Portugal is beckoning to Air France-KLM as the group evaluates opportunities to expand in southern Europe. An investment in state-owned TAP Air Portugal would complement a potential deal for Italy’s ITA Airways in several of Europe’s fastest recovering markets.
“We’re very comfortable with the Iberian peninsula, and TAP could be [an] option for us to have a larger presence,” Air France-KLM CEO Ben Smith said during its third-quarter earnings call on Friday. The group will “definitely engage” with the Portuguese government on a “formal basis” when it is ready to sell down its full ownership in TAP, he added.
An Air France-KLM and TAP deal would just be the latest in what is becoming something of an airline consolidation spree in southern Europe. The group is already part of the preferred bidding consortium selected by the Italian government to takeover ITA; private equity firm Certares leads the bid. And International Airlines Group is working on a new structure for its proposed takeover of Spain’s Air Europa with an aim to close the deal by the end of 2023.
All these potential airline deals come as Europe’s budget carriers, from EasyJet to Ryanair and Wizz Air, are rapidly expanding in many of the same markets. This is fueled, in part, by slot divestitures that legacy airlines like Air France-KLM and TAP agreed to as conditions of the state Covid relief they received during the crisis.
Consolidation Mania
The interest in consolidation is multi fold. For one, larger airlines benefit from better economies of scale, for example when buying new planes, and improved pricing power in the market. However, regulators often push back against deals for some of the very same reason airlines want them: Improved pricing power often means higher ticket prices for travelers. That said, larger — and one hopes stronger — airline groups can also grow more, which benefits travelers.
In the U.S., after four major airline mergers following the Great Recession, domestic capacity grew at a compound annual rate of 2.7 percent from 2010 through 2019, U.S. Bureau of Transportation Statistics data via Diio by Cirium show. Domestic capacity shrank at a compound annual rate of half a percent during the decade prior, which was also before the last round of mergers.
And while some airline consolidation has occurred in Europe, the big three groups — Air France-KLM, IAG, and the Lufthansa Group — retain much smaller shares of the market than their U.S. peers. The three flew just 29 percent of the seats in Europe during the first nine months of the year compared to the U.S. big four’s — American Airlines, Delta Air Lines, Southwest Airlines, and United Airlines — 78 percent of seats in their home market, according to Diio.
Southern Europe’s large markets and strong rebound is another reason groups have their eyes on takeover deals there. Spain is the European Union’s second largest after Germany, and Italy its fourth. And ever since leisure travelers began trickling back onto planes during the pandemic, they have shown an overwhelming preference for visit outdoor destinations, particularly in southern Europe. Portugal, for one, has directly marketed to remote workers, and Lisbon was even named by Savills as one of the best cities globally for digital nomads. Similarly, Spain’s Canary Islands proved a popular spot for roving remote workers.
Passenger traffic in Portugal and Spain recovered to 96 percent and 80 percent, respectively, of 2019 levels in the first half of 2022, Eurostat data show. Comparatively, Germany and France only recovered to 61 percent and 73 percent, respectively, of pre-pandemic numbers. Data for Italy was not available for the period.
The big airline groups want a larger piece of this pie, especially as they see their discount rivals circling. EasyJet, for example, will pass Ryanair and become the second largest airline in Lisbon by December after acquiring a number of slots divested by TAP, Diio schedules show.
On the ITA acquisition, Smith said the consortium’s exclusivity period to finalize a deal with the Italian government expires at the end of October. He did not say more about what could happen if the deadline passed, or if the Lufthansa Group could make a renewed push for the airline. Certares is leading the negotiations for ITA.
Transavia Growth
Air France-KLM also sees growth opportunities within its own airline portfolio. The focus is on its budget arm Transavia France that is in the process of taking over the bulk of the group’s operations at Paris’ Orly airport. Smith said the shift is “almost complete,” and added that, when finished, would allow the group to grow profitably at the airport while staying in line with French laws that bar most flights on routes where a train makes the journey in two-and-a-half hours or less.
Asked how that the growth of Transavia translates into future growth for the group, Smith said the group would shift its focus to adding new point-to-point routes in Europe from second tier cities in France once the Orly transition was complete. While he did not name names, these would likely include Lyon, Nice, and Toulouse. This growth would act as a sort of “consolidation” by allowing the group to capture a larger share in these markets, Smith said.
Secondary French markets have proven a successful strategy for competitors. Spanish discounter Volotea opened bases in Lille and Lourdes this year, and Lyon in 2021, bringing its total to bases eight in France.
Transavia brought in 25 percent more revenues, or $849 million (€855 million), on just 11 percent more passenger capacity in the third quarter compared to 2019.
And the Numbers
Air France-KLM reported a $1 billion operating profit, and a $457 million net profit during the September quarter. Revenues increased 5 percent year-over-three-years to $8 billion after a roughly $224 million hit from the operational issues airlines’ faced across Europe this summer. Importantly, yields — or an indirect measure of airfares — were up 24 percent compared to 2019 despite passenger capacity being down nearly 15 percent.
Corporate revenues, long a mainstay of network airlines like Air France-KLM, recovered to 76 percent of 2019 levels in the third quarter.
Looking ahead, Air France-KLM plans to fly roughly 85 percent of its 2019 capacity in the fourth quarter. Full year capacity will be down roughly 20 percent from three years ago. The group forecasts a roughly $894 million operating profit for the year.
Air France-KLM Chief Financial Officer Steven Zaat, when asked about 2023 capacity, said it would continue to recover towards 2019 levels but warned that the operational issues the industry faced this year would “probably not be totally over.”
