Podcast: Will There Be More Airline Consolidation In Europe?

After Lufthansa's investment in ITA Airways was approved, Aviation Week editors discuss the implications of the deal and what it means for other consolidation moves in Europe.

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Rush Transcript

David Casey:

Hello, everyone, and thank you for joining us for Window Seat, our Aviation Week air transport podcast. I'm David Casey, editor-in-chief of Routes. Welcome aboard. This week, we'll be talking about consolidation in Europe's airline industry that seems to be edging forward after the European Commission approved Lufthansa's move to acquire a stake in Italian flag-carrier ITA Airways, subject to several competition remedies. And to do that, I'm delighted to be joined by my colleagues, Jens Flottau, executive editor for commercial aviation at Aviation Week Network, who's based in Frankfurt, and Victoria Morse, European Bureau chief at Air Transport World, who's in the UK. Great to be with you today.

Just to set the scene a little, ITA is, of course, the successor to Alitalia, which filed for bankruptcy in 2017. Now, Lufthansa agreed to take a 41% stake in ITA in May 2023 in a €325 million deal, with the option to acquire all remaining shares at a later date. This led to the European Commission launching an in-depth investigation after expressing concerns that the acquisition may reduce competition on certain long-haul and short-haul routes, and strengthen ITA's dominant position at Milan Linate Airport. Now, Jens, I know you've been following this case very closely, and it's felt like a decision that's been dragging on for a long, long time. But on July 3, after more than a year of waiting, the Commission finally gave the green light. Perhaps you could just start off by explaining what the latest is with this deal?

Jens Flottau:

Yes, the short answer is it is approved. The deal is approved, but the longer answer is there are still some conditions that need to be met. The Commission has particular concerns about the competitive situation at Milan Linate Airport, and wants to ensure that even when ITA and Lufthansa join forces, there will be a sufficient level of competition at the airport. So what needs to be done is Lufthansa and ITA have to give up around 200 weekly slots at the airport. And not only that, they actually have to make sure that someone actually picks up those slots. So they have been in talks with their competitors over the last few months to see who is interested in establishing a base in Linate and fly those routes.

I understand it's easyJet or Volotea who are the most likely candidates to come in and kind of help Lufthansa. There's also a similar requirement for some of the long-haul routes from Rome, transatlantic routes in particular, which is important for Lufthansa, because if that condition isn't met, then ITA cannot become part of the A++ joint venture on the transatlantic routes that it has with United and Air Canada. So it's not yet a done deal, that all still needs to happen. They say it's going to happen in the fourth quarter, and given the talks that they've already entertained with their competitors, it seems like it's possible, but it'll still be a few more months until this can all be implemented.

David Casey:

Okay, and in terms of those short-haul remedies, you mentioned some of the LCCs that are looking to potentially step in and take those slots. Now, Victoria, we've seen that Italy is such a competitive market in recent years. Does this provide a big opportunity, would you say, for another airline to come in and to really expand its market share?

Victoria Morse:

Getting those slot pairs out of Milan Linate and having the ability to come in and create a base is the kind of opportunities that we've seen low-cost carriers in particular waiting for. So the conversation that I've been having with the airlines over the last two years or so, I'd say, particularly in the low-cost area, is that they're not really necessarily looking for direct acquisitions. What they're looking for is exactly this, it's the remedy packages that are coming out of wider industry consolidation.

And because we've already seen a lot of the larger airlines consolidate, we've just got a couple of opportunities left. It really is that opportunity to get into the market and have a sizeable presence in one go. So yeah, I think that the low-cost carriers are definitely interested in these kind of remedies, and it's going to be the kind of thing that isn't going to come up so often in future, once we've got to the end of the current consolidation round.

David Casey:

And on the long-haul side, Jens, you mentioned that Lufthansa needs to potentially enter agreements with rivals to improve their competitiveness through either interline agreements or slot swaps, but you also mentioned that it hasn't been excluded from the A++ joint venture on the North Atlantic. How important was it for Lufthansa that the commission opted not to block it entering this JV?

Jens Flottau:

I think that was a crucial step. I mean, in the process, a few months ago, the commission came up with the idea that if they were to approve the deal, then ITA cannot be part of the joint venture. And I think from Lufthansa's perspective, that would've been a real no-go. The long-haul market is such an important part of the rationale to go in and acquire ITA in the first place that excluding it from the joint venture would completely contradict the purpose or defeat the purpose. So I think a lot of the efforts in the negotiations over the past few weeks and months have gone into preventing the commission from making exclusion from the joint venture a condition, and they have succeeded in doing that, albeit at the price of some additional remedies. But yes, it was absolutely crucial.

David Casey:

And I suppose, as well, it's not just the US where Lufthansa will benefit. I know CEO, Carsten Spohr, he's outlined a strategy to create an even more global direct mention, with ITA helping to fill network gaps in Latin America and parts of Africa, which are perhaps not as well served by the Lufthansa group already. But I suppose, Jens, what is the overall rationale of this acquisition? Because Italy is a market that Lufthansa has been seeking to grow its footprint for a while. We saw, I think it was 2008, when Lufthansa was interested in Alitalia, and then shortly afterwards, it set up an Italian subsidiary at Milan Malpensa, which lasted quite a short time. But it's a really crowded market. As we've said, Ryanair, easyJet, Wizz, Volotea, they've all expanded in recent years. So what is the rationale for Lufthansa? Why is it so keen on ITA? Why is it so keen on expanding in Italy in particular?

Jens Flottau:

To understand this, you kind of have to go back into Lufthansa's corporate thinking that's been developed over decades, really. Literally for decades, thinking has been you have to acquire a local airline to buy market access. And that, if you look back into what they've done so far, Swiss, Austrian, Brussels, yes, they have succeeded in buying market access, but if you look at what the contributions to its bottom line were, then the results have been mixed. Really, Austrian financially hasn't been a success over... If you go from 2008, when they acquired them until today, mostly losses or marginal profits. Same for Brussels. The only exception has been really Swiss, which has been a lot more profitable, and the Lufthansa Airlines itself. So they kind of hope that ITA could repeat that success, but I frankly have my doubts.

Yes, ITA is a startup company that does have some cost benefits right now. Lufthansa argues those benefits will continue as it grows, and they can benefit from economies of scale. I would say that's probably true, but also, don't forget that they will not be able to retain pilot salaries at this kind of low level that they are in now. And you mentioned the competitive situation in Italy. I just looked at the CAPA numbers for capacity for last week, actually, and Ryanair offers three times as many seats in the Italian market as ITA. easyJet is the size of ITA, Wizz Air is only a little bit smaller than ITA. So if you add those up, then you just come to the conclusion that ITA's market share in the country is relatively minor. It's a small player, and that leads you to the long-haul market.

Lufthansa thinks that Rome can be a hub for Eastern Africa, and in particular for Latin America. Now, I would argue the East African market is not that big. Okay, I will say, yes, that's probably a good location for a hub between Europe and that part of Africa. Latin America, I would doubt that Rome will get Lufthansa anywhere near they need to be, just because, when you look at the map, most parts of Europe are just too far west, or Rome is too far east to capture most of the market going from Europe to Latin America, so I have my doubts.

David Casey:

Is a huge inbound market, though, isn't it? I mean, I think it's the fourth-largest tourism inbound market in the world, 57.2 million arrivals in 2023, I think is the figures. So it's only behind France, Spain, and the US in terms of that inbound traffic. I think it's also the third-largest aviation market in Europe, and Milan as well, it's a big corporate market. It's got a big catchment, it's got a strong business and corporate segment. Surely, that must play into the thinking?

Jens Flottau:

Yeah, Milan is the crown jewel for sure. And yes, I'm not denying that it's a big long-haul market, but you also have to take into account that ITA has a relatively small long-haul widebody fleet. I'm not saying it's impossible to be successful, it's just going to be really expensive for the next few years, as they build up that fleet. Whether it works out in the long run, yes, I would say not at the same level of profitability as Swiss. If they're lucky, at the levels of Austrian and Brussels. And yes, it's a big market, but it's the big markets dominated by low-cost carriers, so why do it?

David Casey:

So of course, the Lufthansa-ITA deal isn't the only consolidation move happening in Europe right now. We've got IAG trying to buy Air Europa, and we've got Air France-KLM, which is looking to take a stake in Scandinavian carrier SAS. Victoria, what would you say the implications are for the Lufthansa-ITA approval on the wider industry, and the other deals and the other deals that are in the pipeline?

Victoria Morse:

One of the things that's notable from this one, David, for me, is the fact that even though it was 14 months for the approval, it's actually been reasonably quick, when we look at some of the other acquisition deals that are going on right now. I mean, you look at IAG-Air Europa, that process has been going on now, in terms of trying to hammer out the deal and trying to get the approval, for five years. And it must be quite difficult for airlines that are keen to integrate these other carriers into their strategy to have to be in limbo for that kind of length of time.

Also, these Air France-KLM-Scandinavian Airlines deal, that's slightly complicated by the fact that SAS has been going through bankruptcy proceedings, so that's forming part of that overall process. But one of the things that really stood out to me was that, earlier on this year, I was in Brussels for the Airlines for Europe conference, and it surprised me quite how keen absolutely everybody in the senior leadership of the airlines that were represented there were on just really pushing forward and getting the European Commission to act more quickly on these approvals.

And I'll share a few comments that were said there. So for example, Luis Gallego from International Airlines Group said that if we don't allow consolidation in Europe, it's going to destroy the airlines here. We've had Michael O'Leary saying that Europe needs to get on with it and approve the mergers, because ultimately, that's the way forward. You've got Lufthansa saying, this was Carsten Spohr, saying that he can't imagine a Europe where there's only three big airlines that operate the large hubs. There has to be a variety of airlines in Europe, but some of the smaller airlines can only survive as part of a group. And Air France-KLM's Ben Smith said that it was a true net positive in Europe to have consolidation. Now, you would've thought that airlines like Ryanair might get in there and oppose this, but they're really not. O'Leary said, "We need this for a proper functioning industry."

So I think there's quite a lot of pressure there from all of the majors to allow consolidation. Obviously, they're in the game, most of them, but then, on the smaller scale, you see other airline consolidation in the regional sector, like Air Nostrum and CityJet, which are two regional airlines which came together recently. So I think that the opinion is actually quite pro-consolidation, from what I'm hearing at the events that I'm attending. One of the other interesting comments I'd like to bring in is from the chief executive of Scandinavian Airlines, who was speaking earlier on this year at Aarhus in Denmark, at Routes Europe, and he said that the European Commission is a bit split on what they want from the European airline industry. So on their one hand, they're implementing a lot of regulation, particularly around sustainability and passenger rights that makes flying in Europe a lot more expensive.

Chief executive of Brussels Airlines said that by 2035, European flying will be up to over $200 more expensive because of the kind of regulation that we're introducing. And what the chief exec of Scandinavian Airlines said is that, on the one hand, Europe is making flying a lot more expensive and doing that intentionally. On the other hand, when it comes to European consolidation, the thing that they want is a competitive market and to keep fares competitive, to keep fares low, so that consumers can travel. So which is it that they want? Do they want affordable travel or do they want travel to be expensive, to decrease demand, for sustainability? It is quite confusing.

David Casey:

So would you agree with that, Jens? Is the Commission then being too cautious when it comes to M&A? Do we need the regulatory conditions to change for further consolidation to happen? Otherwise, as Victoria said, some of the scrutiny and demands for remedies could deter major airlines from further deals?

Jens Flottau:

I would say it's easy to blame the Commission for the slow progress that we've seen, and there may be some truth to that. On the other hand, I understand that it is looking at competition concerns, that's its job. But if we look at the airlines themselves, they are to blame too for this, right? I mean, if you look at the way and how they have tried to integrate over the past decade or two, then you have to really say they have not really integrated well, and the Lufthansa Group, for a very long time, the airlines that have been acquired have enjoyed a lot of autonomy, and there hasn't been the kind of synergies that would've been possible for one reason or another.

Likewise, Air France-KLM, I mean, the constant fights between Air France and KLM, we've all written about that for years. So progress in consolidation in Europe has been slow, and I would argue, yes, I can see a point that being bigger has advantages, and fleet acquisition, and so on, but it also makes you more complex, and sometimes I think airlines forget that what's really key is to have a strategy that works for a specific market.

I mean, if Lufthansa, for example, doesn't get its cost under control in its core market in Germany, if it continues to build complexity, continues to not have a clear approach to these issues, then it doesn't matter whether it acquires ITA Airways, it doesn't improve things. It just kind of adds another layer of complexity. So I'm a little bit cautious when people say, you know, "Consolidation is the solution for our problems." It's not. I mean, it does have its benefits, for sure, I don't deny that, but it also adds risk and the risk of management distraction, and people thinking that, "Of course, now we're bigger and everything is going to be smooth sailing." It's not.

David Casey:

Before we end this episode, then, I've just got one more question for you. Perhaps you might want to take this, Jens. Is this a good deal for Lufthansa then, overall? Are they going to look back in 5, 10 years' time and wish they hadn't got involved, or do you think it will benefit the group in the long term?

Jens Flottau:

Okay, I'll make a forecast here. So it's a good deal for ITA, because for obvious reasons, they have a strong shareholder now, now they will survive. For Lufthansa, in 10 years, if we look back and we just look at financial metrics, then I would say it will not have been a good deal.

David Casey:

Well, on that note, we are all out of time for this week's episode of Window Seat. Jens, Victoria, thank you so much for joining me and for your insights. We'll soon be together at the Farnborough Airshow, of course, and we'll be bringing Window Seat and Check 6 podcasts from the event. Thank you to our producers, Cory Hitt and Guy Ferneyhough, and of course a big thank you to our listeners. As always, please make sure you don't miss our weekly recordings by signing up via Apple Podcasts or wherever you listen. So until next time, this is David Casey, disembarking from Window Seat.