Air Berlin's Delayed Takeoff

The German low-cost carrier postponed its planned IPO. Industry watchers -- both skeptics and boosters -- weren't surprised

Discount airlines are soaring in Europe, and investors are eager to get in on the action -- but apparently not at any price. Late on May 4, German low-cost carrier Air Berlin postponed an initial public offering planned for May 5 on the Frankfurt stock exchange, saying it will extend the offer period for share sales until May 10 and start trading the following day.

While not anticipated, the delay was hardly a surprise to many market watchers. Air Berlin's planned IPO, which was slated to raise up to $1.1 billion, had run into heavy turbulence in the days prior to May 4, as analysts and shareholder activists voiced growing concerns that the shares were priced too high. The final blow was delivered by institutional investors, whose orders for shares before the IPO, came in at prices below the company's hoped-for range of €15 to €17.50 per share ($19 to $22).

Why the lukewarm reception for a fast-growing company in a hot business (see BW Online, 5/8/06, "A Closer Continent")? Investors were worried that surging oil prices and increased competition from larger rivals Ryanair (RYAAY) and easyJet could slow Air Berlin's growth, which clocked in at 17.5% last year. What's more, some shareholder activists griped that too much of the IPO's proceeds would land in the pockets of former managers -- and not enough in the company's own coffers.


  On May 5, the company spelled out a plan to make the offering more attractive. It announced that it will drop the share price range to €11.50 to €14.50 ($14.60 to $18.42) and reduce the number of shares offered to 42.5 million, which will raise between €489 million to €616 million. Of that amount, the company aims to retain gross proceeds of €225 million to €284 million when shares list on May 11.

Founded in 1978, Air Berlin is the second largest carrier in Germany after Lufthansa, and now focuses mostly on vacation shuttles between Germany and Mallorca. It's planning to use proceeds from an IPO to fund expansion into Eastern Europe and Scandinavia, increase frequency of flights on existing routes, and boost its focus on business travelers (see BW Online, 2/15/06, "The British 'Jet-to-Let' Set").

As recently as a few weeks ago, Air Berlin CEO Joachim Hunold told a Frankfurt press conference that he believed the issue price was fair. The carrier lost €116 million ($146 million) last year, and now faces spiraling fuel prices and increased competition. But Hunold says Air Berlin is still on target to be profitable in 2006.


  Some analysts aren't convinced. Air Berlin's biggest doubter is Jürgen Pieper, an analyst with Frankfurt-based Bankhaus Metzler, who predicts Air Berlin will report a net loss of €200,000 this year. Pieper released the only independent research report on Air Berlin in the run-up to its IPO. "It is my view that the shares are definitely priced too high," he said a few days before the planned offering. "I am telling my customers not to buy the shares because they are too expensive and the risks are too high."

Pieper also has longer term concerns. He says Air Berlin will face high capital expenditure for the next six years, and won't show positive cash flow until 2008. In addition, the company has had to hedge against rising oil prices at unfavorably high rates, driving fuel costs to 23% of sales in 2006, up from 19.5% in 2005.

Passenger growth of 8.5% in the first quarter of 2006 was below the company's expectations, leaving vacant seats on its planes. And in comparison to Ryanair and easyJet, Air Berlin flies mainly to high-cost airports such as Berlin, Düsseldorf, Hamburg, and Palma.


  The picture Pieper paints is starkly different from the one put forth by Morgan Stanley and Commerzbank, the lead banks in the Air Berlin IPO consortium. Commerzbank, for instance, forecasts that Air Berlin's net profits will come in at €51 million this year, on revenues of €1.46 billion ($1.84 billion), up 20% from €1.215 billion in 2005.

Commerzbank also predicts that Air Berlin will trim costs and wring out more revenues per passenger over the next few years. By changing the way it packages catered food and reducing choices, for instance, Air Berlin will cut its per-customer food and drink expenses from €4.32 last year to €2.68 in 2008, Commerzbank says. The bank wouldn't comment on the study.

Air Berlin says it expects to see stable or falling airport and handling costs, and aims to reduce sales commissions to agencies. It also expects to boost ancillary revenues per passenger from €2.51 last year to €3.46 in 2008, in part by introducing a fee for credit-card booking.


  Yet despite such assurances, as the IPO approached, skeptics were in the ascendancy. Pre-trading orders for Air Berlin shares changed hands on May 4 at around €14 to €15, below the bottom end of company's range. Traders at brokerage Lang & Schwarz in Düsseldorf said institutional investors were showing up exclusively as sellers of the shares. The few large buy orders appeared to be to be from wealthy retail investors. "Interest is not really huge," said Lang & Schwarz trader Stefan Chmielewski on May 4. "Fund managers are saying it's too expensive."

Hunold also took heat from shareholder advocates. "There's substantial risk associated with Air Berlin and there isn't a lot of room for growth in the share price," said Malte Disselhorst, a lawyer active with the German Association for the Protection of Security Holdings, before the IPO delay. "Because of the lack of transparency and risks involved, we're telling investors to be very careful."


  Disselhorst's main complaint: Air Berlin's old shareholders appeared to be cashing out in the deal. More than half the expected proceeds were slated to go to former owners rather than into the company's treasury.

For now, Air Berlin's shares are grounded, and the storm may not pass quickly. Over the next week, investors all over Europe will be watching closely to find out whether the aborted takeoff was merely one company's poorly executed offering -- or a bigger sign of weakening IPO demand.

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