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Transaero and Aeroflot Part 1: The airlines have a 70% overlap but the government won't want cuts

On 3-Sep-2015, Russia's leading airline Aeroflot agreed to an offer from Transaero Airlines' shareholders to sell it at least 75% plus one share of number two ranked Transaero. The price requested for control of the heavily indebted and loss-making airline, to be paid within 24 days, was "no more than" RUB1.

Aeroflot chairman Kirill Androsov hailed the deal's “transformational significance" for the Aeroflot Group, saying it was "fully in line" with its strategy". He added that it should help the group in its aims to carry 70 million passengers by 2025 (compared with 35 million in 2014, versus 13 million for Transaero) and be in Europe's top five and the world's top 20 airlines by revenue and passenger numbers.

Nevertheless, Mr Androsov may have been attempting a brave face. The decision was influenced by a government seeking to maintain market and employment stability and also requires tough negotiations with Transaero's creditors. Moreover, Aeroflot faces a difficult choice. Either it tries to maintain Transaero's unprofitable fleet and network, which overlaps significantly with its own, or it must attempt the politically more challenging closure of large chunks of Transaero's operations. Neither option looks easy.

In this first part of a detailed two part report on Transaero, we look at its network and the extent of overlap with that of Aeroflot. In the second part, we will examine its financial track record.

Combination of number one and number two airlines in Russia with almost 50% passenger share

Transaero Airlines carried 13.2 million passengers in 2014, making it the second largest airline group in Russia. Its traffic was a little more than one third of the 34.7 million carried by the Aeroflot Group and just over half of the 23.6 million carried by the parent Aeroflot airline. In 1H2015, Transaero's passenger numbers were virtually stable year on year at 5.8 million (+0.5%), while the Aeroflot Group grew its numbers by 14.0% to 17.9 million and the Aeroflot airline by 9.3% to 12.0 million.

This means that Transaero is now less than one third of the size of the Aeroflot Group and less than half the Aeroflot airline by passenger numbers.

Based on their traffic data for 1H2015, the combined share of passengers in the Russian market is approaching the 50% mark (Aeroflot Group 37% and Transaero 12%). This would open up a huge gap to the next nearest competitor, S7 Airlines, which had just below 10% of 1H2015 passenger numbers in Russia.

See related report: Aeroflot back in operating profit in 1H. Transaero acquisition to take its market share close to 50%

Transaero has a higher proportion of its seats on international routes than Aeroflot

According to data from OAG for the week of 14-Sep-2015, Transaero's seat capacity is split in a ratio of 42:58 domestic to international, compared with 49:51 for the Aeroflot parent airline (53:47 for the Aeroflot Group excluding Transaero). By number of routes, both Transaero and Aeroflot airline are split 39:61 domestic to international.

On average, Aeroflot operates 2.3 times more seats per route than Transaero deploys, even more on domestic routes (2.7 times) and slightly less on international routes (2.1 times). This advantage is due to Aeroflot's greater average frequency on its routes.

Aeroflot* and Transaero: number of routes and seats 14-Sep-2015 to 20-Sep-2015

Eastern/Central Europe takes 45% of Transaero's international seats

Perhaps unsurprisingly, the largest share of Transaero's international seat capacity is on routes to Eastern/Central Europe (45%), followed by Western Europe (15%). Aeroflot is around 2.5 times larger in Eastern/Central Europe and more than six times larger in Western Europe, according to OAG schedules data for the week of 14-Sep-2015.

Looking beyond its own continent of Europe, North Africa (13% of international seats) is Transaero's largest region, with three leisure destinations (Enfidha-Hammamet in Tunisia and Sharm el-Sheikh and Hurghada in Egypt). By contrast, Aeroflot has almost no capacity to North Africa, with only a twice weekly narrowbody service to Cairo. North Africa is the only region where Transaero is bigger than Aeroflot.

The relatively nearby region of Central Asia also takes up a double digit share of Transaero's international capacity (10%). It has roughly the same capacity as Aeroflot in Central Asia in absolute terms. Northeast Asia and the Middle East each account for around 4% of Transaero's international seats and Aeroflot has a much bigger presence in both of these regions.

Transaero has only a little more than one third of Aeroflot's seat capacity on routes to North America, which represent just below 4% of Transaero's international seats.

Transaero Airlines international seat capacity by region: 14-Sep-2015 to 20-Sep-2015

Ukraine is the biggest country destination for both Transaero and Aeroflot

By country, Transaero's largest international market by seats is Ukraine, which is also Aeroflot's largest international market. However, its second and third country markets  – Egypt and Cyprus  – indicate a more leisure-oriented network than that of its new parent, for whom Germany and China rank next behind Ukraine. Kazakhstan and Greece also feature more prominently in Transaero's list of top country markets than they do for Aeroflot.

Transaero Airlines international seat capacity by country: 14-Sep-2015 to 20-Sep-2015

Transaero is more leisure-oriented

Transaero has a very high proportion of premium economy seats, almost 27% of its schedule, compared with less than 1% for Aeroflot and a global average of less than 2%.

Transaero's business class accounts for 7% of its seats, less than Aeroflot's figure of 13%, but greater than the 4% global average (data source: OAG, week of 14-Sep-2015).

Transaero Airlines seat capacity by class: 14-Sep-2015 to 20-Sep-2015

Other features of Transaero's more leisure-oriented network compared with Aeroflot include a higher proportion of low frequency routes. Only a quarter of Transaero's routes have a frequency of once daily or more. For Aeroflot, the equivalent number is 64% (data source: OAG, week of 14-Sep-2015).

Moscow Vnukovo is Transaero's biggest airport

Although its head office is in St Petersburg and Moscow Domodedovo is usually regarded as its main hub, Transaero's biggest airport by seat capacity is Moscow Vnukovo, with Domodedovo ranking second and St Petersburg third. Sochi ranks as Transaero's fourth largest airport.

Vnukovo's position as Transaero's biggest base is built on international capacity, while Domodedovo is its biggest domestic hub. Around 70% of the airline's seats at Domodedovo are domestic, compared with 24% at Vnukovo, according to OAG data for the week of 14-Sep-2015.

Transaero is the leading airline by seats at Vnukovo, with a share of 34%, followed by UTair on 29% and two other Aeroflot Group airlines, its new LCC Pobeda (17%) and Aeroflot itself (11%, with capacity operated by subsidiary Orenair under Aeroflot's SU code). The acquisition would give the group a dominant position at Vnukovo, with almost 52% of seats.

At Domodedovo, Transaero and Ural Airlines both have 14% of seats, behind leader S7 on 36%. Aeroflot currently (week of 14-Sep-2015) has less than a 2% share at Domodedovo, but this comes to around 3% in combination with its subsidiary Orenair so that the Aeroflot Group now has 17%. Moreover, Aeroflot's seat share at Domodedovo is set to jump to 9% in the first week of the winter schedule (week of 26-Oct-2015, source: OAG).

St Petersburg is the main hub for Aeroflot subsidiary Rossiya, which operates under Aeroflot's SU code as the airport's biggest airline with a seat share of 49%. Transaero is in second place with 10% of seats, potentially giving the Aeroflot Group a dominant share of 59%.

At Sochi, Transaero's 25% of seats places it second behind Aeroflot's 27% (including flights operated under its code by subsidiary Donavia). Two other group airlines, Pobeda (10%) and Orenair (2%) are also present at Sochi, potentially giving the Aeroflot Group a total share of 65%.

At Vladivostok, Transaero's 10th biggest airport, its 14% seat share places it third. This would add to Aeroflot's leading share of 47% and Aurora's 2% to give the Aeroflot Group a dominant 63%. At Krasnodar, Transaero's 7% share would combine with Aeroflot's 42% (including flights operated by subsidiary Donavia) to give the Group 49%.

Transaero Airlines top 10 hubs/bases by seat capacity: 14-Sep-2015 to 20-Sep-2015

Aeroflot's main hub is Moscow Sheremetyevo

Aeroflot's main hub is the country's biggest airport Moscow Sheremetyevo, where it has a seat share of 88% and where Transaero is not present. Following its acquisition of Transaero, the Aeroflot Group would also have a leading position at Vnukovo (the main base of Pobeda) and a significant, although lesser, share at Domodedovo.

An important question for the Aeroflot Group now will be whether to consolidate its Moscow operations into one or two airports, or to continue with three. It has been reported that Transaero may be considering reviving plans to transfer its Domodedovo operations to Vnukovo, to achieve efficiency of aircraft deployment, improve connections and reduce operational expenses (RBC, 15-Sep-2015).

As previously reported by CAPA, the carrier considered relocating services in Dec-2014, in exchange for a 30% discount on fees. This would now seem more compelling within the wider context of the Aeroflot Group's relative weakness at Domodedovo.

Aeroflot/Transaero would have more than 50% of seats at five out of top 10 Russian airports

The transaction will also improve Aeroflot's position at Russia's other leading airports. The Aeroflot Group (and the parent airline) is present at all of Russia's 10 biggest airports by total seats and Transaero is present at all bar Sheremetyevo. Based on OAG schedules data for the top 10 airports (week of 14-Sep-2015), the Aeroflot Group had a seat share of more than half only at Sheremetyevo prior to the acquisition.

Transaero's inclusion in the group would mean that the Aeroflot Group operates the majority of seats at five of the top 10 airports (Sheremetyevo, Domodedovo, St Petersburg, Sochi and Rostov-on-Don).

Aeroflot Group* seat capacity and share of seats at Russia's 10 largest airports by seats: 14-Sep-2015 to 20-Sep-2015

Moscow-Simferopol: Transaero's (and Russia's) largest international route

Transaero's biggest international route (indeed, its biggest route across its entire network) is Moscow Domodedovo-Simferopol in the Ukraine's disputed Crimea. It also serves Simferopol from Moscow Vnukovo (this is its ninth biggest international airport pair).

As a city pair, Moscow-Simferopol is also the biggest overall international route by scheduled seats from Russia and Aeroflot's biggest in the week of 14-Sep-2015, according to OAG data. Transaero's top 10 international routes also includes other city pairs that are important international routes from Russia. Moscow-Antalya ranks as the number 14 international city pair and Moscow-Larnaca number 20.

In addition to Moscow-Simferopol, other city pairs that appear in the top 10 international routes for both Aeroflot and Transaero are Moscow-Beijing and Moscow-Tel Aviv. Five of the remaining six routes in Transaero's list are leisure routes (Moscow and St Petersburg to Larnaca, Moscow to Hurghada, Antalya, Paphos) and the remaining one (ranking fourth in its list) is Moscow-Almaty, the largest city in Kazakhstan.

Transaero Airlines top 10 international routes by seat capacity: 14-Sep-2015 to 20-Sep-2015

Aeroflot/Transaero: more than 50% seat share on all of Transaero's top 10 international routes

Transaero is the leading airline by seats on a city pair basis on six of its top 10 international routes, number two on two routes and number three on two routes (Moscow-Simferopol counts as two routes in the top 10, but one city pair).

Transaero faces other airlines on all of these routes, but, in every case where it is not the leading airline, Aeroflot airline occupies the number one rank by seats. The only two of the 10 not operated by Aeroflot are Moscow-Paphos and Moscow-Almaty. The Aeroflot Group, following its acquisition of Transaero, would have a seat share in excess of 50% on every one of the 10 routes (on a city pair basis).

Transaero Airlines' competitive position on top 10 international routes by seat capacity: 14-Sep-2015 to 20-Sep-2015

Route

Transaero rank & seat share on city pair

Competitors on city pair ranked by seats

Aeroflot Group rank & share on city pair

Moscow DME-Simferopol

3 (17%)*

1 Aeroflot* (44%, SVO & VKO), 2 Ural (21%), 3 Transaero* (DME & VKO), 4 S7 (14%), 5 Orenair (3%), 6 Alrosa Mirny (c.0%)

1 (64%)

Moscow VKO-Larnaca

1 (48%)*

1 Transaero* (DME & VKO), 2 Aeroflot* (31%, SVO), 3 S7 (18%), 4 Ural (4%)

1 (79%)

St Petersburg-Larnaca

1 (90%)

1 Transaero, 2 Aeroflot (10%)

1 (100%)

Moscow VKO-Almaty

1 (50%)

1 Transaero, 2 Air Astana* (50%, SVO)

1 (50%)

Moscow VKO-Tel Aviv

2 (30%)*

1 Aeroflot* (51%, SVO), 2 Transaero* (VKO & DME), 3 El Al* (19%, DME)

1 (81%)

Moscow VKO-Hurghada

1 (100%)*

1 Transaero* (VKO & DME), (Aeroflot*, DME from Oct-2015)

1 (100%)

Moscow VKO-Antalya

1 (27%)

1 Transaero, 2 Aeroflot* (25%, SVO), 3 Ural* (17%, DME), 4 Onur* (17%, SVO), 5 Turkish (14%)

1 (52%)

Moscow VKO-Paphos

1 (81%)

1 Transaero, 2 S7 (19%, DME)

1 (81%)

Moscow VKO-Simferopol

3 (17%)*

1 Aeroflot* (44%, SVO & VKO), 2 Ural (21%), 3 Transaero* (DME & VKO), 4 S7 (14%), 5 Orenair (3%), 6 Alrosa Mirny (c.0%)

1 (64%)

Moscow VKO-Beijing

2 (20%)

1 Aeroflot* (52%, SVO), 2 Transaero, 3 Air China* (20%, SVO), 4 Hainan* (8%, SVO)

1 (72%)

Moscow-St Petersburg: Transaero's (and Russia's) largest domestic route

Many of Transaero's top 10 domestic routes are also among Russia's overall list of top 10 domestic routes, including Moscow to St Petersburg (number one), Sochi (number two), Krasnodar (three), Rostov (six), Khabarovsk (19) and Vladivostok (21). Aeroflot also operates on all bar one of the 10 routes on a city pair basis (the exception being Moscow-Blagoveshchensk).

Transaero Airlines top 10 domestic routes by seat capacity: 14-Sep-2015 to 20-Sep-2015

Aeroflot/Transaero: leader on all of Transaero's top 10 domestic routes (monopoly on five)

On a city pair basis, Transaero is the leading airline on only one of its top 10 domestic routes by seats, namely Moscow to the far eastern city of Blagoveshchensk, on which it is the only operator, according to OAG data for the week of 14-Sep-2015. Aeroflot is the leader on all of the remaining nine routes. Transaero is second on five of the 10, third on two, fourth on one and fifth on one.

Although, when viewed in terms of the number of individual airlines, Transaero's domestic top 10 routes appear more competitive than its international top 10, when combined with the other airlines in the Aeroflot Group, this would not the case. On a city pair basis, Transaero's inclusion in the group would make it number one on every route in Transaero's top 10 domestic routes, with a monopoly on half of them.

Transaero Airlines' competitive position on top 10 domestic routes by seat capacity: 14-Sep-2015 to 20-Sep-2015

Route

Transaero rank on city pair

Competitors on city pair ranked by seats

Aeroflot Group rank & share on city pair

Moscow DME-Sochi

2 (21%)*

1 Aeroflot* (27%, DME & SVO), 2 Transaero* (DME & VKO), 3 S7 (15%), 4 Pobeda* (13%, VKO), 5 Utair* (9%, VKO), 6 Ural (7%), 7 Orenair (4%), 8 Yakutia* (4%, VKO), 9 Nordstar (1%)

1 (66%)

Moscow DME- St Petersburg

3 (15%)*

1 Aeroflot* (62%) ,2 S7 (16%), 3 Transaero* (DME & VKO), 4 Utair* (7%, VKO). 5 Ural (c.0%)

1 (77%)

Moscow VKO-St Petersburg

3 (15%)*

1 Aeroflot* (62%) ,2 S7 (16%), 3 Transaero* (DME & VKO), 4 Utair* (7%, VKO). 5 Ural (c.0%)

1 (77%)

Moscow DME-Vladivostok

2 (36%)

1 Aeroflot* (64%, SVO), 2 Transaero

1 (100%)

Moscow DME-Khabarovsk

2 (31%)

1 Aeroflot* (69%, SVO), 2 Transaero

1 (100%)

Moscow DME-Krasnodar

4 (11%)

1 Aeroflot*(41%, DME & SVO), 2 S7 (24%), 3 UTair* (17%, VKO), 4 Transaero, 5 Nordavia* (4%, SVO), 6 Alrosa Mirny (2%), 7 Yakutia* (1%, VKO)

1 (100%)

Moscow VKO-Sochi

2 (21%)*

1 Aeroflot* (27%, DME & SVO), 2 Transaero* (DME & VKO), 3 S7 (15%), 4 Pobeda* (13%, VKO), 5 Utair* (9%, VKO), 6 Ural (7%), 7 Orenair (4%), 8 Yakutia* (4%, VKO), 9 Nordstar (1%)

1 (65%)

Moscow DME-Rostov-on-Don

5 (12%)

1 Aeroflot* (SVO, 40%), 2 S7 (22%), 3 Utair* (VKO, 15%), 4 Ural (12%), 5 Transaero

1 (52%)

Moscow DME-Blagoveshchensk

1 (100%)

1 Transaero

1 (100%)

Sochi-St Petersburg

2 (37%)

1 Aeroflot (63%), 2 Transaero

1 (100%)

There is a significant overlap between Transaero and Aeroflot networks

As shown, there is considerable overlap with Aeroflot on Transaero's leading domestic and international routes. Furthermore, the degree of overlap is high right across both airlines' networks, particularly for Transaero and particularly in the domestic market. Based on city pairs, 51% of Transaero's routes, representing 70% of its seat capacity, are also operated by Aeroflot. For the larger airline, 35% of its routes, representing 60% of its seat capacity, overlap with Transaero.

In the domestic market, the seat overlap figures rise to 78% for Transaero and 67% for Aeroflot. Note that our analysis is based on the Aeroflot parent airline only, although a significant proportion of its subsidiary airlines' operations are carried out under Aeroflot's SU code and, therefore, are captured in this study.

The most significant Aeroflot subsidiary now operating under its own code is the LCC Pobeda, which has only a very small additional overlap with Transaero that is not already captured in our analysis.

So, while the levels of overlap between Transaero and the Aeroflot Group as a whole may be a little higher than our analysis shows, the difference is not very significant.

Aeroflot* and Transaero: proportion of each airline's routes and seats where the other overlaps: 14-Sep-2015 to 20-Sep-2015

Details of debt restructuring and competition concerns are still to be addressed

Although Aeroflot is currently in the process of integrating Transaero, the transaction is not yet a fully done deal, pending the formal offer by its shareholders to sell their shares, scheduled for 28-Sep-2015. However, Aeroflot has said that it will ensure that all obligations to ticketed Transaero passengers are met in full. Moreover, Transaero has appointed Aeroflot deputy director general Dmitry Saprykin as its CEO.

Meanwhile, Aeroflot is reportedly still looking at the financial details, in particular the possible restructuring of Transaero's debt (Kommersant/Interfax/forbes.ru, 15-Sep-2015), in consultation with its adviser Sberbank (which is also a significant lessor of aircraft to Transaero).

Sberbank head German Gref said that Aeroflot and the bank were "trying to understand which method of restructure is appropriate, work out some conditions of compromise between creditors and potential buyers". He added, “If creditors do not accept this, other processes will commence – bankruptcy processes, financial recovery, etc."

There are also competition concerns, not surprising given the near 50% combined market share of the two groups and the degree of overlap between Transaero and Aeroflot. The head of Russia's Federal Antimonopoly Service (FAS), Igor Artemyev, said on 2-Sep-2015 that he preferred the alternative of bankruptcy, but recognised that this may not be practical (and it is not the Russian government's preference, given the disruption it would cause in the market).

Mr Artemyev indicated that FAS may be prepared to approve the deal, but "will ask Aeroflot to sell a part of their routes, where it gains a monopoly". Aeroflot is expected to receive a response from FAS to its application for approval of the purchase in Oct-2015.

Transaero adds little to Aeroflot in terms of geography or brand…

If the deal does go ahead, and even if Aeroflot is required by the competition authorities to sell or close part of the combined network, Aeroflot will need to squeeze synergies from the transaction and to look for ways to reduce debt. Given the high network overlap, synergies are more likely to be cost-related and to come from reducing the parts of the network where there is significant duplication of routes.

Geographically, the only part of Transaero's network that significantly complements Aeroflot's is North Africa. Moreover, in terms of market positioning and branding, it is difficult to see how Transaero could add to what Aeroflot calls its "successful multi-branding strategy".

The group currently contains brands across the spectrum of airline market segments in terms of the product and service offer. Aeroflot itself occupies the premium/network segment across a wide range of geographical regions; Rossiya, Donavia and Aurora are all middle market brands, each with their own regional focus; Orenair is a leisure and budget operator (and its leisure activities have been reduced); and Pobeda is the group's low-cost airline.

Aeroflot Group's multi-branding strategy

…but heavy cuts could meet political opposition

If Aeroflot decides to chop away at the network overlap, this could well lead to a significant reduction in Transaero's fleet. Indeed, even Russia's Prime Minister Dmitry Medvedev has called the size of its fleet "excessive" (TASS, 04-Sep-2015). Nevertheless, speculation that Aeroflot could reduce its new subsidiary's aircraft numbers by 70% should be treated with some caution. The Russian Ministry of Economic Development's Deputy Head Evgeniy Yelin has said that it does not expect large-scale redundancies at Transaero (Interfax, 07-Sep-2015).

One thing is certain: Aeroflot cannot ignore government views on Transaero's future. In spite of its stock exchange listing, Aeroflot is majority controlled by the State and government influence permeates its strategic development.

Since the end of the Soviet era, free market reforms have become well established in Russia, but the State retains a "national champion" approach to many sectors, including a national aviation strategy. The folding of Transaero is unlikely to be a part of this strategy. Minister of Transport Maksim Sokolov said discussions with creditors on the restructuring of Transaero must consider not only the strategy of the airline itself, but also "the entire regional and international aviation future model in the country” (RIA Novosti/Kommersant, 04-Sep-2015).

Aeroflot will have to tread a line between meeting its own commercial and financial needs and respecting the political objectives of its 51% shareholder.

In part two of our report on Transaero, we will examine its recent financial and operational track record and analyse its fleet.

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