UNCLAS SECTION 01 OF 02 VIENNA 001372

SIPDIS

STATE FOR EB/TRA AND EUR/AGS
BRUSSELS FOR FAA (PFELDMAN) AND TSA (PJRODGERS)
PARIS FOR FAA
BERLIN FOR TSA (JRANDOL)

E.O. 12958: N/A
TAGS: EAIR ECON PGOV AU
SUBJECT: BIDDERS FOR AUSTRIAN AIRLINES SHOW CARDS

REF: (A) VIENNA 1130; (B) VIENNA 1005 and previous


1. SUMMARY: The privatization tender for Austrian Airlines (AUA),
which closed September 12, now has a shortlist: Lufthansa, KLM/Air
France and the Russian S7 (Air China, Aeroflot, British Airways and
Turkish Airlines are out). S7 is making a major effort -- in
particularly by promising to keep Vienna operations intact -- but a
Russian takeover of AUA would entail problems for its operating
license and traffic rights. An ongoing labor-management conflict
within AUA could provoke a strike, but is unlikely to be a decisive
factor in the carrier's sale. END SUMMARY.


2. On August 12, the government cabinet formally approved its
earlier decision to fully privatize AUA with the caveat that private
and institutional Austrian shareholders must hold 25% plus one share
(it is possible that OIAG would retain this stake on behalf of the
government), enough to block major decisions under Austrian
corporate law (ref A). Interested bidders had to submit non-binding
offers by September 12; the three short-listed bidders have until
October 21 to submit binding offers.

The Shortlist
--------------


3. The shortlisted bidders are Lufthansa, KLM/Air France and the
Russian S7. British Airways submitted a non-binding offer, but was
selected out; Turkish Airlines reportedly submitted its offer too
late for consideration.


4. Lufthansa is still seen as the clear favorite due to its close
technical and commercial cooperation with AUA and the fact that both
are already Star Alliance members (an alliance change could post
huge costs for AUA). Another argument for Lufthansa is that Germany
is by far the most important market for Austria. A sale to
Lufthansa poses though the greatest risk to AUA's Vienna operations
and Central/East-European network, since Lufthansa already covers
those markets from Munich. For that reason, there is growing
affinity to Air France-KLM who have a serious chance in the tender.



5. The Russian S7, backed by Gazprom-Bank and Sberbank, is making a
major public effort and has reportedly engaged highly regarded
lobbyists, including German ex-chancellor Gerhard Schroeder and
former Austrian Interior Minister Franz Loeschnak. Noteworthy is
that the role that Vienna International Airport (VIE) would plays in
an S7 takeover: S7 says it would make VIE its transit hub for
Russians flying to Western Europe and the U.S. (NOTE: S7 is also
building new terminals at Moscow Domodedovo and the St. Petersburg
Pulkovo and committed to involve VIE in those projects). S7 would
also consider joining the Star Alliance. AUA's purchase price is no
barrier for S7, according to analysts.

Problems Associated with the AUA Sale
--------------


6. In case of an AUA takeover, Lufthansa (and Air France-KLM, to a
lesser degree) may face some problems with EU merger/competition
regulations to prevent abuse of a dominant market position, and
could be forced to divest slots or routes to third carriers. They
probably would also have to renegotiate some traffic and landing
rights with third countries (i.e., non-EU member states). However,
these problems seem manageable in the case of either carrier.


7. S7 would pose greater challenges. Authorities would have to
find a solution for AUA's operating license, because under EU
Council Regulation EEC 2407/92, member states are obliged to grant a
license to an air carrier only if its principal place of business
and registered office are located in that member state. Moreover,
the Regulation stipulates that the air carrier shall be owned and
continue to be owned directly or through majority ownership by the
EU-27 member states and/or nationals of member states and/or
countries having an agreement with the EU (e.g. the U.S.). Problems
of traffic and landing rights with third countries would also be
more serious than in the case of a European takeover.

Strike in the Air?
--------------


8. A wage and labor conflict currently affects 3,400 technical and
commercial AUA personnel (about 40% of AUA's staff but not including
pilots and other flight personnel who have separate collective
bargaining agreements). Shop stewards oppose management plans to
extend the workweek from 38.5 to 40 hours without compensation, the
cutting of bonuses, and tougher conditions for shift workers. Since
management has postponed collective bargaining negotiations for

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those employees until after the decision on a strategic partner, a
strike or slowdown cannot be excluded but is unlikely to be a
decisive factor in the privatization.

GIRARD-DICARLO