Insight: Wednesday 18 November 2020: Airline Consolidation – The Next Round Begins

News:

It doesn’t take a rocket scientist to realize that airlines around the world are in trouble since the global pandemic has decimated air travel demand. Whether in the US, Europe, Asia, Latin America, Africa or Oceania, airlines have been hard hit by the pandemic.

While trans-border mergers are difficult, domestic mergers are moving ahead, with the most recent example the Korean Air acquisition of Asiana in South Korea. With both carriers operating in the same country, under the same regulatory regime, the merger will be easier than a potential cross-border situation with different financial and regulatory authorities.

The question facing several troubled airlines in Asia, Latin America and Europe is how they will survive without cross-border consolidation, and whether stronger alliances and anti-trust exempt codeshares could become an alternative to out and out mergers.

Analysis:

The aviation industry is typically viewed as critical by each country, most of whom have a national airline or flag carrier. Merging and ceding airline sovereignty is difficult for many countries, particularly in markets that may not have adequate traffic to support operations and fare levels needed for economic growth. The African continent is an example, in which two or three larger carrier groups could provide more comprehensive and higher quality services if economies of scale could be captured.

Latin America, with LATAM and Avianca-Taca as large multinational groups, might be an example of what future mergers could look like in trans-border transactions. Today, Eastern Europe has too many legacy carriers (LOT, Czech, TAROM, Balkan) that have strong multi-hub competition from WizzAir and could benefit from consolidation. Western Europe has consolidated to three major groups with Lufthansa Group, IAG, and AirFrance-KLM. Additional consolidation with smaller airlines moving into the fold could occur given the pressures of the global pandemic.

The US has been through several consolidations, but there have been strong rumors regarding JetBlue and Alaska, two of the remaining independent regional operators. American Airlines has struck alliances with both but does not appear to be in a financial position today to merge, so code-share arrangements are the next best thing.

Asia will be the dilemma. Apart from consolidation within countries, Southeast Asia appears particularly vulnerable. Airlines from Thailand to Malaysia and Indonesia are fighting to stay alive, and future consolidation may make sense, much as the Latin carriers have consolidated.

China and Hong Kong remain problematic for Cathay Pacific and the larger international Chinese Airlines. Consolidation in these cases will be driven by Beijing policies more than market dynamics.

Insight:

Will we see more consolidation in international airline markets? The answer is probably yes, with new business models required for Southeast Asia, Eastern Europe, and Africa, all of which have airlines at potential risk. Working through multiple regulatory environments and capital markets isn’t easy, but it can be done, as Latin America has demonstrated. This is an industry in which economies of scale exist, and MRO operations for larger fleets could see specialization and consolidation.

Government bailouts during the pandemic have typically had strings attached regarding maintaining jobs and flight routes and would need to be addressed during potential mergers. While there are difficulties, today is the right time for airlines to pursue consolidation as an alternative to standing alone and failing as government subsidies inevitably shut out.

Of course, the alternative to consolidation is picking up pieces of a failed airline in bankruptcy. That is also a plausible solution for growth, if one has the resources. But given the depth and breadth of the pandemic, it is difficult to find an airline that isn’t suffering financially.

Is there an opportunity for private equity to intervene and roll-up a number of small carriers? The potential is there, but would require strong leadership in an industry that requires specific expertise. That also doesn’t look like a feasible route for many PE firms.

The bottom line is that consolidation in airlines is difficult enough domestically, and very complicated internationally. Developing alternative strategies with codeshares may be as close as we come in the near term, as airlines simply don’t have the money to invest in each other.

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