Premium #133 Can Etihad Really Turn Around Alitalia?

Last week, the long-negotiated agreement for Abu Dhabi based Etihad Airlines to purchase a 49% minority stake in Italy’s beleaguered Alitalia airlines was finalized. The transaction includes several elements: €387.5M in cash for 49% of Alitalia €112.5M for a 75% interest in Alitalia’s frequent flyer program €60M for 5 pairs of slots at London Heathrow airport €300M authorized capital increase from current investors €300M in new loans €598M in debt restructuring of existing short-to-medium loans In total, the package is worth €1.8 billion, or about $2.4 billion US. This should help provide the carrier with stability during a restructuring that will attempt to bring Alitalia back to prosperity. As James Hogan, Etihad’s CEO noted at the press conference, “there is no quick fix.” Alitalia has lost upwards of €1.1 billion since its reorganization in 2009. Etihad is forecasting a €100 million operating profit by the end of 2017. Is it an overly optimistic outlook? Many believe so. Alitalia is currently inefficient, with an over-reliance on short-haul flights, lacking the draw for premium business traffic in comparison to other carriers for long-haul service. While Etihad can help change that over the next five years, it can’t take place quickly. One cartoonist summarized the skepticism in the market, with the thesis that Alitalia will negatively taint Etihad. While we don’t believe either supposition represented to be the case, Alitalia’s reputation has slipped in recent years from what it once was. Nonetheless, it remains an iconic brand, and with the help of Etihad could recover in areas such as customer service and image. At the announcement, Etihad’s CEO James Hogan indicated that the Alitalia brand should convey Italy’s reputation for food, fashion, luxury, culture, history, creativity, innovation, and that “the sexiest airline in Europe should be Alitalia.” Rebranding is scheduled to begin in the first quarter of 2015. It is expected that, like with Air Berlin, Etihad may purchase, and lease-back seats to Alitalia to reduce the investment for a product upgrade. The Strategy The key element will be labor. Fortunately, accords were reached with the major unions that include job cuts as an element of the agreement. It is clear that staff cuts and productivity gains will be needed, and the attitude that Alitalia, as a flag carrier, could never disappear, has to change. LCCs have made major inroads in Italy. Alitalia employees have seen examples such as Malev and Olympic folding because of low fare competition, and these examples are helping to change attitudes that Alitalia is not invincible. Alitalia is better off today than it was in 2009, but has a way to go. If Etihad can turn its projected 2017 profitability by 2019, it will still have accomplished a major turnaround. The new strategy for Alitalia is a renewed focus on long-haul, eliminating some unprofitable short-haul flights. The new business plan calls for Alitalia to grow its wide-body fleet by 32% from 22 to 29 aircraft, and to shrink its narrow-body fleet from 90 to 78 aircraft. Alitalia's current fleet is comprised of the following: Alitalia currently has no aircraft on order, so growth in the wide body fleet will likely come from existing Etihad orders. Etihad placed orders for 50 Airbus A350s, 71 Boeing 787s, and 25 Boeing 777X s last fall, and can supply Alitalia with new aircraft from its order book. Etihad plans to take delivery of 14 wide-bodies in 2014, and 9 in the first half of 2015. While plans for new routes have yet to be been announced, an increased focus on northern Italy is likely. Alitalia trails Ryanair, Meridiana, Lufthansa, and British Airways in the number of seats offered at Bologna, trails easyJet, Emirates, Meridiana, and Lufthansa at Milan Malpensa, and trails easyJet, Volotea, Air One, Air France, and Lufthansa in Venice. Clearly, low cost carriers have had an impact domestically, and Alitalia will scale back routes in which it cannot effectively compete with commodity service, or high speed rail. But the opportunity for additional international operations certainly makes sense for Alitalia, particularly from Milan’s Malpensa, a major business center. Alitalia has routes to the US that Etihad currently does not have rights to. As a result, expansion in Milan, and potentially Venice, may make sense. Alitalia also has a small footprint in Asia. Whether additional non-stop service makes sense, or service connecting via Abu Dhabi, opportunities for growth exist. We expect Alitalia to offer additional flights to Abu Dhabi from Italy, which should bring the Etihad/Alitalia combination close to Emirates current frequencies in the Italy-Gulf market, and double that of Qatar. This should help both Etihad and Alitalia via connecting traffic. Running the Show Despite an ownership of only 49%, Etihad tends to run the show at the airlines it invests in. With Alitalia, Etihad has investments in eight airline partnerships: Alitalia will remain in the SkyTeam alliance, and will continue to have close relations with Air France and KLM. Delta has complained about unfair competition from Gulf Carriers (see our ExIm bank story from last week), so it remains to be seen whether relations with Delta will cool. With AirBerlin also in the Etihad alliance being a member of the oneworld alliance, Alitalia could also code-share with is own and rival alliances. In many of airline investments, Etihad has placed key executives in senior management positions, and is, in effect, running the show. Will the same thing happen at Alitalia, and has Gabriele Del Torchio just eliminated his own job as CEO? This remains to be seen, but is a possibility as Alitalia joins the Etihad equity alliance. Can Etihad do what no one has been able to accomplish - bring Alitalia into profitability? It will take a massive investment in both talent and money to do so, and this represents the largest challenge for Etihad’s alliance to date. Despite all odds, there is a chance that it could work, and bring “sexiness” back to Italian skies. Time will tell.

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