13-Jun-2017 2:04 PM

NIKI no longer to merge with TUIfly in a setback for airberlin's restructuring

Analysis

On 8-Jun-2017 TUI Group announced the end of talks with Etihad about the planned new leisure airline combining TUIfly with NIKI, the Austrian subsidiary of the Air Berlin Group. According to TUI, NIKI was "no longer available for a joint venture". Etihad, whose appetite for equity investments appears to be waning, said it ended the talks after the parties had been "unable to reach agreement on the final nature of such a joint venture". The new leisure airline was still subject to regulatory approval, but the collapse of the deal was a surprise.

TUI remains open to partnerships, including mergers, for TUIfly, which lacks scale in a German market increasingly penetrated by foreign LCCs such as Ryanair. The sale of NIKI was to have been a further critical stage in airberlin's restructuring. Instead, an enlarged NIKI will continue to operate as part of the Air Berlin Group as a separate leisure brand.

It seems likely that airberlin will seek another buyer for NIKI, which has gained in size and profile, but this is an unwelcome distraction from focusing on its core network airline. It also means that the perennial loss-maker will need to replace the sale proceeds that it would have gained.

35 narrowbodies transferred to NIKI at start of summer 2017

The first phase of the NIKI-related part of airberlin's restructuring has already been carried out. From the start of the summer 2017 schedule, 35 narrowbody aircraft of the Air Berlin Group were transferred to NIKI as part of the group's restructuring announced in Sep-2016. At the same time, airberlin transferred most of its leisure routes to its Austrian subsidiary.

The aircraft transferred to NIKI include 14 Boeing 737s operated by TUIfly under wetlease previously for airberlin and now for NIKI. In addition, NIKI's operation now includes four A321s that were part of the fleet of Belair, also an airberlin subsidiary, which is due to cease operating at the end of summer 2017. The 35 NIKI aircraft now also include 17 A321s previously operated by airberlin and exchanged with A319s and A320s previously operated by NIKI.

NIKI to remain part of Air Berlin Group as separate leisure brand

The next phase of this leg of the restructuring was then to have been the sale of airberlin's stake in NIKI to Etihad for EUR300 million. NIKI was subsequently due to merge with TUIfly as part of a new leisure airline jointly owned by TUI and Etihad, subject to approval by regulators.

Etihad said on 8-Jun-2017 that the leisure operations of Air Berlin Group would continue as a separate business unit, operating under the NIKI brand. Further details of this structure will be announced "in due course by Air Berlin", according to Etihad, which is a 29% shareholder in the German airline.

Airberlin has yet to issue a statement, but reportedly confirmed it will continue with two operating units, a long haul division operated by airberlin and a short haul holiday division operated by NIKI, until it finds a new investor (aero.de, 09-Jun-2017).

NIKI's ownership structure is a little complex and somewhat opaque. Its results have been fully consolidated into those of the Air Berlin Group since 2011, which has made it a full member of the Group to all intents and purposes. Its operations were, until now, almost indistinguishable from those of its German parent.

However, in addition to Air Berlin, its owners also include the private foundation NIKI Privatstiftung, which was to have become a shareholder in the new leisure airline merging NIKI and TUIfly.

Air Berlin Group planned to sell its shareholding in NIKI to Etihad, who then planned to contribute it to the new airline's holding company. The new airline's owners would have been Etihad, TUI Group and NIKI Privatstiftung.

The new Air Berlin Group structure does not change NIKI's ownership, but it does give it a higher profile and a bigger operation.

NIKI's seat capacity is up by 160% this summer

Following airberlin's transfer of most of its European leisure routes to it, NIKI's seat growth has leapt this summer. According to data from OAG, NIKI's seat numbers will grow by 160% year on year in summer 2017.

This follows annual capacity cuts of 12% in 2016, of 2%-3% in 2015 and 2014, and a 20% cut in 2013.

NIKI: weekly scheduled seat capacity 2014 to 2017*

NIKI's biggest markets are Spain and Germany

NIKI operates as a scheduled airline, but makes block capacity available to tour operators. Its headquarters are in Vienna, but its biggest airport by seats is Palma de Mallorca, followed by Duesseldorf, Munich, Zurich and Berlin Tegel.

NIKI: top 10 airports by seats week of 12-Jun-2017

NIKI's two biggest countries for departing seats are Spain and Germany. Spain accounts for 41% of its seats and Germany for 38% (week of 12-Jun-2017, source: OAG).

NIKI: departing seats by country, week of 12-Jun-2017

TUI remains open to partners for TUIfly

TUI remains persuaded of the "strategic sense" of a "strong European leisure airline". In a statement, Sebastian Ebel, who is in charge of its Central Region (which covers Germany, Austria, Switzerland and Poland) said that the aviation sector was "characterised by overcapacity in Germany".

TUI has not given up on finding a new strategic direction for its German LCC and will "push the repositioning of TUIfly further ahead in order to develop long-term prospects for the airline and its employees".

This is likely to mean searching for another joint venture or other form of partnership for TUIfly with other airlines. TUI declared itself "prepared to contribute to the stabilisation of the German aviation market".

German airlines are looking for defences against foreign LCCs

Taken with its reference to overcapacity in Germany, this illustrates the ongoing manoeuvring by German airlines to defend the market mainly against the growth of foreign LCCs. This manoeuvring has involved two approaches, which sometimes converge: seeking consolidation opportunities and finding ways to help to prop up the loss-making airberlin.

These two courses of action intersected when Lufthansa Group agreed to wetlease 38 airberlin aircraft from Feb-2017 (35 aircraft for operation under the Eurowings brand and three for Austrian Airlines). The now abandoned merger between TUIfly and NIKI would also have combined the two strands.

For all of Germany's incumbent airlines, propping up airberlin has been seen as preferable to allowing it collapse for the simple reason that this continues to fill a space that could otherwise be rapidly filled by the likes of Ryanair.

LCCs are indeed a growing threat to Germany's incumbent airlines. According to data from CAPA and OAG, LCCs account for 30% of international seats and 23% of domestic seats in Germany in the first five months of 2017.

For international seats, the figures were 27% in 2016 and 25% in 2015; for domestic seats, the LCC share was 22% in 2016 and 20% in 2015. The figures for 2017 year to date are relatively low compared with most of the rest of Europe, but are higher than they have ever been in Germany.

Germany: LCC and non-LCC seats 2007 to 2017*

Lufthansa has responded through Eurowings

Lufthansa's Eurowings brand has been a major contributor to the growth of LCCs. It has also been a significant part of the response of German airlines to the growing threat of LCC competition from non-German operators, albeit not a very low cost response.

According to OAG data for the week of 12-Jun-2017, Eurowings has 11% of all seats in Germany (this figure includes Germanwings, which operates under the Eurowings brand). This makes it the second largest airline in Germany, after Lufthansa, which has 30% of seats.

NIKI would have taken TUIfly from eighth to fifth largest in Germany

Airberlin has a 7% seat share, just ahead of Ryanair (now the number four brand in Germany). Condor, the German leisure airline owned by TUI Group's main rival Thomas Cook Group, has a 3% share just ahead of easyJet.

NIKI is the number seven airline in Germany, with 3% of seats, and TUIfly has 2% in eighth place.

The combination of TUIfly and NIKI would have created an airline with almost 6% of seats in Germany, ranking fifth behind Ryanair but ahead of Condor.

Germany: airlines by share of total seats week of 12-Jun-2017

Rank	Airline	Share of seats
1	Lufthansa	29.6%
2	Eurowings*	11.0%
3	airberlin	7.1%
4	Ryanair	6.9%
5	Condor	3.5%
6	easyJet	3.4%
7	NIKI	3.1%
8	TUIfly	2.4%
9	Turkish Airlines	1.9%
10	SunExpress	1.8%
11	British Airways	1.5%
12	Austrian Airlines	1.5%
13	Germania	1.4%
14	Wizz Air	1.3%
15	KLM	1.2%
	All others	22.6%

Germany's overcapacity is in high cost airlines

TUI's reference to overcapacity in Germany is worthy of closer examination.

According to OAG data, seat growth in Germany will be 5.7% this summer, which is an acceleration relative to growth of 3.7% in summer 2016. Growth in annual seat numbers across the whole year increased from 3.7% in 2015 to 4.2% in 2016 and will be 5.7% in 2017 (based on the available data from OAG for the first 11 months of the year).

This relatively modest acceleration in capacity growth must feel a bit like overcapacity to the incumbent airlines in Germany.

However, growth in Germany is still noticeably slower than in Europe as a whole. OAG data for Europe indicate a total seat growth rate of 7.5% this summer and point towards growth of 7.1% in 2017 (again base on the first 11 months of the year).

Moreover, Germany is already a more concentrated market than Europe. Germany's top 10 airlines account for 71% of seats, while Europe's top 10 account for just 43% (week of 12-Jun-2017, source: OAG).

Positive load factor developments so far this year for Lufthansa German Airlines and for Eurowings are also not consistent with a narrative of overcapacity, although airberlin has seen its load factor decline.

Of course, load factor can be bought with discounted yield and unit revenue has indeed been weak for most European airlines in the past couple of years, although Lufthansa's commentary around this at the time of its 1Q2017 results was more encouraging.

Perhaps a more accurate interpretation of TUI's complaint about overcapacity is that Germany still has too much high cost capacity.

Germany: load factor for selected airlines Jan-May 2017**

Airline	Load factor	Change year on year
Lufthansa German Airlines	79.0	+3.6ppts
Eurowings*	76.5	+0.6ppts
Airberlin**	81.2	-1.7ppts

airberlin and TUI needed the deal; NIKI and Etihad perhaps less so

Airberlin needed the NIKI/TUIfly merger to go ahead so that it could concentrate on its remaining core business of operating a network airline with a greater long haul focus and a full service positioning. Continuing to run NIKI, even as a more visible separate leisure brand, could be a distraction for airberlin from its new focus on its core.

Moreover, airberlin needs the EUR300 million that Etihad agreed to pay for its stake in NIKI. This sum had already been paid to airberlin by Etihad by the end of 1Q2017, in advance of the sale, but airberlin may now be required to return it.

TUI Group needed the deal to proceed so that it could build TUIfly to a critical mass that could generate the necessary synergies to become more competitive in Germany.

It is less clear what NIKI needed from the transaction. It has achieved a significant reversal of its previous contraction and will now have a bigger network and much higher profile, while staying in the Air Berlin Group.

The TUIfly merger would simply have moved it from the opacity of its previous position within the Air Berlin Group to what may well have been a similar level of opacity in the new leisure airline group. Perhaps the NIKI Privatstiftung was not happy with the planned merger, although this is not known.

The end of talks over the TUIfly/NIKI merger came only weeks after the appointment of Etihad interim CEO Ray Gammell to replace James Hogan. Perhaps Etihad's wider rethinking of its equity strategy made the transaction less attractive to the Abu Dhabi airline.

It would have helped airberlin, one of Etihad's biggest investments, but it would have meant adding yet another minority stake to its portfolio. Mr Gammell has said the group will continue supporting airberlin during its restructuring efforts, but perhaps Etihad is no longer willing to bail out airberlin at all costs.

airberlin is once again fighting for its life

Airberlin made another record loss in 2016 and losses widened once more in 1Q2017. After years of successive restructuring programmes, its most recent one seemed better than most. The current plan was to bring it focus as a network airline - scaling down, and largely exiting from leisure.

However, the breakdown of the deal to sell NIKI and signs of Etihad's diminishing enthusiasm to support airberlin are serious setbacks.

Airberlin is now looking elsewhere for help. It is reported to have asked the German states of North-Rhine Westphalia and Berlin to consider granting loan guarantees (Reuters, 08-Jun-2017).

In addition, Airberlin CEO Thomas Winkelmann has expressed interest in finding other partners, with Lufthansa a named possibility (Reuters, 07-Jun-2017). Lufthansa CEO Carsten Spohr said airberlin would need to reduce its operating costs and debt before a takeover would be considered.

Consequently, Germany's airline sector remains in a state of flux and airberlin is once again fighting for its life.