Turkish Takeover?

Turkish Airlines is interested in acquiring Poland’s LOT. Monika Trappmann, Industry Analyst for Frost & Sullivan asks, is this possible?

Monika Trappmann is an Industry Analyst; Aerospace, Defence & Security for Frost & Sullivan.

For 12 years the Polish Government has been trying to find an investor so that it can privatise its national carrier, Polskie Linie Lotnicze LOT, which trades as LOT Polish Airlines.  The first attempt was made in 1999 when the SAirGroup, the owner of Swissair, bought 37.6% of LOT’s shares.  LOT remained independent and started thinking about building a hub in Warsaw, but, unfortunately, Swissair went bankrupt in 2001.  After that, the Polish Government increased LOT’s capital and reduced SAirGroup’s (Swissair’s trustee) shares to 25.1%.
When Poland joined the EU on May 1, 2004, it brought mixed blessings.  Though LOT could access the whole EU market, its EU competitors could also serve Polish destinations.  LOT continued its hub building plans while also starting to expand its airline group.  In 2005 it launched low-cost carrier (LCC) Centralwings, and ordered eight Boeing 787 Dreamliners, which were to be delivered in 2008.  Just a few months before Centralwings started operations; Wizz Air’s first flight took place.  Then, within months of Centralwings starting up, the Irish budget carrier, Ryanair, introduced its Polish routes.  Today, Wizz is Poland’s second biggest carrier and its largest LCC in terms of passenger numbers.
With a good knowledge of the Polish market and a route network that supported LOT’s infrastructure, Centralwings was seen as a strong competitor and an attractive investment for LOT.  However, LOT didn’t have a successful strategic plan for the group it was creating and this, along with a lack of market segmentation, meant that Centralwings was losing money from the beginning and became a burden for LOT.
Finally, in the first half of 2008, LOT decided that Centralwings would only offer charter flights, but it ceased operations completely at the end of May 2009.
Restructuring Attempts
In early 2008, the Polish Government renewed its search for an investor, who could make LOT grow rather than just use it for carrying passengers to its own hub.
Polish Government representatives stated that they would not sell shares to Lufthansa, which had been expressing an interest, and eventually started negotiations to get back the shares owned by the trustee of Swissair.  At the same time, the first attempts to change Polish law to make privatisation possible began.
It was anticipated that private investors would own up to 49% of LOT shares, but the government’s plans were difficult to realise.  By the end of the year, LOT was in serious financial trouble.  Like many other commercial airlines, faced with rising fuel prices – a trend that was expected to continue – it signed fuel hedging contracts in 2007 and early 2008 betting on continuously rising prices.  Unfortunately for LOT, fuel prices plummeted in the second half of 2008 and the contracts turned out to be a huge financial burden.  Faced with this situation, the Polish Government dropped its plans to privatise LOT as the carrier was forced to concentrate more on restructuring and reorganising its finances.  This, however, brought the airline’s management into conflict with seven unions.
The depth of the airline’s leadership and strategy problems became apparent.  Between 2005 and 2011 LOT’s management team was changed 11 times.  As the majority of the state carrier was state owned, many industry observers felt the changes were mainly politically motivated, as some of those appointed had very limited experience of the aviation business.  As a consequence, sometimes political decisions overruled economical ones.
However, a new, ambitious, restructuring plan was put forward.  The company said it needed to cut 900 jobs from its 3,500-strong workforce, and change the employment conditions that had been in place for 17 years.  Unsurprisingly, LOT faced strong resistance from the staff unions and, after a year of negotiations, the job-cut figure was reduced to 440.  A court trial in May 2010 allowed LOT to cut about 400 jobs, but this didn’t make the carrier profitable.  In the meantime, state-owned investment company Silesia bought 25.1% of LOT shares from Swissair’s trustee.
To try to compensate for its losses, LOT decided to sell assets such as buildings and outside shares and investments.  Some aircraft were sold to leasing firms and then leased back.
Looking for Investors
Today, LOT’s biggest remaining assets are its brand name; its shares in Petrolot (Poland’s biggest aircraft fuel agent); its acquisition contracts for the 787 Dreamliners, and the prospect of building up a hub in Warsaw.
Now, with fuel prices rising again and with European airlines suffering from the widespread financial crisis it is even harder to find an investor than before.  Considering these difficult conditions, Turkish Airlines’ (THY) recent declaration that it was considering investing in LOT sounds like the solution the Polish carrier has been looking for.  THY is a fast-growing and profitable company that is looking for new opportunities to expand its business.  Nevertheless, making this investment may not be easy.  Polish law still prohibits more than 49% of LOT’s shares being privately-owned.  In addition, EU legislation also prohibits organisations from outside its borders taking a majority interest in the airline.  As a consequence, THY can invest in LOT, but it will have to remain as the minority owner, thereby leaving the Polish state in control.  Without a controlling majority, THY will not have any guarantee that LOT’s restructuring will be effective.  Even if the Polish Government presents a realistic rebuilding plan and an experienced management team, nobody can be sure that political requirements will not overrule economic ones and impede progress.
In view of previous conflicts with labour unions, it remains to be seen if LOT can be profitable in the near future.  Can things like maintaining a steady corporate culture and delivering a suitable level of comfort be accomplished?
An alternative view is that from an investment perspective, LOT offers significant advantages.  The Polish market is currently one of Europe’s fastest growing in terms of passenger numbers.  It will soon receive eight 787 Dreamliners which should enable it to offer its passengers a higher level of comfort while reducing fuel consumption.  This will finally enable LOT to use the shortest – Trans-Siberian – routes to Asia.  Also, as Warsaw isn’t dominated by any of the big airline alliances, it may be possible to build a new hub for eastward connections, especially when considering the airport slots that are available and the potential of destinations that LOT is already offering within Europe.
Taking into account that THY will face the same problems about ownership and control as any other European carrier, and considering that it would like to expand, its declaration of interest in LOT is not too surprising.  For now LOT has to wait for the results of THY’s analyses as they will decide if serious negotiations with the Polish Government are deemed worthwhile.  The recent failings of Spanair and Malev show the difficulties faced by mid-size carriers and that finding investors can be a serious challenge under the current market conditions.  On the other hand, the failure of those two carriers brings further opportunities for other airlines that are still looking for investors.  This, together with THY’s declaration that it wants to invest in Europe, could make a lot of carriers interested in forming partnerships with the Turkish flag carrier.