Austrian Airlines Skates on Thin Ice as Lufthansa Takeover

UNCLAS SECTION 01 OF 02 VIENNA 000910 SIPDIS STATE FOR EB/TRA AND EUR/CE PARIS FOR FAA BRUSSELS FOR FAA BERLIN FOR TSA (RANDOL) E.O. 12958: N/A TAGS: EAIR ECON PGOV AU SUBJECT: Austrian Airlines Skates on Thin Ice as Lufthansa Takeover Enters 11th Hour REF: (A) VIENNA 0585; (B) VIENNA 0225 and previous ¶1. SUMMARY: As the buyout of Austrian Airlines (AUA) by Lufthansa (LH) nears its contract deadline of July 31 (AFTER which LH can back out or seek modified terms),AUA is preparing for the worst while hoping the European Commission and LH can come to an understanding. Commission approval for key elements of the merger -- its effects on competition and the implicit GoA subsidy (in the form of debt forgiveness) -- has proven more difficult than expected by the GoA, which supports the deal. AUA capital is drying up as it loses money and passengers, so interim management have responded with further job cuts. If LH walks away entirely, AUA would have to shrink by almost half into a regional carrier -- and would ask for an EUR 1 billion GoA subsidy to cover legacy costs (again requiring Commission approval). END SUMMARY. Commission Playing Hardball - - - - - - - - - - - - - - ¶2. Examining the competitive impact of the AUA-LH merger, EU competition authorities (COMP) found it would lead to fewer carriers serving certain routes and potentially higher fares, a situation they termed incompatible with the Single Market. COMP representatives called LH?s package of remedies insufficient, with Competition Commissioner Neelie Kroes saying she hoped to find a mutually acceptable solution but was not optimistic. Since mid-July, LH and COMP have oscillated between public brinkmanship -- with COMP saying that it would not be bound by the deal?s July 31 deadline and LH saying it had already ?paid? for any reduced competition at the time of its alliance with AUA -- and conciliatory signals. Kroes and Lufthansa CEO Wolfgang Mayrhuber met behind closed doors on July 20, but gave no further indications where the takeover stands (NOTE: Mayrhuber is an Austrian national). ¶3. Austria?s Finance Ministry is reportedly in regular contact with both LH and the Commission, trying to facilitate a solution. Austrian Chancellor Werner Faymann has repeatedly lobbied Commission President Jose Manuel Barroso in favor of the deal as important for AUA, Vienna?s airport, and the Austrian economy. ¶4. COMMENT: While the Commission recently approved LH takeovers of British Midland (May 14) and Brussels Airlines (June 22),the AUA deal appears to have higher stakes since AUA is a full-service network carrier with an important hub in Vienna and two subsidiaries (Lauda Air and Tyrolean Airways). Since any EU carrier can already serve any EU route, the critical point of contention appears to be primetime slots held by LH and AUA, particularly in Frankfurt. More Cuts at AUA - - - - - - - - - ¶5. AUA's financial situation is grim and deteriorating; if the LH takeover fails, AUA may have to file for bankruptcy soon (though there are no public indications that AUA will run out of cash in the coming days). For 2008, AUA reported a loss of EUR 429.5 million (ref A) and another loss of EUR 88.1 million in Q1/2009. Financial results for the first half of 2009 are not yet available, but the passenger drop in June (-13.7% from June 2008) and for the first half of 2009 (?14.3%) do not bode well. By comparison, LH?s passenger traffic fell in the first half by ?only? 6.1%. ¶6. In early July, AUA interim management announced new austerity measures on top of EUR 425 million in cuts announced in February (ref B). The new cuts are significant -- 1000 jobs (of about 8000) would disappear by mid-2010, as would 14 out of 55 small fifty-seat aircraft -- but the cuts affect AUA subsidiaries (whose employees are paid less) more than AUA?s own highly-paid staff. AUA is reviewing all of routes, frequencies and transfer points for service reductions. All AUA staff will be subject to unpaid leave. A special general shareholder meeting on July 14, originally intended to bless the LH takeover, authorized an equity increase of EUR 132.2 million by issuing new shares. COMMENT - - - - ¶7. With barely a week until the takeover?s July 31 deadline and tough backroom negotiations by LH and COMP, it is entirely unclear whether the Commission can and will provide antitrust clearance in a timely fashion. The Commission must also approve GoA debt forgiveness subsidy (in a separate investigation under EC Treaty state aid rules),but this appears less problematic. Niki Lauda of Fly Niki (a competing carrier that works with AirBerlin) has been a vocal critic of the LH takeover; it may be that KLM / Air France (who protested the GoA?s conduct in the AUA tender, ref B) are also VIENNA 00000910 002 OF 002 lobbying against the deal. ¶8. If AUA is not taken over, experts here say it would have to shrink drastically (by up to half) into a regional carrier -- but legacy costs and contract commitments mean the carrier would need another GoA subsidy of about EUR 1 billion in that case. According to Merck Finck analyst Robert Heberger, if the current LH share offer falls through, it wouldn't necessarily hurt LH; LH might even benefit from an AUA bankruptcy / restructuring by picking up AUA?s core business more cheaply or expanding in markets where AUA is forced to retreat. ¶9. The current AUA share price (about EUR 4) reflects market uncertainty over prospects for the current Lufthansa takeover -- it?s a 10% discount to the LH offer of EUR 4.49 / share) -- but suggests that markets are not entirely pessimistic about Austrian Airlines? future, inside or outside of Lufthansa. END COMMENT. HOH