DAL - Air France-KLM Buys In European Airline Consolidation

2023-10-15 06:34:26 ET

Summary

• Air France-KLM has a history of failed equity investments in European airlines.
• The company is now investing in SAS AB, aiming to strengthen its position in the Nordic markets and weaken Lufthansa's influence.
• Air France-KLM is also eyeing a stake in TAP Portugal to maintain access to the South American market and potentially force the airline to leave the Star Alliance.

In 2004, Air France and KLM merged, creating the world’s biggest airline group. It is seen as the start of appetite for consolidation. What the airline group itself did not know is that it would set in motion a consolidation round among European airlines, in which the airline group would repeatedly end up not being able to invest in airlines or straight out acquire them. Internationally, the rise of Gulf carriers put pressure on Air France-KLM, but with Lufthansa ( DLAKF ) and International Consolidated Airlines Group (ICAGY), Air France-KLM would see two airline groups that were significantly more successful in acquiring airlines.

With a successful bid for part of SAS AB ( SASDQ ), Air France-KLM is back and hungry for more.

Air France-KLM Has A List Of Failed Equity Investments

For years, Air France-KLM has been trying to strengthen its position on the European airline market. The company had its eyes on Alitalia and eventually took a stake of 25% in 2009, but the Italian airline remained lossmaking, requiring recaptilization and restructuring which eventually saw Air France-KLM’s share reduced as Etihad Airways took a non-controlling interest. Etihad Airways, however, also underestimated and on the fundaments of Alitalia a new airline was founded: ITA Airways. Together with Delta Air Lines ( DAL ), Air France-KLM had been interested in taking a stake in the newly formed airline. However, it was competitor Lufthansa ( DLAKF ) that was given the right to acquire 41% of the company.

Another airline that Air France-KLM has shown interest in is Spanish airline Air Europa. The airline group had shown interest in acquiring Air Europa dating as far back as 2016, but Iberia (Part of International Consolidated Airlines Group) eventually made a bid for the airline. This take over is under scrutiny from the European Commission, but if approved would once again see an Air France-KLM take over, target end up with a competitor.

Air France-KLM’s list of failed take-overs do not only include bids that it did not win. The airline group earlier won bids for ownership of VLM Airlines and CityJet, but VLM Airlines and its successor ended up ceasing operations, while CityJet was sold to Intro Aviation.

Air France-KLM Adds Strength On The Nordic Markets

So, Air France-KLM has been the airline group that set in motion airline consolidation on the European market two decades ago, but it has not seen huge successes apart from the successful integration of Transavia. With the investment in SAS AB, Air France-KLM has a new chance to turn an investment accretive to the company, something that has proven challenging before.

Air France-KLM is part of a consortium including the Danish State, Lind Invest and Castlelake investing $1.175 billion upon approval of the investment wiping existing shareholder value. SAS AB filed for Chapter 11 bankruptcy in July 2022 following pilot strakes that added to travel chaos, while the company was already considering a flexible restructuring framework. Pending regulatory approval, Air France-KLM would be owning around 20% of the company, providing $109.5 million in direct liquidity and $35 million in secured convertible bonds.

One can, however, wonder how much a 20% stake would do for Air France-KLM because it does not allow the airline to make major adjustments to the airline. Furthermore, Apollo ( APO ) is eyeing a stake in the company as well. Apollo has previously shown interest in SAS to become a majority stakeholder, and the company also provided debtor-in-possession or DIP financing in the amount of $700 million.

One can wonder why Air France-KLM would be interested in taking a 20% stake. I would think that is because there are opportunities to increase that stake in the future. Furthermore, we see that Norwegian recently tried to increase its grip on the Nordic markets and an investment of Air France-KLM in SAS would add to the strength in the Nordic markets with key presence in the hubs of Stockholm, Copenhagen and Oslo. In case, KLM will face further issues to expand its capacity in Amsterdam, the group as a whole could utilize Copenhagen to grow. The equity investment in SAS also will require SAS to leave the Star Alliance, of which Lufthansa is part. So, with the equity investment, the company is strengthening its position on the Nordic markets while also weakening Lufthansa.

Air France-KLM Is Hungry For More

The big risk obviously is that Air France-KLM won’t be able to generate value with its investment, as the company has a relatively weak past of airline investments. Part of the reason seems to be that airlines in the group used to remain largely independent within the airline group, and there has not been a deep restructuring and streamlining process. While that risk does exist, since Benjamin Smith took the lead of the airline group, fleet decisions are taken more on group level and there seems to be an aim to better streamline the businesses.

A major difference is also that Air France-KLM is better identifying the targets of its interest. The SAS stake allows better control of the Nordic markets while giving better group access to Stockholm, Copenhagen and Oslo, weaken Lufthansa’s influence sphere and provide a counter to Norwegian ( NWARF ). SAS has been one of the second tier airlines that saw significant pressure from low-cost operators such as Norwegian and Air France-KLM, now could be intending to use SAS to arm itself against the same low-cost carriers.

One thing is clear, and that is that Air France-KLM wants more. The company also is eying a stake and potential full ownership of TAP Portugal and while Air France-KLM is certainly not the only airline interested in acquiring TAP Portugal, we see that the identification process for equity investment has strengthened. An investment in TAP Portugal would make a lot of sense, because if successful we would see Air France-KLM, which is part of the SkyTeam airline alliance, once again invest in a Star Alliance airline, likely forcing the airline to leave the alliance and once again weaken another airline alliance. Furthermore, with an investment in TAP Portugal, Air France-KLM would keep lucrative access to the South American market. Years ago, KLM negotiated cooperations with Air Europa, but with that airline possibly becoming part of IAG, the company had to identify opportunities to maintain strong access capabilities. With the existing strength of TAP in Brazil, Air France-KLM would remain strong in the South American market and add Lisbon as a hub for its operations.

Conclusion: Air France-KLM Investment Strategy Is Making More Sense These Days

The post-pandemic era combined with pressure from low-cost carriers has set off a new round of airline consolidation, in which Air France-KLM wants to play a big role. The airline set in motion the airline consolidation engine two decades ago, but its investments have not been fruitful. That is also the risk that the airline could once again face. However, with the interest in SAS as well as TAP Portugal, the company seems to be better identifying its needs and what investments in airlines offer.

As the deal with SAS still requires regulatory approval and its impact on the Air France-KLM balance sheet is not known, I am maintaining my buy rating with the notion that Air France-KLM seems to be more active in the current round of airline consolidations with a stronger set of performance requirements that should yield more fruitful investments.

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