GOI UNVEILS AVIATION POLICY PACKAGE

C O N F I D E N T I A L SECTION 01 OF 03 DUBLIN 000606

SIPDIS

E.O. 12958: DECL: 01/31/2015
TAGS: EAIR ECON ETRD EFIN ELAB
SUBJECT: GOI UNVEILS AVIATION POLICY PACKAGE

Classified By: Political-Economic Counselor Mary E. Daly; Reasons 1.4 (
B) and (D).


1. (C) Summary: On May 18, the Irish Government announced an
aviation policy package that includes plans to sell a
majority stake in Aer Lingus, the national carrier, and to
build a second terminal at Dublin Airport. The package
capped months of negotiations between the governing party,
Fianna Fail, and its coalition partner, the Progressive
Democrats, as to who would build and operate the new
terminal. Critics, including opposition parties, have called
the package a "fudge" for its failure to specify when, by
what method, and how much of Aer Lingus will be sold. This
lack of specificity could portend a delay in the carrier's
privatization beyond the 2007 general elections, which would
be safer for Fianna Fail, given the party's support among
airline labor. Such a delay would also allow the GOI more
time to see whether possible renewed U.S.-EU attempts to
reach a trans-Atlantic Open Skies agreement might provide the
carrier greater access to the U.S. market. End summary.

The Aviation Package
--------------


2. (U) On May 18, the Irish Cabinet approved a long-awaited
package of policy measures for the aviation sector. The
package's key components include plans to: (1) sell a
majority stake of Aer Lingus, the national carrier; (2) build
a second terminal at Dublin Airport by 2009, to be owned by
the Dublin Airport Authority (DAA); (3) conduct an open
tender to choose the second terminal's operator; (4)
construct a new pier for aircraft parking stands at Dublin
Airport by 2007; and, (5) prepare to build a third terminal
when the yearly passenger volume for the first two terminals
combined reach 30 million (likely by 2015). Aer Lingus
Chairman John Sharman and the DAA issued statements welcoming
the package, which Transport Minister Martin Cullen described
in a news conference as the "first-ever comprehensive plan
for the long-term success and growth of Irish aviation."


3. (U) The package caps several months of negotiations
between the governing party, Fianna Fail, and its coalition
partner, the Progressive Democrats. (Willie Walsh's
resignation as Aer Lingus CEO last November, due to
government indecision on Aer Lingus, future, catalyzed the
negotiations.) Although the two parties had agreed by late
2004 to privatize Aer Lingus, attempts to secure Cabinet
approval faltered over differences on Dublin's new airport
terminal. The Progressive Democrats, who campaign on a
free-market platform, had pressed for the private sector
rather than the DAA, a state body, to build and operate the
terminal. Fianna Fail, with several parliamentary seats in
Dublin constituencies and strong labor support at the
airport, preferred the DAA to be the terminal's builder and
operator. The final package was a compromise, whereby the
DAA would build the terminal, but would compete with private
parties for the right to operate it.

Unanswered Questions
--------------


4. (U) Several significant questions remain, however,
regarding the privatization of Aer Lingus, which posted a
final, pre-tax profit of euro 1.2 million in 2004 after
dedicating euro 98 million from its operating profit to
severance packages for 730 staff. Minister Cullen declined
to specify the percentage share of the carrier that would be
sold and the timing and method of the sale. He said that
advisors would be chosen to make recommendations on these
issues, but added that the Government would keep at least a
25 percent share. (With Aer Lingus, 3,500 employees holding
a 14.9 percent stake, a 25 percent Government share would
mean that, at most, a 60.1 percent share would be offered to
investors -- 10 percent less than was recommended by a
government-commissioned Goldman Sachs report in 2004.)
According to the Irish Times, the Government also seeks to
ensure that private investors will retain the Aer Lingus
brand name and the carrier's 44 daily Heathrow slots
(variously valued at euro 300 million or above),but has not
specified the method for doing so. Moreover, there has been
no public discussion of the possibility that Aer Lingus, if
majority-owned by non-Irish citizens, might forfeit rights
under the U.S.-Irish aviation agreement.


5. (U) Questions also surround the second airport terminal,
which the DAA has estimated will cost euro 130 to 190 million
to build, with possible ancillary costs of euro 100 million.
The DAA has not clarified where it plans to build the
terminal, although it is considering two sites on property
that it owns. Funding for the terminal is also an issue,
since the DAA has debt worth euro 400 million. Minister
Cullen stated that the new terminal's operator would have to
respect the wage/benefit terms and union rights that were
reached in last year's national wage bench-marking agreement,
known as "Sustaining Progress." (This condition was included
to secure labor buy-in to an open tender process for
operating the second terminal, since competition between the
terminals might otherwise have entailed pay and staff cuts.)
Cullen did not clarify, however, how these terms would be
protected after the expiry of Sustaining Progress in roughly
18 months, well before the new terminal's expected completion
in 2009.

Criticism of the Package
--------------


6. (U) The aviation package prompted criticism from several
quarters. Ryanair CEO Michael O'Leary threatened legal
action to block construction of the new terminal and faulted
Prime Minister Ahern for breaching 2002 election campaign
promises to allow the private sector to develop the
structure. The McEvaddy Brothers real estate development
firm, which owns 150 acres adjacent to the airport and wishes
to build the new terminal, also said that it would pursue
action against the Government under national and EU
competition law. Opposition political parties jointly
described the aviation package as "a fudge" for its lack of
clarity on when, how, and how much of Aer Lingus would be
sold. A May 20 Irish Times editorial also referred to the
package as "a fudge," saying that it "demonstrated a serious
lack of coherence and joined-up thinking in Government about
how Irish air travel and its facilities can be developed."

Aer Lingus and the U.S.-Irish Agreement
--------------


7. (C) The time frame for Aer Lingus, privatization remains
"up in the air," Colin Hunt, Special Advisor to Minister
Cullen, told Emboff on May 20. Hunt noted that the
Department of Transport would place a public tender in the
coming days advertising for advisors on the sale of the
carrier's majority stake. These advisors would likely need
six months to make their recommendations, making possible a
placement with investors by the third quarter of 2006. Hunt
cautioned, however, that that the timing of the sale, which
he believed would take the form of an IPO for retail
investors, could slip beyond that target. He added that the
proceeds of the sale would go toward the estimated euro 1
billion needed to purchase eight or nine long-haul aircraft,
which Aer Lingus hoped to put on new routes to North America,
the Middle East, Asia, and Africa.


8. (C) Hunt acknowledged that new North American routes
would depend on liberalization of the U.S.-Irish aviation
agreement, which Minister Cullen aimed to pursue as part of
the aviation package. Hunt recalled that Irish negotiators
had conveyed Cullen's support for an Open Skies arrangement
during April discussions with USG counterparts. The Irish
side, however, was unable to conclude such an arrangement
because of the likelihood of legal action against Ireland by
the Commission. Cullen planned to address this legal bar
with EU Transport Commissioner Barrot during a planned late
May/early June meeting in Dublin as well as in the Transport
Council meeting later in June. In those discussions, Cullen
would emphasize the unfairness inherent in allowing 15 Member
States to maintain Open Skies while preventing others, like
Ireland, from negotiating such agreements -- a situation
that, according to Hunt, contravened the principles of fair
competition in the EU common aviation market.

Factors Determining Investor Interest in Aer Lingus
-------------- --------------


9. (C) An institutional placement would be the likely
vehicle for selling Aer Lingus, majority stake, as opposed
to a retail/stock market float, Emboff was told on May 20 by
Joseph Gell, aviation portfolio manager for Goodbody
Stockbrokers, one of Ireland's largest financial houses.
Gell said that floating the carrier's shares to retail
investors would be too risky, given the possibility that the
shares could tank before the 2007 general elections (just as
share values in Eircom fell immediately after the
then-state-owned phone company's stock was floated to retail
investors in 1999). Fidelity, Wellington, and Janus would
probably express interest in an institutional placement for
Aer Lingus. These funds, however, inclined toward
investments in low-cost carriers, like Southwest, and would
focus on Aer Lingus, plans for competing on short-haul
routes with Ryanair and easyJet. Gell observed that the new
Aer Lingus CEO, Dermot Mannion (formerly of Emirates),would
need until late 2005 to assemble a management team and put
forward the carrier's business plans. Institutional
investors would also want to see the level of union buy-in to
these plans, since Aer Lingus would have to countenance
further staff cuts to compete with the likes of Ryanair.


10. (C) Other factors would also determine investors,
interest in Aer Lingus, said Gell. For example, although the
carrier was profitable, its estimated pension deficit was
euro 200 million. Aer Lingus, long-haul strategy was a
question too, since it recently announced plans to stop
service to Orlando due to lower-than-expected earnings on the
route. This decision, along with the recent cessation of
Baltimore service and disappointing earnings on Los Angeles
service, seemed to contrast with Aer Lingus, reported
aspirations to expand trans-Atlantic service in the context
of a liberalized U.S.-Irish bilateral agreement. Gell said
that the retention of a government share in Aer Lingus would
deny investors a free hand with the airline, but would not
scare off investment, just as government shares in Lufthansa
and Air France had not deterred private investment in those
carriers. Gell believed that Aer Lingus could be valued at
euro 300 to 900 million at the time of placement, depending
on the cost of fuel prices, the overall state of the aviation
sector, and the quality of the carrier's business plan.

Comment: A Decision to Delay
--------------


11. (C) The aviation package represents a decision not so
much to privatize Aer Lingus as to delay privatization. The
process could conceivably stretch beyond the 2007 elections,
which would be safer for Fianna Fail, given the party's
support among airline labor. Another advantage to this delay
is that Ireland would have more time to sort out the issue of
liberalizing U.S.-Irish aviation relations. As the
Department of Transport and financial experts have conveyed
to Post, liberalization that would allow Aer Lingus
additional access to the U.S. market would presumably enhance
the carrier's value ahead of an institutional placement or
stock market float. After declining to commit to an Open
Skies arrangement in April, the Irish Government seems
prepared to see whether bilateral liberalization can be
achieved via possible renewed U.S.-EU attempts to reach a
trans-Atlantic Open Skies accord. If such attempts do not
materialize or succeed, the Irish believe that they would
have a stronger case to make to the Commission to pursue a
bilateral solution, even in the face of the Commission's
legal objections.
KENNY