IAG takes Norwegian route to low-cost long-haul travel

In the battle for the skies over the Atlantic, International Airlines Group is eyeing another co-pilot.

The owner of British Airways has taken a 4.61 per cent stake in Norwegian Air Shuttle, the low-cost airline whose launch of ultra-cheap US flights from Europe has led to a scramble among established players to mimic offerings or risk losing passengers. It said it would “initiate discussions with Norwegian, including the possibility of a full offer for Norwegian”.

IAG, which also owns Vueling, Aer Lingus and Iberia, brings with it financial muscle to help patch Norwegian’s wounds, which include deep losses and a NKr22.3bn ($2.9bn) debt mountain.

But its investment, or even a full takeover, does not solve the Scandinavian carrier’s most fundamental problem — how to make money flying passengers across the Atlantic for under £70.

“Unless you have the right business model, deeper pockets only help you fund losses for longer,” says Jonathan Wober, analyst at CAPA Centre for Aviation.

IAG has timed its approach as its quarry looks to raise badly needed finances to help it nurse increasing levels of red ink. Norwegian booked a NKr299m loss last year, against a profit of NKr1.14bn a year earlier — its third year of losses in the last four. Michael O’Leary, chief executive of rival Ryanair, even went as far as to predict last September that Norwegian would run out of cash in “four to five months”.

The move also comes at a time of consolidation among European airlines, driven by a brace of corporate failures as years of discounting drives the need for scale to thrive. EasyJet, which recently bought collapsed airline Air Berlin’s operations at Tegel Airport, is vying with Lufthansa to buy out Alitalia, which the Italian government is seeking to keep running.

In its brief statement on Thursday, IAG offered little insight into the rationale for its move, leaving analysts and industry insiders to speculate over the myriad reasons it may want to invest in another low-cost carrier.

BA, which missed out on the low-cost short-haul bonanza in Europe by selling its cut-price Go brand to EasyJet, is keen to avoid a similar mis-step when it comes to the lucrative long-distance market.

IAG has launched Level, a Spain-based low-cost service offering hand luggage-only flights to the US, but the fledgling operation remains a long way behind Norwegian in its share of the budget market.

“Growing that to scale organically is very, very difficult,” says Daniel Röska, an analyst at Bernstein.

IAG may also bring a degree of business restraint to Norwegian, whose years of rapid growth have seen it plan ventures as varied as domestic flights in Argentina and leasing aircraft to other carriers — on top of operating its existing European short-haul network while pioneering long-haul budget travel.

Mr Wober at CAPA says: “They have been fighting battles on many fronts for too long.”

The move may also give Norwegian the chance to offload some of the 200 new aircraft it ordered in 2012 to other IAG brands, Mr Röska at Bernstein suggests.

Norwegian’s strategy of avoiding larger airports and flying “point to point” from cities such as Edinburgh or Dublin avoids the costs of the “hub and spoke” model offered by larger players, but leaves potential customers the headache of reaching those second-tier airports.

IAG’s network of short-haul flights would offer additional travel options, regardless of whether the businesses fully merge.

At the same time, Norwegian has built a formidable presence at Gatwick, rivalling BA’s position at the UK’s second-biggest airport.

Mr Röska wrote in a note on Thursday: “A partnership that looks to maximise the synergies of the two networks, minimise duplications of capacity and investment on key routes, and use IAG’s travel management capabilities to improve Norwegian’s expertise in this area, could all provide some of the benefits of consolidation without the likely high cost of a deal.”

He said he believed IAG would be gambling if it bought the airline outright because it had no proof that synergies would work and the business could be run profitably.

But the risk in creating synergies now is it drives up the value of the business — making it even more expensive if IAG does want a full takeover.

Ultimately, the move brings Norwegian funding at a time when it was looking to raise more capital by selling some aircraft and putting its frequent flyer scheme up for sale.

Stephen Furlong at Davy says: “Norwegian has been doing in low-cost long-haul what Ryanair did in low-cost short-haul. The difference is that Ryanair did it with conservative financial leverage.

“Norwegian needed a partner with muscle. Perhaps this is it.”

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