Monday, February 27, 2006

Aer Lingus for Dummies

This post was created in response to an excellent analysis by Mark over at From Cork to Toronto and by Omani over at From Bath to Cork with Baby Grace. (what is it with you Munster men?)
Neither are analyses that I would agree totally with but then it is good to talk. However, I'm so bored with this subject I'm going to bury this post into the depths of my blog archives!


Nice analysis. The only problem is that Mark missed my point and didn't really address the non-economic arguments put forward by Omani. I don't object to the sale of Aer Lingus. I just believe that it makes no sense to sell a portion and retain majority control. That is the worst possible option of three. (Sell ; Sell bit ; Hold)

Some minor comments on Mark's well made points.

In fact both Aer Lingus & Ryanair can raise international capital whenever their shareholders approve. If run properly, it should be easier for the former to raise finance (smaller number of shareholders, Govt bond security, etc). The availability of capital is the sole determinant.

O'Leary's placement of firm and tentative aircraft orders in the immediate aftermath of 9-11 was a typically opportunistic and entrepreneurial move. However unless Ryanair quadruples revenues in the intervening years, they will not be able to pay for all these orders. Any rate, the aircraft manufacturers don’t have the capacity to fill the orders. The orders become forward options that will most likely be sold/renegotiated.

As you say, Ryanair operate in a largely deregulated environment ; Aer Lingus (by choice) don’t. This makes the latter less attractive to potential bidders.

As you eloquently describe, Aer Lingus is a tiny player in international air travel and probably not likely to attract the attention of any major aviation player.

The issues with Swissair et al were only partly the national flag. The biggest problem was that as semi-state or state-owned, none of these companies were exposed to the harsh economic realities. They were highly inefficient airlines. Most of the North American airlines (American, US Air, etc) had a similar problem to Aer Lingus. Too many overpaid pilots & crew and not enough passengers. At one point, Aer Lingus had over 300 pilots but only 34 planes. They were in effect the National Aircraft Training Academy that ran commercial flights as a hobby. When passenger growth stagnated, having lived beyond their means, all major airlines were forced into bankruptcy. So while I agree that the Unions played a part in bringing about this calamitous collapse by demanding excessive packages, mis-management by the airline also contributed.

I would suggest that semi-state organisations are highly inefficient and are in effect the compromise that the state chooses to retain control. As an investor, I’d not be too keen on investing in an organisation with such industrial relations issues and a management with such a poor track record.

Retrenchment by Willie Walsh into Airbus aircraft simplified operations but took the company from a duopoly of aircraft suppliers to an effective monopoly supplier. It’s never that good if you cede so much power to the supplier.
The advent of the Airbus’s A380 aircraft (another ludicrous example of economics of diminishing returns) will probably result in at most only 10-15 (max) long haul hubs around the world fed by satellite airports. Gatwick/Heathrow or Charles De Gaulle will most likely be the West European hub.

With an aging fleet and a serious overstaffing, the Heathrow slots are Aer Lingus’s only real assets. And it isn’t clear how liquid these are.

The Shannon stop over masks the fact that soon both it and Dublin will be by-passed in the long haul consolidation. There are barely enough passengers to support direct flights from Dublin to the main US cities. There isn’t enough passenger numbers to justify direct flights to Canada over the winter period.

Dublin can become a key feed to any Western Europe hub. The only real hope for Shannon long term is to offer it self as a cargo-dominated hub close to the main Western Europe hub.

Much has been made of the “turnaround” in Aer Lingus. Clearly Willie Walsh & co made a good start in slashing costs. But claims that Aer Lingus is a profitable airline are a joke. It is very easy for a company to be profitable if it is given its operating assets free and makes no provision to replace them. At $55-60 million per A320 aircraft, it would take Aer Lingus many years to expand its fleet let alone become profitable.

Your points re: inefficiencies of Dublin Airport reinforces my view that state monopolies generally don’t work in economic terms.

However, having ceded control of goods importation by sea to the commercial sector (with disastrous consequences for Ireland Inc.), the country might be advised to retain control over air freight. But it could only reasonably do so in the context of ceding long haul routes.

The introduction and subsequent cancellation of flights from Cork airport by Ryanair show the efficiencies of the market. Commercial companies are not charities. Nor should we expect them to be. Nevertheless, it also highlights that strategic interests of a country (e.g. development of Cork airport) are not best served by the markets. Sometimes the state has to lead and the market follows. If the market thinks an option is attractive, the state has no business trying to compete. Ireland is a very small, open economy.

The emotional attachment to a National airline is generally not an argument that I think stands up to much scrutiny. It would be much cheaper to lease 12 BA flights a week and have them painted in Aer Lingus livery. However, I recognise that not all decisions are made on the basis of economics.

So in balance while I can understand the emotional attachment to Aer Lingus, I think there is a simple choice. (a) Recognise that the National Airline is a piece of strategically important infrastructure (like the National Gallery) and look to minimise costs (drop long haul) while maximising value (expanding access). Or (b) Recognise that no country has any right trying to run an airline - since most airlines can’t – and sell it to the highest bidder. Option 3 (selling part of Aer Lingus) does a disservice to the hard working & misguided people at Aer Lingus is still a stupid option.


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