Lufthansa Hangs Tough To Make Acquisitions Pay

Lufthansa could turn an airline sector slump to its advantage by negotiating lower prices and more cost cuts out of acquisitions it agreed last year that threaten to hurt its shares.

The German flagship carrier could pay close to EUR1 billion euros (USD$1.4 billion) to buy airlines including Brussels Airlines, Austrian Airlines (AUA) and a majority stake in UK carrier bmi.

The deals were remarkable especially as the airline's rivals were noticeably abstemious, but analysts say that Lufthansa is playing a tactical game well and also has the financial strength to make the deals pay longer term.

"Lufthansa's acquisition strategy currently definitely has more momentum than that of its peers. It can pull that off because it has greater financial power," said Commerzbank analyst Frank Skodzik.

"Lufthansa's negotiations tactics are a smart move. At bmi, it significantly reduced the purchase price, saving shareholder money, and at AUA it is making sure that the acquisition economically makes sense," said Skodzik.

Rival Air France-KLM's only major deal in 2008 was the acquisition of a stake in bankrupt Alitalia, worth around EUR322 million, while British Airways was most frugal, having failed so far in its pursuit of Iberia.

Worry about its deal making has contributed to taking a third off Lufthansa shares over the past year but investors still appear more sanguine about the airline than its rivals.

Over the past year, Lufthansa has traded at up to 16.9 times its 12 month forward earnings, compared with highs of only 10.4 and 12.4 for Air France-KLM and British Airways, respectively.

CRANKING UP THE PRESSURE

The German airline has been playing hardball with the sellers and regulators, and announced a EUR1 billion savings program, sending a signal that its financial means are limited and it could back out of deals if necessary.

Lufthansa earlier this year became embroiled in a legal row with Sir Michael Bishop, putting pressure on him to lower the cost of its acquisition of his 50 percent plus one share stake in bmi, a decade after the terms of the deal had been agreed.

Last month, Lufthansa agreed to pay GBP48 million for the stake and an additional GBP175 million to Bishop to cancel his bmi options. Bishop had earlier sought to enforce a claim of EUR400 million as per the 1999 agreement.

The acquisition of a majority stake in bmi, which one analyst last month called a "disaster" because it just adds a loss-making airline to Lufthansa's portfolio, will nevertheless gain it lucrative slots at London's Heathrow airport that will help it compete with British Airways there.

Analysts have estimated that the Heathrow slots alone could be worth EUR2 billion.

And while Lufthansa has agreed to more concessions to allay the EU Commission's competition concerns as it nears an end-July deadline for AUA, it did so only after AUA approved a third cost-cutting program to slim down ahead of the buy.

"I still think Lufthansa wants AUA, and if the first offer was weak it was to scare -- to pressure AUA into cutting more jobs, and to strengthen its hand against the EU," said UniCredit analyst Katherina Kastenberger.

ACQUISITIVE IN TOUGH TIMES

Lufthansa's next possible target could be Polish airline LOT, which will soon be privatized, some industry watchers have said, though no concrete talks seem to have emerged so far. Such a deal could help further expand Lufthansa's eastern European network.

But market conditions continue to be tough, and Lufthansa cannot relax in its efforts to make the acquisitions already agreed to pay off for shareholders.

It isn't easy: since mid-January, oil prices have doubled to USD$65 a barrel, while demand for air travel has failed to recover. Industry body IATA has said it expected that the world's airlines could lose USD$9 billion this year.

British Airways last week unveiled a USD$1 billion fundraising aimed at securing its future, including USD$540 million in bank loans that had been earmarked for a pension fund as a safety net against the airline going bust.

AUA lost EUR429 million last year and has piled up more than EUR1 billion in debt, or more than five times its equity. It only survived this spring due to a EUR200 million lifeline by the Austrian government, two-thirds of which it has used up.

"The Austrian deal would probably destroy value for shareholders at this point," said LBBW analyst Per-Ola Hellgren.

But analysts said that while Lufthansa sees only EUR80 million of potential synergies from the deal, it will pay off in the long run as it gives access to growth regions in eastern Europe such as Krasnodar, Kosice and Odessa.