Fighting For Altitude

British Airways ejects its CEO, but the struggling carrier may still be targeted for a takeover

The only surprising thing about the Mar. 8 announcement in London was the timing: Why did it take so long? British Airways PLC has endured a succession of pratfalls and earnings disappointments since Robert Ayling took over as chief executive officer in 1996. Now, pushed by outside directors frustrated at Ayling's abrasive management, the board has finally decided that enough is enough and dumped its pilot--even before it names anyone to take over the stick.

Whoever does replace the brainy but unpopular Ayling faces huge challenges. If the economics of the industry are turning in BA's favor, as its executives insist, it may not be too difficult to dig out of the estimated $400 million loss the airline is likely to report for the year ending Mar. 31. And with a dominant position at London's Heathrow, Europe's busiest airport, BA enjoys a powerful franchise. But some rivals think the troubles run deep--and that BA's cost-cutting, downsizing strategy is flawed. Richard Branson, CEO of Virgin Atlantic Airways and BA's most persistent critic, says only BA's grip on Heathrow has saved it: "If British Airways were any other company, it would have been driven out of business by now."

What is clear is that BA has lost its leadership position in both the European and global markets. Unless it regains high altitude quickly, it could be takeover bait when an expected easing of the regulatory environment makes a radical consolidation of the European industry easier.

LETHAL MARKET. Both Air France and Lufthansa are now outperforming BA in what could be a long-term battle to be one of Europe's two or three surviving major airlines. While they have added flights and offered new routes, BA has become complacent. Under Ayling, it did little to draw customers and seemed not to bother promoting economy-class business--as if its position at Heathrow left passengers with few alternatives.

To be fair to BA, overcapacity, price wars, and high fuel costs have made the airline industry a rotten place to work of late. BA's 30% share price drop over the last year is not that much worse than the European airline average of 24%. Branson says Virgin's profits for the year ending in March will fall by 50% from last year's $175 million. BA has suffered particularly from competition on its U.S. routes, where it makes most of its money. And regulators have refused to approve an alliance with American Airlines, saying the two carriers would enjoy a near monopoly between Heathrow and the U.S.

In response to such pressures, BA has embarked on a radical downsizing. Over the next three years, passenger capacity will drop about 12%. BA is replacing roughly half of its 330-plane fleet, swapping older Boeing 747s and 757s for smaller models from Boeing Co. and Airbus Industrie. The idea is to chop total seats while boosting the percentage available to business- and first-class customers. BA also is spending $900 million to install beds in business class and refurbish its lounges and supersonic Concordes. If the strategy works, BA will have regained the initiative. "I think the corner is turned, and we are moving in the right direction," says Colin Marshall, chairman and former CEO, who has temporarily replaced Ayling. As to the next CEO, Marshall says BA wants a team player to follow Ayling, a loner who alienated top execs and the work force.

There are indeed some hopeful signs at BA. Premium traffic was up 11.6% in February from the previous year. And the tough European market may be improving. Chris Tarry, an analyst at Commerzbank in London, predicts that European airlines will see demand grow at 6% to 7% this year, while capacity will increase at half that rate. That could curb painful price-cutting. If the economics improve, BA would enjoy a boost from a higher percentage of business-class passengers and its relentless cost-cutting, which is to take out about $400 million this year. While some analysts put 2001 profits in the $80 million range, Tarry thinks BA will earn $190 million next year.

But others contend that giving up market share could be a critical mistake. "The successful airlines at the moment are driven by volume, not price," says Richard Hannah, airline analyst at Deutsche Bank in London. Hannah has a point. The pacesetters in Europe these days are the upstart and old-line airlines that are grabbing passengers by adding seats and cutting prices. If price-cutting continues--and it seems to be the way of the world--BA's strategy could prove a bust. If it backfires too severely, it could eventually undermine BA's position at Heathrow.

The star among the newcomers is Dublin-based Ryanair Holdings PLC. Its specialties are bargain flights between London's suburban Stansted Airport to destinations such as Dublin and Venice. And its success has paid off handsomely: In the last year, Ryanair has more than doubled its market cap, to about $1.5 billion. Ryanair's costs are about one-third BA's 21 cents per mile, Tarry estimates. BA has copied the discounters with Go, which also flies from Stansted to such cities as Barcelona and Copenhagen. But Go has yet to turn a profit.

Lufthansa and Air France, once considered also-rans, have brought down costs to where they are comparable to BA's and are now building market share. Air France is growing at 8% to 9% per year; Lufthansa, which boosted its available seats by about 13% in 1999, will add 5% to 6% more in 2000. Both carriers also remain profitable. Tarry says Lufthansa will report pretax earnings of about $810 million for 1999 and that Air France will earn about $340 million for the year ending this March. And Lufthansa recently bought 20% of privately owned BA rival British Midland PLC for $148 million--an aggressive move into the British market.

The next year or so may define BA's future. It still has many strengths, including close ties to Prime Minister Tony Blair's government, which would scrutinize any suitor carefully. But its margin for error is steadily narrowing.

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