Complex Made Simple

Mergers in Middle East aviation sector unlikely anytime soon, say experts

Mergers and acquisitions in the aviation sector create headlines whenever they are on the cards, primarily because they rarely happen. However, experts say mergers in the Middle East are even less likely in the foreseeable future due to a range of factors, including national pride and lack of economic incentive for the major carriers in the region.

by Jamie Knights

Whether it’s KLM Royal Dutch Airlines being taken over by Air France in 2004 or Swiss Airlines becoming part of the Lufthansa group, M&A (mergers and acquisitions) activity has remained very much outside of the Middle East.

The reasons for this phenomenon are varied, according to aviation experts. Partner and managing director at The Boston Consulting Group Middle East, Rend Stephan, explained it was important to first understand why airlines merge in the first place.

“Airlines tend to merge because they think this is one of the levers for them to create value,” he told AMEinfo.com. “If you actually look at the valuation creation record of airlines as an industry across the years, airlines actually destroy value as opposed to create value as an industry.”

Despite this, there have been exceptions that have bucked the trend, allowing consolidation and acquisitions to happen.

Deregulation seen as key enabler of mergers

Another enabler of M&A activity has included the relative deregulated nature of many of these countries.

“So when you look at these things for the Middle East, first you look at the Middle East carriers, and of course we don’t know the numbers for all of them – Emirates publishes its numbers, but not everybody does that – but from a structural perspective they tend to be better positioned to create value than the average legacy carrier globally, which means there is less incentive to think about value creation through an M&A lever,” Stephan said. “Second it is not as deregulated as other countries, which makes it even more difficult to think of M&A as a lever.”

He also asserted that the big three carriers (Emirates, Etihad and Qatar Airways) are trying to play a similar game, albeit with slightly different fleet mixes and routes, but essentially they have very defined business plans.

“Other carriers are struggling because they have not figured out what exactly they want to do. The issue is that carriers think they can emulate these three when it is very difficult for them to do so, so it’s an issue of a business model as opposed to an issue of ‘let me merge and everything will be okay’,” he explained.

“I think the biggest problem in the region is there are a lot of carriers who have not figured out how to play between some of the successful Emirates-like carriers, and some of the successful low-cost carriers who have figured out what their model is.”

Stephan believed M&A activity in the region was unlikely in the near term; however, he noted that “strong carriers”, such as Emirates, Etihad and Qatar, buying additional airlines globally was a possibility.

“There has been some talk and some of them are exploring these options. But other legacy carriers wanting to expand their networks in the region – a European carrier envisaging buying one of the small carriers in the Middle East? I would be very doubtful in this day and age as they are under so much pressure to improve their own performance that they don’t have the luxury to go after M&A in the Middle East.

“The two words are ‘not now’. There are no offers for it, neither on the profit/value creation side nor on the regulation side, nor on the competiveness, nor on the country pride and personal commitment side.”

Strategic importance of flagship carriers

John Strickland, Director of London-based JLS Consulting, agrees that M&A activity in the Middle East is unlikely, citing the strength of the aviation sector in the region and the strategic importance of the carriers.

“Growing on national lines, with carriers such as Emirates and Etihad, you can have that control. There is national pride and identity and it’s a growth part of the world,” he said. “Then there is the geography, Europe, to Asia and Africa – not the same amount of pain.”

Like Stephan, Strickland said there is a disparity in the region in terms how well carriers are managed, noting the loss of smaller carriers that have already folded such as Wataniya Airways in March of this year and Sama in August 2010.

“You have Emirates, which is strongly profitable and has been around for a long time, but others are not so well managed. are losing money, carriers which wouldn’t naturally exist in an open market,” he asserted. “Equally, these carriers are not likely to merge due to politics and national pride.”

But Strickland argued that change is happening within the aviation sector in the Middle East. “The landscape is changing, just as we saw the Arab Spring, we have seen an aviation spring, and we have seen what the full service can do as well as the low-cost sector, such as Air Arabia – that will force change.”