AUSTRIAN AIRLINES? PRIVATIZATION IN TROUBLE

UNCLAS SECTION 01 OF 02 VIENNA 001606

SIPDIS

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

E.O. 12958: N/A
TAGS: EAIR ECON PGOV AU
SUBJECT: AUSTRIAN AIRLINES? PRIVATIZATION IN TROUBLE

REF: (A) VIENNA 1372; (B) VIENNA 1130 and previous


1. Summary: The GoA?s plans for selling AUA by the
end of October failed because of the miserable handling
of the privatization process, which was aggravated by
the financial crisis and the stock market problems,
which alone should have triggered calling off or
postponing the sale. On October 29, the GoA extended
the privatization deadline to year?s end 2008. Since
the major problem for the bidders is AUA?s debt burden
of about Euro 1 billion, the GoA also decided on a
maximum Euro 500 million state subsidy for AUA by way
of a debt relief or equity injection. The GoA still
has to coordinate this state subsidy with the EU
Commission for compatibility with EU competition
regulations. AUA?s latest financial report will only
make potential buyers even more cautious. End Summary.

Messed-Up Procedure
--------------


2. As in earlier privatization cases, the GoA and its
holding company (and majority owner of AUA),the OIAG,
showed unprofessional handling of the AUA case ? aside
from the financial crisis and the stock market
problems, which alone should have triggered calling
off or at least postponing the sale, according to many
experts. Lufthansa reportedly was the only bidder to
submit a binding offer, but this reportedly included a
request for a debt relief and rejection of any
guarantee for AUA?s continued existence. The Russian
airline S-7 reportedly submitted a non-binding offer,
stipulating conditions under which it would consider
an investment. Air France/KLM refrained from
submitting an offer.


3. It is no surprise, however, that AUA?s
privatization ended up in such difficulties, not only
because the GoA first delayed it?s privatization
decision and then tried to sell the airline in a rush.
The information policy of all involved parties, GoA,
OIAG, and AUA, was miserable and left the public and
potential bidders confused. The openly shown bias of
many for Lufthansa was certainly not helpful, either.
Moreover, GoA/OIAG expectations for a high sales price
under the conditions stipulated (i.e., taking over
AUA?s debts, maintaining the AUA brand name,
guaranteeingAUA employees? jobs, accepting that
Austrian shareholders hold a blocking minority of 25%
plus one share, and maintaining Vienna International
Airport (VIE) as CEE/SEE hub),were probably deal-
breakers from the beginning.

Government Extends Deadline for AUA?s Privatization
-------------- --------------


4. When it became clear that the privatization
procedure would not be completed by the end of
October, particularly given Lufthansa?s request for
considerable debt relief, the GoA on October 29
extended the privatization deadline by two months to
year?s end 2008. The GoA also agreed on a maximum
Euro 500 million state subsidy for AUA, whether in
form of a debt relief or equity injection remains
unclear. The most pressing problem now for the GoA is
to make this state subsidy compatible with EU
competition regulations, so that it will not qualify
as forbidden state aid. The EU Commission reportedly
has sent a letter to the GoA requesting notification
of any measures and offering help in structuring them
according to EU regulations.


5. The fresh GoA capital for AUA presents a new
situation and indications are that Air France/KLM, and
possibly S7, will reconsider submitting an offer.

AUA?s Needs in Case Privatization Fails
--------------


6. If the GoA?s Euro 500 million injection is

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approved, AUA should not face a liquidity squeeze in
the near future. However, if privatization fails
completely, the airline will likely need additional
fresh money in the coming year to survive. Also,
expectations are that AUA would have to shrink
considerably to a regional airline and implement harsh
cost-cutting. AUA would likely have to cut more long-
haul destinations (limited cuts were announced Oct.
28),ground its six Boeing 767 jets used for these
destinations, and cut up to 2,000 of the current 8,000
jobs.

AUA?s Performance in 2008
--------------


7. AUA recently published miserable third quarter
results and a higher-than-projected loss for 2008.
News also leaked that AUA?s debt, so far estimated at
some Euro 900 million, has meanwhile exceeded Euro 1
billion. AUA?s third quarter 2008 results show a net
loss of Euro 16.4 million and of Euro 65.1 million for
the first three quarters. Since AUA reports that the
economic downturn has already led to a decline in
flight bookings and expects that a further drop in
demand in the fourth quarter as well as negative
effects from fuel hedging and an increasing US$
exchange rate, the projected net loss in 2008 will
likely reach Euro 100-125 million rather than the so
far projected Euro 70-90 million.

GIRARD-DICARLO