Lufthansa's Franz Faces Strategy Test Over Plan for Europe-Led M&A Growth

Deutsche Lufthansa AG’s new chief executive officer must decide whether to continue a policy of regional acquisitions to become Europe’s biggest airline or switch funds to a more ambitious drive for global expansion.

Christoph Franz, who takes over Jan. 1, could continue the run of European deals by buying SAS AB, the unprofitable Scandinavian carrier which says it’s open to bids in coming years. A bolder plan would involve preempting Air France-KLM Group and British Airways Plc by investing in emerging markets.

“Acquisitions outside Europe would make the most sense,” said Hendrik Leber, a fund manager at Acatis Investment GmbH in Frankfurt, which owns 450,000 Lufthansa shares. “Germany and its surroundings have a great customer base, but they have a gigantic cost disadvantage against the Gulf and Asia.”

Lufthansa’s current CEO, Wolfgang Mayrhuber, has bought ailing local carriers Swiss International Airlines, Austrian Airlines, British Midland and Brussels Airlines since taking charge in 2003. That contrasts with the strategies of Air France, which added a second global hub with the purchase of Amsterdam-based KLM, the European No. 4, in 2004, and British Airways, which will merge with Spain’s Iberia Lineas Aereas de Espana SA next month to tap the surging Latin American market.

Photographer: Goh Seng Chong/Bloomberg

The head of Swiss International Air Lines from 2004 to 2009, Christoph Franz, seen here, made the carrier profitable after it was taken over by Lufthansa by cutting costs. Close

The head of Swiss International Air Lines from 2004 to 2009, Christoph Franz, seen... Read More

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Photographer: Goh Seng Chong/Bloomberg

The head of Swiss International Air Lines from 2004 to 2009, Christoph Franz, seen here, made the carrier profitable after it was taken over by Lufthansa by cutting costs.

Lufthansa’s focus on central Europe stems from a lack of hubs serving large individual markets like London and Paris, the European Union’s biggest urban areas, said Jonathan Wober, an analyst at Societe Generale SA in the U.K. capital who rates the German company “buy.” That forces it to seek extra passenger feed for long-haul flights from Frankfurt and Munich, he said.

SAS Talks

Cologne-based Lufthansa may announce takeover plans for SAS as early as the first half of 2011 pending talks with the governments of Sweden, Denmark and Norway, which own half of the Stockholm-based carrier, according to a person with knowledge of the discussions. SAS surged 14 percent today, the biggest increase in more than eight months.

Buying SAS would bolster Lufthansa’s central-European dominance and offer shorter polar flights from the Scandinavian company’s hubs to Canada and the northern U.S., said the person, who declined to be identified because the plans aren’t public.

Andreas Bartels, a Lufthansa spokesman, said from Frankfurt that the carrier didn’t want to comment on its acquisition plans and that Franz, head of the main passenger division since June 2009, wasn’t available for interview.

Lufthansa Chairman Juergen Weber said last month the airline is taking a “wait-and-see” stance after previous approaches didn’t yield a pact.

Italian Option

SAS, which rose 3 kronor to close at 23.70 kronor at the 5:30 p.m. close of trading in Stockholm, expects a new phase of consolidation in Europe in two or three years but isn’t in any merger talks, acting CEO John Dueholm said Nov. 10. Sture Stoelen, the carrier’s head of investor relations, declined to comment on Dec. 20.

Lufthansa, priced 0.7 percent higher today, is also looking at expanding in Italy in coming years to complete a north-south axis through Europe and force east-west travelers to use its network, according to the person familiar with the plans.

“They’re right to focus on Europe because it’s the market that offers the most synergies and needs the most consolidation,” said Frederic Redel, who manages 500 million euros ($654 million) at UBS AG’s CCR Asset Management in Paris.

While buying SAS would add sufficient traffic for Lufthansa to leapfrog Air France-KLM and become Europe’s biggest carrier, it would divert vital funds away from strengthening the global position, said Royal Bank of Scotland Plc’s Andrew Lobbenberg.

Star Role

Franz, 50, should consider seeking a stake in the merged carrier to be formed from Chile’s Lan Airlines SA and TAM SA of Brazil in order to secure the enlarged company for the Star Alliance, said Lobbenberg, who rates Lufthansa “buy.”

While TAM is a member of Star, Lan, which is leading the merger, is in Oneworld, a rival group that includes British Airways, so that the transaction could leave Lufthansa without a Latin American ally. Lan-TAM have a combined value of $14.2 billion, versus about $1.1 billion for SAS; Lufthansa held about $2 billion in cash and cash equivalents as of Sept. 30.

“It makes sense to expand beyond Europe because airlines need to be able to offer passengers access to all corners of the world, either by themselves or via alliance partners,” said Olivier Mueller, an analyst at Credit Suisse Group AG in Zurich. “Lufthansa should have a foot in the door in Latin America, but a deal needs to create synergies and be financially prudent.”

Marco Antonio Bologna, TAM’s CEO, said Dec. 21 in an e-mail that “decisions regarding air alliances” will be considered once the merger is completed in the second quarter of 2011. Enrique Cueto, Lan’s chief, didn’t respond to messages seeking comment.

‘Comfort Zone’

The cost of even a 35 percent stake in Lan-TAM would leave Lufthansa “quite heavily” leveraged, said Yarek Aranowicz, who helps manage more than 100 billion euros at Lord Abbett & Co. in Jersey City and disputes the wisdom of a move in Latin America.

Lufthansa, whose only non-European holding is a 15 percent “financial investment” in U.S.-based JetBlue Airways Corp., has the highest junk rating on its debt at Moody’s Investors Service and the lowest investment level at Standard & Poor’s.

“They’d have to grow out of their comfort zone,” Aranowicz said, adding that local ownership rules would be problematic outside of Europe and that, in Asia, Lufthansa couldn’t hope to compete with Hong Kong-based Cathay Pacific Airways Ltd., Singapore Airlines Ltd. and Australia’s Qantas Airways Ltd.

Lufthansa views inter-continental mergers as an “exciting topic” and likely to proliferate in coming years, board member Stefan Lauer said Aug. 25.

With British Airways scouting around for the next big deal even as it prepares for the Iberia merger, Franz may not have much time to explore options. The U.K. carrier has drawn up a list of the 12 most attractive candidates and they aren’t all in Europe, CEO Willie Walsh said Sept. 4.

To contact the reporter on this story: Cornelius Rahn in Frankfurt at crahn2@bloomberg.net

To contact the editor responsible for this story: Kenneth Wong in Berlin at kwong11@bloomberg.net

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