Why Brussels remains sceptical on airline mergers

Airline executives are no strangers to failed mergers in Europe. 

Michael O’Leary, chief executive of Ryanair, notably made three failed bids to buy Aer Lingus in a campaign over nearly a decade. He finally gave up in 2015 after EU regulators insisted the deal would force up prices and cut choice.

But O’Leary’s experience has done nothing to reduce the appetite for deals among big airline groups in Europe, with two of the region’s leading carriers under close scrutiny in Brussels over consolidation plans.

Regulators have launched probes into deals by Germany’s Lufthansa and British Airways owner International Airlines Group (IAG), which were announced in the first half of last year.

Lufthansa agreed to buy a 41 per cent stake in ITA Airways, the successor to bankrupt Alitalia, for €325mn, while IAG agreed to purchase the remaining 80 per cent of Spain’s Air Europa it does not already own for about €400mn.

The main concern of watchdogs is that the airlines could use the acquisitions to boost already dominant positions, with passengers losing out because of higher fares and fewer airlines competing on routes.

“Regulators have seen airline deals make matters worse for consumers,” said a person with knowledge of the EU’s thinking. “They lead to less competition on routes that it is impossible to restore, less frequency of flights and less quality of service.”

Regulators, however, have not yet launched a probe into a third deal announced last October involving Air France-KLM.

The carrier is to take a 20 per cent stake in Scandinavian airline SAS in a rescue plan including private equity firm Castlelake and the Danish state.

Luís Rodrigues, the boss of Portugal’s TAP, thinks Air France-KLM has received less scrutiny because it has been working as a minority investor in a wider consortium and not seeking a full takeover of SAS.

The chief executive, whose own airline is about to be privatised — with Lufthansa, IAG and Air France-KLM all showing interest — added that the SAS deal was a potential model for a successful merger.

“Nobody is talking about [the SAS deal] because it is a good example of how you go through without making a lot of noise,” Rodrigues said. Deals involving “100 per cent” acquisitions did not sit well with regulators, he added.

In general, the merger rationale for the airlines is obvious: They offer a way to scale up and access new routes in a market where opportunities for organic growth are limited because of ferocious competition from low-cost rivals in the short-haul market and capacity bottlenecks at key airports. 

Executives also believe that creating larger and more profitable airline groups is the only way to succeed when competing with the historically more profitable US market, which consolidated around four big airlines following the financial crisis, and deep-pocketed Gulf and Asian carriers. 

“We need consolidation because we are squeezed between the US, where they are much bigger, and the Middle East, where they are much richer,” said Rodrigues. 

Airlines typically offer to give up valuable airport take-off and landing slots to rivals to clear the way for deals.

But regulators in Brussels have told the Financial Times they will seek tougher concessions from airlines, amid concerns that historically some slots were not taken up, or not used on the routes originally planned.

“Some years ago, we were sure the slots solution was fine. Maybe the results are not there,” then EU antitrust commissioner Didier Reynders said in an October interview.

The crackdown by regulators follows increased prices and worries about the quality of services after the reopening of travel in the wake of the pandemic.

According to data published by the European Commission, the executive body of the EU, flying is becoming increasingly costly for consumers with average airline fares up 20 per cent to 30 per cent last summer compared with 2019.

The cost of living crisis and inflation has made regulators even more reluctant to wave through deals as consumers struggle with bills, say analysts.

“Regulators look to protect competition in the market. There may be a concern that previous consolidations have led to price rises and a reduction in choice,” said Alec Burnside, a Brussels-based partner at law firm Dechert who advised Aer Lingus during Ryanair’s attempted takeovers.

“Officials focus on the competitors who will remain in the market and whether they can be expected to maintain competition on prices and the routes they choose to fly.”

However, some industry figures worry about the fragmented state of the European market, particularly when compared with the US, which has fewer big airline companies.

There are also concerns over the way some national carriers in Europe have been propped up.

Despite some notable collapses in recent years, such as Alitalia and the UK’s Monarch and Flybe, few major airlines have been allowed to fail by governments because they are considered valuable strategic assets.

Even where consolidation has happened, airlines have kept national carriers’ brands and management teams. 

The airlines and national governments, however, are not about to give up on their deals as they step up lobbying.

Italian officials, including Giancarlo Giorgetti, the minister for economy and finance, have met EU regulators multiple times to discuss the Lufthansa deal in an attempt to win them over.

Remedies to get regulatory backing for Lufthansa could include handing over airport slots, traffic rights and planes to a competitor. “If you offer enough, it can be cleared,” said an EU official.

EU officials stress all airline deals are different and scrutinised on their merits. Brussels could support the Lufthansa proposals, people familiar with the probe added.

The German airline said it was in constant exchanges with the EU to try and win support for its agreed purchase of a stake in ITA, adding that it was confident the commission would approve it as soon as possible.

As for the IAG deal, the company said this month that it was in talks with airlines including Ryanair, Avianca and Volotea over giving up some routes to bring regulators onside.

“We are in the middle of the process, talking to the commission and presenting remedies . . . we are working with the commission to try to address the concerns they have . . . but if the remedies make sense for us we will go ahead,” IAG’s chief executive Luis Gallego said on an earnings call this month. 

But IAG may have to do more after Brussels said the removal of Air Europa as an “independent airline” risked having “negative consequences” for consumers.

Regulators want one network carrier to replace Air Europa in contrast to IAG’s plan to have one carrier taking long-haul routes and another the short-haul flights.

There are also question marks over the US consolidation experience with the industry under growing scrutiny as passenger satisfaction drops and prices rise on some routes, which European regulators will no doubt have noted.

The European industry has started to thrive, too, with some groups announcing record profits as passengers return to the skies after the pandemic, weakening the argument for consolidation.

“It was bad before [to get an airline merger cleared], it is even worse now,” a person familiar with the EU’s thinking warned.