What does International Airlines Group have planned for Vueling?

The offer by International Airlines Group to acquire the 54% of Vueling’s shares that it does not already own expired on Friday 19 April. The airline group initially made an offer priced at €7.00 per share which Vueling management chose not to recommend. IAG subsequently increased its offer to €9.25 per share. However, the minimum acceptance level was reduced to just 4.16% of Vueling’s capital to leave IAG with at least overall control of Vueling, if not 100% ownership.

Assuming the transaction completes this will be the second airline acquired by IAG since its formation in 2011 and the third member airline of the group (the first acquisition, bmi, being subsumed into British Airways).

So why is IAG so interested in Vueling and what does it have planned for the airline?

To date, IAG has been coy as to its intentions regarding Vueling, other than to say it will remain as a separate operating company within the IAG group.

However, the original announcement of the takeover offer coincided with IAG announcing a radical restructuring of Iberia and the second revised offer coincided with the replacement of Iberia’s Chief Executive Rafael Sánchez-Lozano with the Chief Executive of Iberia Express, Luis Gallego.

IAG has faced numerous difficulties in Spain, prompting some commentators to question the original rationale for the merger with British Airways. The decision by Iberia to launch a new airline, Iberia Express to operate short and medium-haul routes faced considerable resistance from Iberia pilots with many days of industrial action in 2012. The matter went to arbitration, and the decision of the arbitrator, which is understood to be subject to further appeal by IAG, effectively capped the growth of Iberia Express.

Separately, IAG has been able to push through wage cuts for all Iberia staff following a very recently concluded arbitration process. However, whilst the decision of the arbitrator was accepted by IAG and most unions, the pilots’ union SEPLA did not. Whilst matters should settle down at Iberia for at least six months, there is the possibility of unfinished business flaring up at some point in the future.

In terms of what Vueling brings to IAG, for a start, Vueling is a profitable and cash generative airline in its own right. In 2012, it tripled its annual net profits to €28.3m. This is in sharp contrast to Iberia which made an operating loss of €351m. It also increased passenger traffic by 20%. It has a strong balance sheet with net cash of €339.4m as at 31 December 2012 (an increase of some €92.8m on the previous year).

It has a 37% market share at Barcelona El-Prat airport as well as growing hubs in Amsterdam, Paris-Orly, Rome Fiumicino and Florence. It has an ambitious growth strategy, with a plan to increase capacity measured in Available Seat Kilmetres in 2013 by 10-15%. Although categorised as a low cost airline it does codeshare and inter-line with other airlines (about 11% of Vueling passengers are now transfer passengers) and has its own form of business class called “Excellence” so there is scope for co-operation with IAG airlines and, potentially, other Oneworld alliance member airlines.

Whilst Vueling has its own ambitions to become a true pan-European low cost carrier, will Vueling also take over the short-haul operations of either British Airways and Iberia?

Both BA and Iberia’s short-haul operations are now largely concentrated on feeding their respective long-haul operations at London Heathrow and Madrid. BA withdrew entirely from UK regional point-to-point operations over five years ago. It, however, has a small short-haul operation at London Gatwick. There have been numerous initiatives to make BA’s London Gatwick short-haul operation profitable, the latest being the introduction of “hand baggage only fares”. However, the scope for such revenue raising initiatives are in part stifled by the need to keep a degree of parity with the Heathrow short-haul operation where there is still a small market for short-haul business class and a large feeder operation.

BA has also set itself an internal target to make its own short-haul profitable and announced last week it would be fitting its short-haul aircraft with new seats which will no doubt raise revenue by increasing seating density and decrease cost through fuel savings.

In the short-term, it seems unlikely that Vueling will replace either BA or Iberia short-haul hub operations as this is likely to cause brand dilution and confusion. However, that does not preclude a form of “internal outsourcing” with Vueling operating short-haul flights under either the BA or, most likely, the Iberia brand, particularly if IAG cannot achieve a satisfactory structuring of Iberia. However, this is likely to risk further industrial action at Iberia and resistance at BA (both in the form of industrial action and legal challenges over pilot scope agreements).

One other question is what are Vueling’s ambitions for the UK market?

At present Vueling’s coverage of the UK is relatively patchy with a small number of flights from London Heathrow and Gatwick, Cardiff and Edinburgh. It serves A Coruña, Bilbao, Majorca and Florence from London Heathrow and Barcelona from London Gatwick. Vueling may have decided that the UK is too mature a market to establish a hub in. Or Vueling may have unrealised ambitions for the UK.

This leaves open the question whether IAG is prepared to support Vueling setting up its own hub in the UK, most likely at London Gatwick and either placing it in direct competition with BA (and thus creating internal tensions within IAG) or allowing BA to largely withdraw from the London Gatwick short-haul market and enabling Vueling to expand.

Although BA has long struggled competing against easyJet at London Gatwick, I’m not entirely convinced BA would want to withdraw from London Gatwick short-haul entirely. BA does benefit from the flexibility of moving short-haul flights between Heathrow and Gatwick when Heathrow slots need to be used to avoid being forfeited, either for slots that are recently acquired (as in the case of the takeover of bmi) or when long-haul capacity is reduced during a downturn, as was the case after the collapse of Lehman Brothers.

To add one final item of speculation, there is the question of whether Vueling may enter the long-haul market (as Norweigan and JetStar have done), perhaps serving leisure long-haul routes from Spain that Iberia cannot serve profitably and has withdrawn from. However, IAG Chief Executive Willie Walsh has expressed scepticism that long-haul low cost airlines can be successful.

Whatever happens, with Vueling having a strong growth story and ambitious pan-European expansion plans, its growth across Europe and membership of IAG is one that will be keenly watched across the industry.

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