KLM CEO SAYS 'BREAKTHROUGH' MERGER TO SPUR MORE

C O N F I D E N T I A L SECTION 01 OF 03 THE HAGUE 002733

SIPDIS

E.O. 12958: DECL: 10/28/2013
TAGS: EAIR EU NL
SUBJECT: KLM CEO SAYS 'BREAKTHROUGH' MERGER TO SPUR MORE
CONSOLIDATION; EXPECTS UK TO STALL U.S.-EU TALKS

REF: SECSTATE 299649

Classified By: AMBASSADOR. REASONS 1.5(B) AND (D)

Summary
--------------

1. (C) KLM's "breakthrough" merger with Air France sets a
precedent that will spur further consolidation within the
airline industry, KLM President and CEO Leo van Wijk told
the Ambassador in an October 9 meeting. Van Wijk likened
the pact to the Netherlands' first-ever Open Skies
agreement with the U.S., which also set a pattern for other
such arrangements. Van Wijk commented that the British
would try to stall or block a US-EU Open Skies deal as long
as possible to preserve BA's competitive edge at
Heathrow. He reported that the AF-KLM deal was greatly
facilitated by the fundamental economic logic of the
arrangement, since Air France would have been at a severe
competitive disadvantage had KLM
chosen to link up with either BA in oneworld or Lufthansa
in the Star Alliance. As it is, the deal will
preserve the most even competitive balance among the three
principal alliances, since joining the
KLM-Northwest-Continental group's nine percent market share
to Skyteam's 12 will nearly match the
Star Alliance's 22 percent and oneworld's 17. The British,
who could have merged with KLM years ago, appear to have
chosen to preserve the status quo, especially regarding
slot allocation at Heathrow, currently not served by either
Northwest or Continental. Van Wijk did not expect US
regulatory opposition
to the merger. Regarding the antitrust implications of a
link-up of Northwest and Continental with Delta in Skyteam,
he counseled that, with six principal international US
carriers and only three alliances for
them to join, the choice is between allowing such
cooperation or potentially forcing the weaker carriers
into bankruptcy.

End summary.


French understanding of GoNL concerns
-------------- --------------
--------------

2. (C) In an hour-long discussion October 9, KLM President
and CEO Leo van Wijk told the Ambassador
that he was very satisfied with the deal with Air France
announced September 30, which succeeded despite some
last-minute issues thrown into the negotiations by the
GoNL. Although this caused some embarrassment, it did not
prove to be a fundamental obstacle, as the French were
relatively understanding of such state concerns. Despite
some media commentary to the effect that Air France had
overpaid for the deal, said van Wijk, in reality the
agreement had been facilitated by the fundamental economic
logic
behind the merger. (Note: according to the KLM-Air
France press release, the deal values KLM stock at EUR
16.74, or a 40 percent premium over its September 29 level
and at a 77 percent premium calculated on the basis of the
average share prices of KLM and AF over the previous three
months. End note.) Had KLM chosen to link up with either
BA or Lufthansa, AF's competitive position would have been
significantly disadvantaged; the French thus had a strong
incentive to wrap up KLM for themselves, creating Europe's
largest carrier in the process.


3. (U) Note: the Air France-KLM merger, which was signed
October 16 but still requires regulatory
approval, creates a new holding company which will own and
run the two airlines as separate operating companies. KLM
will have 19 percent of the shares in the new holding
company, with the French portion divided between the GOF
(44 percent) and other AF shareholders (37 percent). To
preserve KLM's international landing rights, 51 percent of
the voting rights in the KLM operating company will be held
by two Dutch foundations and the GoNL for a transition
period of three years. End note.

Competitive implications
--------------

4. (C) As it turns out, continued van Wijk, the AF-KLM
merger will create a more balanced competitive situation
than had KLM merged with either BA or Lufthansa. With the
addition of KLM, Northwest, and Continental, Skyteam's
market share will rise to 21 percent, just short of the
Star Alliance's 22 percent
and ahead of oneworld's 17. That should allay US
regulatory concerns about the linkup of Northwest
and Continental with Delta in Skyteam. In fact, he argued,
with six major US international carriers (American, United,
Delta, Northwest, Continental, and USAir) and only three
alliances for them to choose from, the options for the US
authorities were to allow such intra-alliance cooperation
or to face the
possible bankruptcy of excluded carriers. Van Wijk
reported that he had discussed the possible merger with Air
France with USDOT some months ago and encountered no
fundamental opposition, provided that such cross-border
mergers were done between the national carriers of
countries with which the US has Open Skies agreements
(i.e., excluding the UK).

UK to stall US-EU talks?
--------------

5. (C) Thus far, said van Wijk, the reaction from both BA
and Lufthansa had been complete silence. While KLM had
engaged in merger discussions with BA several years ago,
the deal was not concluded because BA evidently felt that
gaining regulatory approval for such a merger could have
upset the status quo at Heathrow. BA's preference for the
status quo led van Wijk to expect that the UK would be a
delaying
force in the current US-EU civair negotiations. Although
the UK also had to consider the interests of
Virgin and British Midland (which cooperates with Lufthansa
and has ordered long-range aircraft to fly transatlantic
routes out of Heathrow),van Wijk said, the Brits would
probably try to delay or block agreement by, for example,
pushing for intra-US service rights or increases in the cap
on foreign ownership of US carriers. European carriers
were really not interested in serving the US domestic
market, in light of their codeshare arrangements, thought
van Wijk. But pushing for reciprocal intra-domestic
rights, which had some resonance among members of the
European Parliament,
could be an effective delaying tactic, he thought. As the
only EU country without an Open Skies
agreement, the UK would have extra influence with
Commission negotiators, he added.

Preserving KLM and Schiphol
-------------- ---

6. (C) Van Wijk was pleased that the merger with Air France
would preserve KLM's corporate identity, at least for an
initial transition period, and would also preserve the
position of Schiphol, Europe's
4th-busiest airport, as an important international hub.
The terms of the deal called for both Schiphol and Charles
de Gaulle to be operated as co-equal hubs of the merged
company, and for adjustments in
service to be implemented proportionately. The agreement
also specified 35 long-range routes that
would continue to be serviced from Schiphol, at least
initially; any decision to cut such services would have to
be taken jointly.

More mergers to come?
--------------

7. (C) Van Wijk also thought that the deal would clear the
way for other, similar deals involving the smaller and
weaker European carriers, which, he implied, were not
viable as independent entities in the long run. He also
thought that such mergers would increase pressure to revise
or reform the 1944 Chicago Convention governing landing
rights, since in a world of steady consolidation of
carriers across national borders, the current system of
granting landing rights on a binational basis would become
increasingly unworkable.

No pressure to buy Airbus
--------------

8. (C) In response to the Ambassador's question about the
effect of the merger on KLM's fleet, van Wijk said that KLM
would not be pressed to replace its current aircraft with
Airbus equipment. KLM was taking delivery of some 10-20
new Boeing 777 aircraft over the next few years and would
stay with 737s for its regional operations. There was no
economic sense in trying to combine or replace those
aircraft with Air France's all-Airbus short-range fleet.

Security concerns
--------------

9. (C) On security issues, van Wijk said that his major
concern was the impact of increased screening on the rapid
and efficient flow of air cargo, which could have a
significant effect on business supply chains. On PNR, he
said that, although KLM is continuing to cooperate with the
US, it would eventually have to comply with whatever stance
the EU takes. He also raised the competitive impact of
security measures, arguing that USG compensation to US
carriers for security-related costs would have negative
competitive implications for non-US carriers.

COMMENT
--------------

10. (C) We have reported van Wijk's comments at length
because we believe him to be particularly well-positioned
to offer insights into the current state of play among the
major national carriers in Europe, as well as how their
interests might shape the current US-EU civair talks.
Embassy would appreciate any similar commentary that other
posts might pick up.


SOBEL