A LOT of trouble in the skies above Central Europe

By bne IntelliNews September 16, 2009

Jan Cienski and Nicholas Watson -

The turbulence that has hit the global airline industry has been particularly harsh on mid-sized regionals like CSA Czech Airlines and LOT Polish Airlines. Not only are they, like all airlines, trying to survive whipsawing fuel prices, dropping passenger numbers and the vanishing of business class travellers, but regionals are also trying to work out whether they have any future at all.

LOT, flying since 1929, is the flag carrier for a country of 38m, but that does not give it the scale to compete against behemoths like Germany's Lufthansa, British Airways and Air France-KLM, which have global networks and, crucially, airports that serve as international hubs. Instead, LOT serves its home market with domestic flights - which are likely to become less important as road and rail improvements reduce travel times - as well as international flights. LOT is a much larger operation than CSA and Sky Europe, the recently bankrupt Slovak low cost carrier, but it is much smaller than the largest European airlines, which does not give it the scale to compete outside of Poland.

The man charged with working out LOT's future is Sebastian Mikosz, the airline's CEO for the last half year, who is trying to turn the loss-making carrier around before embarking on a partial privatisation, likely next year. The airline is coming off a terrible year. It lost PLN733m (€175m) last year, with more than half of those losses coming from ill-timed fuel price hedges. Passenger numbers are down by a fifth, as the global recession has taken a toll on central European fliers.

Mikosz is trying to improve the airline's cost structure. Central Wings, LOT's floundering low cost affiliate, has been closed, and unions are being pressured on pay and redundancies. Until recently, workers were guaranteed bonuses no matter what the effect of their own work, or the financial results of the airline. Those early changes are having some effect, and LOT's numbers are starting to show some signs to improvement. In the first three months of this year, LOT lost PLN310m, but in the following three months it made PLN132m. "We are going to fight for the rest of this year to reduce those losses," Mikosz told the Polish Press Agency. "We have to actively attract both passengers and revenues. We have already succeeded in increasing our market share by 7%. We will try to ensure that 2010 is a lot better, and that the company will become profitable."

A wing and a prayer

If LOT is to be turned around, it will likely have to find an outside investor to pump in more capital. At the moment, the airline is 93% owned by the state, with 67% being owned outright by the state treasury, and more than 25% held by a state-controlled investment fund, which took the shares from the liquidators of Swissair, which had bought a stake in LOT in 1999.

The airline has retained Morgan Stanley, the investment bank, to advise it on its planned privatisation. However, current Polish law mandates that 51% of LOT remain in state hands. In today's very difficult airline environment, it is hard to imagine an investor being willing to buy only a minority stake in a potential acquisition target.

For years, Lufthansa had been seen as the likeliest candidate to buy LOT. The two airlines both belong to the Star Alliance, and Lufthansa's hubs in Frankfurt and Munich act as transit points for many Polish passengers. However, Lufthansa recently bought Austrian Airlines, and is seen as unlikely to want to buy yet another Central European regional airline. Other global airlines have less interest in the region. The one player that would likely be keen in LOT is Russia's Aeroflot, but for political reasons a tie-up between the Polish and Russian carriers is far-fetched.

With legal and business hurdles preventing the quick appearance of a foreign partner, Mikosz is going to have to build some sort of a solid future for LOT on his own. For now the airline is focusing on its European flights, with a few transatlantic destinations like Toronto, New York and Chicago, aimed at traditional destinations with large local Polish populations. "Our aim is to be the airline of choice for Polish and ethnic Polish passengers," says Mikosz.

Czech in

The fate of the Czech flag carrier CSA is also unclear, with its privatisation, slated for later this year, in disarray after all but one bidder dropped out of the race.

On September 14, the entire supervisory board CSA quit at a general meeting in protest at the attacks on the CSA management by trade unions and politicians in the run-up to the snap general elections later this year for mismanagement at the airline. CSA reported a net loss of about $100m in the first half of this year, the worst loss it has ever recorded, after posting a pre-tax profit of $28m in 2008. The airline then announced a plan to reduce both its fleet and its workforce as it seeks to return to profit next year by saving CZK1bn (€39m). However, the unions rejected the proposed wage cut, while politicians of the opposition Czech Social Democratic party (CSSD) accuse the firm of selling off assets too cheaply.

In response, the chairman of the board of trustees of CSA, Ivan Kocarnik, said in his resignation on September 11 that the airline is paying for the errors made by the preceding management, such as buying excessive numbers of airplanes and collective wage agreement with the unions for 2005 through 2007. That previous management was headed, incidentally, by Jaroslav Tvrdik, who is now CSSD's election manager.

All this, plus the generally gloomy climate for aviation, has taken its toll on the chances of a successful privatisation. When the tender was launched in February, CSA was valued at CZK5bn-10bn. Four companies submitted bids in late March: Air France-KLM, the Russian Aeroflot Group's Darofan, and Czech companies Odien Group and a consortium of Travel Services and Unimex Group. But when Air France-KLM announced August 19 that it was no longer interested in taking up the Czech government's 91.5% stake in CSA, that left only the Travel Services and Unimex Group bid remaining.

The government is due to decide on whether to accept that offer in early October. But with the elections due in the same month, few politicians will want to have to take such a politically charged decision.

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