COUNT DOWN TO APRIL 30TH,2007: DEADLINE!!THE CONSOLIDATING OPTIONS OPEN TO DOMESTIC OPERATORS

(article written April 2007)
RECAPITALIZATION OPTIONS OPEN TO DOMESTIC AIRLINES:

Once again the Nigerian aviation industry is counting down to another form of consolidation. The first time it happened was after the EAS crash in Kano when BAC 1-11 aircrafts were banned and airlines with only one aircraft were directed to cease operations. Some airlines fizzled out as a result of that law. Some new start-ups also ended the dream with glittering Air Transport Licenses (ATL) and Air Operators Certificates (AOC) adorning their office walls.

The present government has set a new capital base that must be met by Nigerian airlines on or before the 30th of April 2007. Domestic operators are to re-capitalize to the tune of N500 million, regional operators N1billion and international operators N2billion. This is the second time the government is setting a capital base for Nigerian airlines within eight months.

The air transport industry has at some point made the transition from tough regulation to complete deregulation of competitive practices, but the track record for mergers and acquisitions in the sector is hardly encouraging. Evidence has it that deals that have gone through have yielded little or no real value.

Despite this somber history, the Minister of State for Aviation has a strong determination to see this through. The industry really appears to be lining up for another round of consolidation.

Consolidation is not uniquely a Nigerian thing, but global as airlines are consolidating at a very rapid pace. Some recent examples include:

In Germany, Air Berlin has just concluded its merger with LTU airlines.

In Russia, forerunner of the merger trend was S7, which acquired Vnukovo Airlines in 2001 and soon after became Russia's second-biggest carrier. In 2004 it absorbed Chelyabinsk Airlines. It used consolidation mostly to enlarge its presence in the domestic market by adding new bases and inheriting commercial rights.

Aeroflot is using the same strategy. By year end it plans to complete the acquisition of Yamal Airlines, following up on its takeover of Aeroflot-Nord and Aeroflot-Don in 2004 and 2005. At every turn another set of merger talks seems to appear. The business logic behind these talks is straight forward enough allowing partners to build bigger networks and achieve lucrative economies of scale.

In the Caribbean, Star Airlines and LIAT have "commenced formal negotiations toward the merger of the two carriers" following a decision by the LIAT board. Caribbean Star Chairman R. Allen Stanford said the tie-up “could eventually become the most modern and efficient airline in the Caribbean.”

In Australia, Regional Express Airlines of Australia said it has "fast tracked" merger discussions with Sunshine Express Airlines. Under the proposed transaction, all Sunshine shares will be transferred to Rex "for a nominal consideration." Rex MD Geoff Breust said the deal is in line with its "mission of connecting regional Australia".

In the United States of America, airline consolidation in the US this year began on a smaller scale as ATA Airlines parent, ATA Holdings bought out World Air Holdings (WAH), parent of World Airways and North American Airlines for $315 million in cash or $12.50 per share. WAH itself bought North American Airline last year, just before the latter commenced New York-Lagos-New York flight. Last year a minnow, American West acquired the whale, US Airways.

In Belgium, on the 25th of March 2007, Virgin Express ceased operations as it merged with SN Brussels Airline to form Brussels Airline. They were anticipating an increase in demand for low fare services and primarily to insulate themselves from the European “vultures”, Ryan Air & Easy jet.

In India, after a protracted on and off discussion Jet Airways eventually bought Air Sahara for INR14.5 billion rupees an equivalent of $340 million. Also the Indian government has just approved the merger of Air India and Indian Airlines, both airlines were government owned.

In China, the consolidation is involuntary since it was a directive by the Chinese authorities. Grand China Airlines was established in 2004 as the vehicle to merge the major aviation assets of Hainan Airlines, Xinhua Air, Changan Air and Shanxi Air. The move paves the way for Grand China Airlines to complete a planned listing in Hong Kong. Also, China Southern Airlines is in merger discussions with some regional airlines.

We can go on and on about mergers & acquisition in the industry that is not to say there have not been some hiccups which has manifested in the failed bids of Ryan Air to acquire Aer Lingus and US Airways to acquire Delta Airline and the protracted efforts of Air Tran to acquire Midwest.

Airline failure is one way to achieve consolidation and reduce excess capacity. It is inevitable that some airlines, particularly those being crippled by high liquidiy, labour and operational costs will continue to fall by the wayside.

Carrier failures would relieve the pressure on yields, but most say the respite would be relatively brief and regionally restricted, ending when surviving carriers fill in the vacated markets. Yet it seems as if failure is the preferred consolidation mode. Clearly in the past consolidation has not been very successful, either from the government point of view or even from the airlines in terms of pulling off mergers.

The options open to domestic airlines, which have not met the minimum capital level as enunciated by the ministry, are to source for scarce funds from unwilling Nigerian banks or consolidate through mergers and acquisitions (M&A).

At the recent LAAC seminar, Bank PHB’s MD/CEO, Mr. Atuche reiterated that “aviation industry requires high level of investments and that a large capital outlay is also required, which runs into millions of dollars with a long gestation period of re-payment which requires pooling of resources at great risk”.

The options have their attendant costs.

For re-capitalization, airlines are expected to pay the Corporate Affairs Commission (CAC) some amount in relation to signing and duty fees which ranges from N15 to N60 million, also interest to be paid to banks or institutions that facilitate the loans and other related taxes.

For mergers and acquisitions, the cost ranges from fleet repainting to severance package, expensive customer service disruption, tricky labour negotiations and job cuts.

The government, regulators and airlines involved will necessitate elimination of day-to-day decision making during the integration period. This “strategic paralysis” is perhaps the biggest merger related cost, as competing airlines take advantage of the distraction by poaching key personnel and customers.

Consolidation has been a voluntary process in the industry, which is much easier for the weaker airlines than raising capital. It is ongoing in Europe, America, Asia, Oceania etc. Here in Nigeria, airlines have been finding it difficult to take this option. We see instead the struggle to own, operate and retain an airline even when it is barely surviving. The government has now tasked operators to look at this option before April 30th. It is expected that some mergers would be announced during this period.

I would like to advise operators to take these precautions “if” and “when” initiating talks:

• Deal With Emotional Issues: a number of emotional decisions that will not go down well with some people. The Board and Management should decide quickly and decisively an organizational structure, top team and location of key jobs. It is also extremely important to be very clear on selection process and criteria upfront.

• Integrate Finance, IT and Planning: It is important to start the integration with the Finance, IT and Planning Units before eventually integrating other units. This ensures adequate tracking of cash flow. Also, a process of tracking expenditure and savings must be quickly established.

• Project Team: A highly disciplined Project Management Team should be formed with the vision of formulating clear protocols for identifying and implementing integration synergies and “breaking ties” where “best practice are concerned.”

• Manage Government And The Regulator: Before, during and after the merger Management must ensure that government and the regulator, which is the NCAA are properly briefed and carried along as, we all know that approval is still mandatory when aircraft and personnel are to be brought into the country.

• Involve Labour: Airlines with labour unions should involve them, but must ensure they do not get caught in the middle. The Project Team should recognize that upsets and disquiet are unavoidable and leave no-win issues, but focus on high priority issues where management is a stake holder such as intermingling agreements, severance package e.t.c.

• Customer Service Challenge: As discussions are going on, so will the rumor mills and customers will buzz the call centers to ascertain the fate of their itineraries such as bookings, tickets and timing. The earlier reciprocal Customer Service benefits are implemented, the sooner the gains to the integrated networks.

• Manage the Cultural Integration: Airlines typically possess unusually strong cultures and identities. Company handbooks and some operation processes will differ. Managers and supervisors need to be prepared to “walk the walk” from day one projecting a common voice for front-line staff. It is important for cultural integration to begin immediately.

What are the benefits?

• Nigerian carriers will acquire greater strength to react to vagaries of operations.
• Enhanced bargaining power with key suppliers.
• Cost rationalization in areas such as sales forces, back office functions, part inventories, management teams, etc.
• New market growth.
• Increased market share and power.
• Network optimization.

Conclusively, the underlying logic behind consolidation is, on the surface, rational and compelling. The value is clearly there, but capturing it remains elusive in Nigeria.

Personally, I look forward to the next round of voluntary or involuntary consolidation where the boys will be separated from the men, the N500 Million minimum capital base required by April 30th, is a mere $3.85 Million, which cannot buy one B737, but will send virtual domestic operators who do not own aircraft, but lease aircraft for their operations to the morgue.