DealTalk: Bmi facing break-up in battle for Heathrow

LONDON/FRANKFURT Tue Oct 18, 2011 9:40am EDT

A BMI Baby aircraft takes off over a wind turbine at East Midlands Airport, central England May 10, 2011.   REUTERS/Darren Staples

A BMI Baby aircraft takes off over a wind turbine at East Midlands Airport, central England May 10, 2011.

Credit: Reuters/Darren Staples

LONDON/FRANKFURT (Reuters) - Deutsche Lufthansa AG (LHAG.DE) may have to break up its British bmi unit to sell the underperforming carrier, as larger airlines eye its access at Heathrow airport and smaller players look to pick off its budget and regional operations.

Lufthansa, which has seen loss-making bmi drag on its earnings since acquiring it in 2009, has effectively admitted turnaround efforts are stumbling, by saying it is now also seeking a partner for the airline.

While it would prefer to sell the whole unit than break it up, managers have not ruled out a partial sale -- and Lufthansa sold six of bmi's daily take-off and landing slots to IAG's (ICAG.L) British Airways last month.

Bmi comprises three underperforming businesses: a traditional airline serving Europe, the Middle East and Africa; bmi regional, serving the UK; and low-cost unit bmibaby.

RBS aviation analyst Andrew Lobbenberg does not believe IAG, which is keen on bmi's Heathrow slots, is interested in owning or operating bmi regional or bmibaby, and puts smaller UK airlines in the frame for those.

"We could imagine a competing UK low-cost carrier taking bmibaby free, or in return for a contribution toward restructuring costs, running out the leases (on its 14 jets) and taking on staff and routes," said Lobbenberg.

"Flybe (FLYB.L) (the UK regional airline) is in our view the most logical acquirer of bmi regional. There is only one other UK regional airline, Eastern, which could be a potential buyer."

With 9 percent of the take-off and landing slots, bmi is the second-largest carrier at Heathrow, Europe's busiest airport, which is now operating at full capacity after plans to build a third runway were scrapped.

Citigroup analyst Andrew Light last month estimated these slots to be worth around 460 million euros ($633 million).

"Around 460 million euros for the slots sounds sensible but one thing you should bear in mind is the cost the future owner of bmi would have to bear (if its bought the whole airline) as the company needs a total restructuring," said a sector banker.

Interested suitors include BA and Iberia parent IAG, and the UK's Virgin Atlantic VA.UL.

Abu Dhabi's Etihad Airways is discussing the possibility of making a joint bid with Virgin, according to sources in the United Arab Emirates.

The successful bidder would have to spend millions to restructure bmi to stem losses, forecast by analysts at around 250 million euros this year, or sell off the individual airline units if all they wanted from bmi was the Heathrow access.

The latest annual results filed by LHBD Holding, the Lufthansa subsidiary that owns bmi, showed it put 45 million pounds ($71 million) into bmi in 2010, after 95 million pounds in the second half of 2009.

"Bmi's business model is flawed -- it is neither a full service airline or a low-cost carrier -- and that's why it lost 145 million euros last year and is forecast to lose more this year," said Davy Stockbrokers analyst Stephen Furlong.

"Whoever buys it will almost certainly want to keep bmi's slots and sell the rest of the business, because it will cost millions of euros to turn it back into a profitable airline."

A transport banker said Lufthansa could ease bmi's restructuring by providing part of the necessary financing.

"They really want to get rid of bmi to focus on the group's integration following multiple acquisitions," he said.

Davy's Furlong said Lufthansa was likely to push for a sale as a whole to remove a big negative from its books.

"That means Lufthansa might have to take a lower price because, on one hand it is selling the slots, which it has capitalized at 515 million euros, but along with that comes a loss-making company with a 100-million pound plus pension deficit and serious legacy issues."

SLOTTING IN

Bmi, which reported a first-half loss of 120 million euros this year, will make 806 air transport movements (take-off or landing) at Heathrow in a typical week in the winter of 2011/12, equivalent to 8.7 percent of the total, according to UK aviation services group Airport Coordination Ltd.

IAG's BA is the largest carrier at Heathrow with a 43.1 percent share of the slots -- ahead of Virgin in fifth with 3.1 percent -- and has most to gain if it can snap up bmi slots.

Take-off and landing slots can be sold individually or in bulk, and their price varies depending on where and when they are sold. Slots at a full-up Heathrow are so valuable that Continental Airlines paid $209 million for four pairs in 2008.

"Buying bmi would give IAG a unique opportunity to increase its slot share at Heathrow," said RBS's Lobbenberg, the remote prospects of airport expansion.

"Adding bmi would allow IAG to safeguard future long-haul growth. In the short run, it would allow IAG to broaden the BA network at Heathrow and strengthen the hub function," he said.

Abu Dhabi's Etihad would not be able to pursue a bid alone due to foreign ownership issues, but a partner such as Virgin could help the UAE carrier build its emerging market network.

"Etihad's goal is to bring traffic to their Abu Dhabi hub so it would make sense for them to expand in a hub offering connections to travel to Asia, and bmi has a corporate client base that Etihad could benefit from," the banker said.

The banker added IAG was the most likely buyer because of its scale and ability to absorb bmi.

While it could be better for Lufthansa to avoid selling bmi to a strong rival such as IAG, analysts said price and just getting rid of the loss-making unit would take precedence.

"There are competitors who are closer than others. However, if getting the right price means they have to sell it to a closer competitor, then they will probably do that," said Equinet analyst Jochen Rothenbacher.

Virgin has written to the Office of Fair Trading and the European Commission requesting the sale of bmi's assets are examined to ensure competition is not eroded.

However, IAG's holding is small compared with rivals at other European hubs -- Lufthansa holds two-thirds of the slots at Frankfurt, while Air France-KLM (AIRF.PA) has 59 percent at Charles de Gaulle in Paris and 57 percent at Amsterdam's Schiphol.

($1 = 0.634 British Pounds)

($1 = 0.727 Euros)

(Additional reporting by Sophie Sassard in London, with Stanley Carvalho and Praveen Menon in Dubai; Editing by David Hulmes)

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