London Heathrow slots.

According to media reports (Live Mint, 23-Sep-2015), Jet Airways' proceeds from its share of the EA Partners transaction will be used to buy bonds worth INR7,380 million (USD112 million) issued by India's second largest airline. Although this will refinance part of its debt at lower interest rates, the sum represents only around 6% of Jet Airways' total consolidated debt of INR119,030 million (USD1.9 billion) as at 31-Mar-2015.

EUR100 million for Air Serbia and USD45 million for Air Seychelles

Etihad invested EUR40 million for a 49% stake in Air Serbia in 2014 and also agreed to provide a further EUR60 million to the Belgrade-based airline in shareholder loans and other funding mechanisms. Its investment in Air Seychelles consisted of USD20 million for a 40% stake and USD25 million in shareholder loans in 2012.

See related reports:

Etihad is stretching the limits on archaic foreign ownership and control rules

Etihad's equity alliance, with its minority stakes in foreign airlines, is to a large extent a response to restrictions on foreign ownership and control in the airline industry. While honouring these limits from a strict definitional point of view, Etihad has pushed the spirit behind them to the limit.

As it continues to develop, it is difficult to look at Etihad Airways Partners as anything but an increasingly integrated group, centrally directed from Abu Dhabi. In many ways this is actually not greatly different from the branded global alliances, Star in particular, as the most tight-knit; the main difference is that Etihad Partners is more successful in convincing the partners to adopt common paths.

There may be some voices in the industry that will take this financing transaction as their cue again to raise the volume of protest against Etihad for circumventing ownership and control rules. These are the same voices that always seek to raise protectionist barriers against disruptive new business models that threaten their own less nimble and less efficient approach. Almost everyone seemingly is agreed that the ownership and control rules should disappear; however they do offer a perfect refuge for hiding behind when competition threatens the status quo.

What Etihad's model clearly demonstrates is the redundancy of that archaic aviation regulatory framework that spawned the ownership restrictions more than 70 years ago. It is time to remove them.

And for those who genuinely support liberalisation to encourage gradual erosion of the principles, where full removal seems too much to hope for.