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Alitalia's long-haul network and Etihad's short-haul feed are enhanced with Etihad's proposed stake

Alitalia has lost over EUR1.1 billion since its 2009 reincarnation, hardly an indication of fundamental change. Despite this, Etihad Airways remains in negotiations to invest potentially up to EUR500 million for a 49% stake in the carrier, the maximum allowed under EU regulations. What, it might be asked, does Etihad see of enough value to be in nearly five months of serious negotiations?

First, possibly, is Italy's domestic market, the 13th largest in the world and largest in Europe after Spain for seat and ASK capacity. Overall when ranked on all seats to/from/within the country, Italy is the world's eighth largest market overall for seats but lower when looking at ASKs. Etihad is weak in Italy, entering only in 2007 when Emirates and Qatar already had a sizeable presence. Etihad's 2014 capacity into Italy is expected to be a fraction of Emirates' and Qatar's. A role in Alitalia can help bolster Etihad in Italy, building on their existing codeshare.

In turn, Etihad can provide a virtual network solution for Alitalia in Asia, where Alitalia is extremely small despite sizeable capacity from competing Asian carriers. Etihad meanwhile can feed Alitalia's European network, alleviating some pressure from LCCs, in addition to Alitalia's eastward long-haul flights to the Americas. The network synergies have potential, but Etihad will need a long time-frame to capture a return on its investment; that is, assuming the Italian government is finally willing to restructure Alitalia in a sustainable way.

Etihad has lagged Emirates and Qatar in the local Italian market

Etihad entered the protected Italian market in 2007, by which time Emirates already had a sizeable presence with around two daily flights and Qatar was establishing itself. In 2014, Etihad's capacity into Italy is about equal to Emirates' size in 2005. Emirates in 2005 had about 140,000 seats and a daily flight; in 2014 Emirates will have (between Dubai and Italy only) 810,000 seats and six daily flights.

Qatar has about 350,000 seats and five daily flights (on smaller aircraft; Emirates deploys larger aircraft including the A380). It is only in 2014 Etihad is moving beyond a daily flight into Italy.

While Etihad repeatedly states it has no intention to be as big as Emirates, there is a noticeable gap in what Etihad versus other Middle Eastern/Asian carriers are able to achieve in scale in Italy. A just-below-majority equity stake in Alitalia would  allow Etihad to share the presumed (eventual) rewards of further scale in Italy, plus other benefits.

Emirates, Etihad and Qatar annual Middle East-Italy seat capacity: 2004-2014

Alitalia is weak in Asia while Etihad offers a solution

If Etihad does invest in Alitalia, Alitalia will join Etihad's equity alliance, which includes (invested and proposed members) airberlin, Air Serbia, Air Seychelles, Etihad Regional (Darwin Airlines), Jet Airways and Virgin Australia. A primary motive of Etihad's partnership strategy is to drive traffic through its Abu Dhabi hub. Between a quarter and fifth of Etihad's revenue is generated from its extensive partnerships, from equity carriers to interlines.

Another objective of the "equity alliance" is to put traffic on each carrier's network, not just between Etihad and partners but also among the partners; for example airberlin and Virgin Australia codeshare - despite airberlin being a member of the oneworld alliance, to which Virgin's competitor Qantas also belongs.

Etihad Airways equity partners

Alitalia can achieve both of these objectives. Alitalia's presence in Asia is almost non-existent. Italy's flag carrier serves just two points in Asia, Tokyo Narita (14 weekly flights from Milan/Rome/Venice) and Osaka Kansai (five weekly flights from Rome). Alitalia is the sole carrier in the Italy-Japan market, but overall is the 36th largest carrier between Europe and Asia ranked on seats. Its approximately 10,000 weekly one-way seats are one-tenth those of Lufthansa (mainline, excluding fellow group carriers) with 100,000 weekly seats.

More to the point, Alitalia has only about a 20% share of the Italy-Asia market. This is equal to Air China's share, and without Alitalia growing its position Air China in the short-term will likely become the largest carrier between Italy and Asia.

Seat capacity share by airline of Italy-Asia market: 21-Apr-2014 to 27-Apr-2014

There are clearly some missed opportunities. The largest Asian carriers operating into Italy have large and extensive hubs, but that does not preclude Alitalia from a larger role. China Eastern and China Southern are both fellow SkyTeam carriers, and Alitalia's European SkyTeam peers Air France-KLM partner with China Eastern and China Southern. To Alitalia's disadvantage, however, any partnership effort on its part would be arriving late - but not necessarily too late.

An Alitalia-Etihad deal would almost surely result in additional flights between Italy and Etihad's Abu Dhabi hub. Some of those would likely be operated by Alitalia, giving it an immediate boost, while others would feed into Alitalia's hubs, helping Alitalia's short-haul network.

CAPA previously analysed Alitalia's cost base, finding it to be too expensive compared with low-cost carriers in its short-haul routes and lacking medium/long-haul scale to feed its short-haul network. Additional feed would help begin to alleviate this problem.

See related report: Alitalia battles for survival in 2013, again, despite operational improvements

While a key Etihad's objective in partnerships is to bolster its Abu Dhabi hub, expanding the virtual airline concept, there are opportunities for development outside Abu Dhabi. For example, in markets (such as China) where Etihad is constrained on air services agreements, Alitalia could launch flights to those markets using available Italian traffic rights. With Etihad now having a range of strategic partner carriers in Europe – Aer Lingus, airberlin, Air Serbia, Etihad Regional – feeding a European hub becomes a distinct possibility. Moreover this potential has many of the signs of mutual wins for all airlines concerned.

However, the greatest synergies would still be where Abu Dhabi is the focal point. This could be achieved by routing an Italy-Asia flight through Abu Dhabi, where traffic rights permit. Air Seychelles operates a Mahe-Abu Dhabi-Hong Kong service. airberlin had operated services from Germany to Phuket via Abu Dhabi but ended the Abu Dhabi-Phuket tag. airberlin found yields to Phuket were, understandably, lower when routing through Abu Dhabi compared to when it operated non-stop to Phuket.

Whatever the details, there are opportunities for Alitalia to gain a larger – and arguably more justifiable – foothold in the Asian market with the help of a carrier with a hub in the Middle East or Asia, such as Etihad. For Alitalia to partner with its European friends, including minority owner Air France-KLM, would entail backtracking through Amsterdam or Paris.

Etihad may be attracted to Alitalia’s North American and Latin American markets

Etihad could potentially help feed – and gain offline access to – Alitalia's America's network. Etihad is more developed in North America than it is in Latin America. Alitalia has more seat capacity to North America than Latin America, although the majority of its North American capacity is to New York, to which Etihad operates and where partner Jet Airways also operates (via Abu Dhabi).

But additional New York inventory could always be sold. Boston, Miami and Toronto represent destinations Etihad does not fly to daily (Etihad's only Canadian service is three weekly flights to Toronto). Boston is likely too small for Etihad in the near future, while expansion in Canada is off-limits due to the capped Canada-UAE air service agreement. Qatar will be the first Gulf carrier to serve Miami when it commences service in Jun-2014.

Alitalia North America seat capacity by destination: Georgia, 'Times New Roman', Times, serif;">21-Apr-2014 to 27-Apr-2014

Airport

 

Seats

BOS

Boston Logan International Airport

3,276

JFK

New York John F Kennedy International Airport

13,348

MIA

Miami International Airport

4,102

YYZ

Toronto Pearson International Airport

2,340

 Source: CAPA - Centre for Aviation and OAG 

For Latin America, Etihad has gained offline access via a partnership with Air Europa, which serves 12 Latin American destinations with about 35,000 weekly seats. Alitalia's footprint is lighter with four destinations and about 14,000 weekly seats.

Alitalia's Latin American destinations all overlap with Air Europa, except Rio de Janeiro, which Air Europa does not serve (and nor does Etihad). Alitalia has more capacity to Caracas and Sao Paulo than does Air Europa (Etihad serves Sao Paulo) and about the same amount to Buenos Aires.

Air Europa and Alitalia Latin America seat capacity by destination: 21-Apr-2014 to 27-Apr-2014

Airport

 

Air Europa

Alitalia

CCS

Caracas Simon Bolivar International Airport

2980

3276

CUN

Cancun Airport

2328

0

EZE

Buenos Aires Ezeiza International Airport

4172

4102

GIG

Rio de Janeiro Galeão International Airport

0

2340

GRU

Sao Paulo Guarulhos International Airport

2980

4102

HAV

Havana Jose Marti International Airport

4892

0

LIM

Lima Jorge Chavez International Airport

4172

0

LRM

La Romana Airport

776

0

MVD

Montevideo Carrasco Airport

2384

0

PUJ

Punta Cana International Airport

776

0

SDQ

Santo Domingo Las Americas International Airport

4172

0

SSA

Salvador Luis E Magalhaes Airport

3160

0

VVI

Santa Cruz Viru Viru International Airport

1788

0

 

Total

34,580

13,820

Gulf-Latin America flights are long and require ultra-long-range aircraft, which is capital intensive and can see a higher fuel cost. Alitalia offers another gateway for Latin American services, and compared to Air Europa potentially allows Etihad to ultimately capture more trip revenue.

Alitalia must cut costs – irrespective of owner. It is stuck in a strategic no-man's land

Etihad has emphasised how its equity alliance offers cost-saving opportunities, although these take time to elaborate - joint purchasing in areas like aircraft and interior acquisitions for example. Etihad's investment in airberlin has yet to produce a satisfactory cost structure for airberlin, but it is too early and simplistic to attribute this to Etihad; airberlin was starting from a very difficult position.

That sort of support can help Alitalia in the future, but more immediately Alitalia has a desperate need to tackle its existing cost base.

Lack of published data precludes an analysis of Alitalia's CASK, but as CAPA previously found, an analysis of Alitalia's cost per passenger shows Alitalia has considerable room for improvement in competing with LCCs.

The urgency has become more severe as Europe's LCCs look to enhance their position in Italy.

See related report: Vueling, Ryanair, easyJet square up and all surround Alitalia in Rome: the gladiators are back!

Nevertheless, an analysis of Alitalia’s cost per passenger and average sector length against those of other European carriers shows that its cost base is quite competitive against other full service carriers (see chart below). Given an average sector length at the low end of the scale for FSCs, its cost per passenger is also at the low end of the scale and actually below the line of best fit for FSCs.

Having said that, its average sector length is much closer to the LCCs, but its cost per passenger is significantly higher than theirs. This shows it to be stuck in a strategic no-man’s land: neither truly a network carrier with a significant long-haul operation, nor truly short-haul point-to-point with a competitive cost base. Moving in either direction presents significant hurdles: up the average sector length curve and making use of a lower cost base, or down the curve into short-haul.

Costs per passenger and average sector length for selected European legacy and low-cost carriers 2011, 2012*

An Etihad role in Alitalia may be very welcomed by Air France-KLM. Delta will have its own views

Some have painted a picture of Etihad's possible stake in Alitalia stirring up Air France-KLM. AF-KLM had owned a minority 25% stake in Alitalia but in Nov-2013 saw this diluted to 7% after it did not participate in a funds injection. Many had assumed AF-KLM would throw Alitalia a lifeline and bring the Italian carrier into the Franco-Dutch group.

But an AF-KLM stake carried the baggage of concern AF-KLM would merely make Alitalia a feeder for the group's existing Paris and Amsterdam hubs. Medium- and long-haul connectivity was seen as being at threat, with an ultimate decrease in workforce numbers. And in Paris, concerns abounded about the risk of becoming the golden goose for a still-unreformed Alitalia.

Etihad however brings a more palatable solution for Alitalia. There is no other European mega hub to shift Alitalia's traffic to.

By contrast the process of boosting Alitalia's Asian presence in tandem with Etihad's Abu Dhabi hub is largely about new opportunities, not re-routing existing traffic. Only some of these benefits could arguably be embedded without the equity stake.

Etihad's consideration of Alitalia comes as AF-KLM also seeks a deeper relationship with Etihad. The two have a limited codeshare on specific routes, but indications are AF-KLM wants to advance to joint-venture status. This would bring to completion the triangle of Alitalia-Etihad (possible), AF-KLM-Etihad, and Alitalia-AF-KLM.

See related reports:

For its part, AF-KLM grew exasperated with Alitalia the company's inability to make needed structural changes. Alitalia is probably more impervious to real change than any other airline and has shown only limited indications of future willingness to embrace reality.

A broader AF-KLM role in Alitalia would have come as Air France confronts major cost and staff problems of its own - its own transformation plan is time consuming and challenging enough already. For Air France, proxy ownership through a linked partnership with Etihad could be a desirable outcome. Someone else could deal with its cantankerous neighbour, without Air France getting its fingers burned any further.

An Etihad stake creates a family by association, although no doubt there will be the typical and occasional family spats. More importantly, an Etihad stake in Alitalia would keep Alitalia in the hands of a group AF-KLM is comfortable with, rather than a direct competition. (That is, aside from the unspoken but ever-present alternative prospect of dissolution of Alitalia; in many ways it is scarcely conceivable that the airline still exists, although the aura of invincibility still seems to prevail.)

See related reports:

The implications of an Etihad stake in Alitalia could also have considerable impacts beyond Europe, and specifically in the US. There, staunchly anti-Gulf Delta Air Lines finds its trans-Atlantic partners in bed with the enemy – and competitor American Airlines, now the world's biggest, looks likely to do something with at least one Gulf carrier. (American has a Gulf love triangle of partnering with Etihad, having Qatar in its oneworld alliance while simultaneously being pursued by Emirates.)

Perhaps Delta will come to the conclusion its European peers already have: if you can't beat 'em, join 'em. But for now the airline seems furiously determined to persist with its protectionist stance.

EU probes foreign ownership of airlines 

Etihad's possible stake in Alitalia comes as Europe considers the role in European airlines of foreign ownership and control, the latter of greater focus. Ownership is relatively clear-cut to determine on paper, but "control" is a murky area and difficult to prove – or disprove, as the case may be.

In recent years Etihad has taken a stake in airberlin (upsetting Lufthansa) and Darwin Airline (now Etihad Regional, further angering Lufthansa).

But there are other examples: paradoxically Delta, the staunchest - and highly litigious - opponent of other airlines' foreign holdings has a 49% stake in Virgin Atlantic, improbably without any intent to exercise control; Korean Air has invested in Czech Airlines, China's HNA has acquired a share in Aigle Azur, and China's Henan province has invested in Cargolux. Darwin Airline, being based in Switzerland, is technically outside the EU's jurisdiction, although it needs to conform with EU rules to retain market access.

European Commission Director Air Aviation and International Transport Affairs Matthew Baldwin, speaking at CAPA’s Airlines in Transition conference in Dublin in Apr-2014, said the EC’s future vision for airlines is to have “global companies in practice and form” flying worldwide but without global consolidation, saying “our interest is in keeping strong airlines based in Europe, flying out of European hubs”. Mr Baldwin added: “We need strong EU companies. We can and should retain a tough competition regime. No apologies.” (In other words, one part of this means that having strong EU companies doesn't mean propping up weak ones.)

Network opportunities are largely evident. Negotiating the details becomes the key issue

So it is evident there are genuine network synergies and growth options, as well as all the other revenue-generating and cost-saving initiatives from an Etihad-Alitalia partnership, and specifically in being part of the Etihad "equity alliance". The question is if these opportunities outweigh the costs.

As Etihad continues what are still reported to be final evaluations, it is clear the carrier has targets that it wants met, as well as guarantees for other aspects. As the leaked preliminary Etihad-Air Serbia contracts showed, these deals are nuanced and varied, ranging from commitments for government travel to infrastructure expenditure. An Etihad deal is about much more than simply buying an airline's aircraft and routes. In fact, those may be almost side notes.

This feature of the equity relationships is often overlooked when analysis of Etihad's strategy compares it with, for example, the ill-judged (or perhaps ill-timed - timing is everything) McKinsey strategy which drove Swissair into the ground. As Etihad evolves its array of acquisitions it is inevitably learning more than any other airline before it about this form of dealing - and what is possible and what is not, what is essential and what is not.

At the heart of what Etihad will want from Alitalia is some form of ironclad guarantee that the Gulf carrier will not be seen as a refuge from reality. Without holding a controlling interest, that sort of guarantee is elusive. So Etihad will need to entrench a cut-and-run solution if Alitalia were to continue along its previously intractable way. But in this absurdly government-dominated industry that brings with it all sorts of political fallout. Getting it right up front is essential.

Alitalia has exhausted most options for survival, but change will still be resisted 

No doubt a contentious point for the Italian government to swallow will be double-digit thousand staff reductions. But these are inevitable, irrespective of owner, if Alitalia is to have a sustainable future. They are long overdue. And it is hard to see any path forward for Alitalia should Etihad walk away; the airline is beyond Plan B and well into the alphabet of alternative plans. Plan C - a Chinese airline - or Plan D - Delta are scarcely plausible as saviours of Alitalia.

Should an Alitalia-Etihad deal emerge, one of Europe's largest markets has a chance at sustainability and realising growth potential rather than merely offering it on a silver platter to competitors - something that will bring out the nascent protectionists in still more airlines.

Far more intricate will be the relations amongst AF-KLM, Alitalia and Etihad – as well as the spillover impact, such as to Delta. Etihad owning nearly half of Alitalia will contrast with Etihad's neighbour, Emirates, being told its existing fifth-freedom Milan-New York service is illegal - a surely temporary judgment. For Etihad, having Alitalia in its team will further extend its management bandwidth. Italian airlines and workforces have sorely tried the patience of more than one suitor attracted to Italy's traffic honeypot.

But there are clear mutual advantages if the deal can be done. Etihad would gain yet another foothold in the world market, continuing the process of connecting the dots and apparently demonstrating viability of a model that has - regardless of the eventual outcome - genuinely changed the course of global aviation.

See related reports:

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