Air France, Alitalia Rise on Takeover Talk

Some experts think the money-losing Italian carrier is a bad risk, but two airlines see it differently and have their money on the table

When it comes to doing business, sometimes practice makes perfect. That might explain why Italy's national air carrier, Alitalia (AZPIA.MI), hopes to strike gold the second time around after it received nonbinding bids from Air France-KLM (AKH), Europe's largest airline, and Air One, a domestic low-cost competitor, on Dec. 6 to take over the money-losing carrier.

This follows a failed attempt to sell Alitalia earlier in the year (, 2/14/07) when all potential buyers—including Texas-based private equity firm TPG—withdrew after the government imposed conditions on the sale, such as not laying off any workers and maintaining the Alitalia brand.

So what makes this time different? Not much, say analysts, but some carriers are still interested in taking the plunge. The Italian airline continues to lose more than $1.5 million a day and posted a $185 million operating loss for the first half of 2007 on revenues of $3.37 billion. That compares to Air France-KLM's $1.07 billion profit in the same period, on revenues of $18.1 billion.

Going Against the Grain

"Any company looking to bid for Alitalia must be a nutter," says Andrew Fitchie, an airline analyst at London stockbroker Collins Stewart (CLST.L). "There are ongoing union issues and the possibility of state intervention that could cause a real headache for any new owner."

Despite these problems, Air France-KLM and Air One appear willing to gamble that Italy's lackluster national carrier can be turned around. The markets seemed to agree: Alitalia's stock closed up 3% in Milan on Dec. 6, while Air France shares rose 2.4% in Paris trading. Air One is a subsidiary of privately held Italian construction firm Toto.

For both airlines, a possible linkup with Alitalia could help expand their businesses at a time when the European airline sector is becoming more cutthroat. Low-cost carriers continue to squeeze margins on routes across Europe, while widespread consolidation has increased competition on long-haul flights.

Expanding International Reach

If Air France-KLM wins out, greater access to domestic Italian routes, as well as a wider range of international flights, could help keep the airline ahead of competitors British Airways (BAY.L) and Lufthansa (LHAG.DE), which ruled itself out of a possible bid for Alitalia on Dec. 6. The Franco-Dutch airline already benefits from great economies of scale through its two hubs in Paris and Amsterdam. Adding Rome as its third base of operations would provide instant access to domestic Italian routes and expand the airline's international reach.

"Air France-KLM has a very successful dual-hub strategy," says Collins Stewart's Fitchie. "An Italian hub would be a good extension, helping to feed passengers across Europe and into long-haul flights."

In contrast, Air One's approach would focus on Alitalia's domestic connections to maintain its position against the likes of low-cost carriers Ryanair (RYAAY) and easyJet (EZJ.L), which have aggressively targeted the Italian market. Since 2000, for example, Alitalia's domestic market share has fallen to just over 40%, while Air One's operations have grown to a quarter of all flights.

Planes Already Ordered

As it offfers both leisure and chartered services, Air One also could use Alitalia's airport slots across Europe to expand its existing services to six international destinations. According to Frankie O'Connell, lecturer at Cranfield University's Air Transport Dept. in Britain, that would help to keep pace with other low-cost carriers and give the airline highly sought-after slots at non-European destinations, which could be either sold off or used as another revenue stream.

"Being an Italian bidder for an Italian airline also has to give Air One an advantage," says O'Connell, who adds the carrier already has 27 Airbus A320s on order to expand its existing 51-aircraft fleet.

Alitalia's board has until the end of the month to choose a preferred bidder, although concerns over union strikes if job cuts are announced, or government meddling if a foreign carrier buys the airline, could still scupper the deal. Wary investors know the failure of this new round of takeover talks would be another setback in the airline's poor financial performance. If the Dec. 6 share spike is anything to go on, however, the sale of Alitalia really could be a case of second time's the charm.

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