A MAGAZINE FOR AIRLINE EXECUTIVES 2008 Issue No. 1 T a k i n g y o u r a i r l i n e t o n e w h e i g h t s A Conversation with Tim Hoeksema, chairman, president and chief the executive officer, pilot Midwest Airlines. pg. 36 Special Section I N SID E Airline Mergers Airlines are scrutinized for affects and Consolidation 26 on the environment Etihad doubles its revenue from 44 2006 to 2007 Carriers can become true customer- 62 centric businesses © 2009 Sabre Inc. All rights reserved. [email protected] industryprofile THE BARBARIANS ARE STILL AT THE GATES Some carriers may continue to be targets of private equity firms as pressure for privatization and consolidation of airlines unfolds this year. By Peter Berdy | Ascend Contributor 28 ascend industry rivate equity has a colorful history, first out prominent U.S. and European carriers that ing investment last year — around the time gaining prominence during the junk-bond were in financial trouble during the year. Apax Partners was rumored to be raising cash Pand leveraged buy-out heydays in the “We believe UAL is a potential private for a stake in Iberia. 1980s. Most notable was the case of RJR equity play, given the US$4 billion we esti- TPG’s investment in Ryanair represents Nabisco. In 1988, RJR Nabisco was purchased mate it can earn in free cash flow over the another start-up example. Ryanair President by private equity firm Kohlberg Kravis Roberts next four years,” Daniel McKenzie of Credit Michael O’Leary said, “He [Bonderman] got & Co. (now called KKR), in what is the second- Suisse told BusinessWeek. McKenzie said 20 percent for pretty much nothing. Sold us in largest buy-out in history (the 2007 buy-out such groups “could take UAL private today, ’97 and made a fortune.” The US$42 million of the Texas-based utilities giant, TXU, by collect dividends and go public when the that Bonderman and his partners invested KKR, TPG Capital and Goldman Sachs is the industry consolidates, thereby capturing the in Ryanair’s initial public offering of stock largest). valuation arbitrage.” increased sevenfold. At that time, the use of a leveraged Private equity firms also rediscovered Private equity firms invest in buy-out buy-out to acquire RJR Nabisco along with proven ways to unleash hidden shareholder situations where they acquire a significant por- the aggressive pursuit by the private equity value by attempting to spin off undervalued tion or a majority control in a mature company. principals was seen as an ominous threat to businesses within the airline’s portfolio, such Buy-outs usually involve a change of owner- the free capitalist structure. The men behind as frequent flyer programs and regional feeder ship. Some examples in 2007 included TPG’s these plays were termed “corporate raiders” divisions. unsuccessful attempts at Qantas and Iberia; and “barbarians at the gate.” (The story was and both TPG’s and Matlin-Patterson’s unsuc- written in the book called, Barbarians at the Opportunistic Focus Of Private cessful bids for Alitalia. Look for private equity Gate, by Bryan Burrough and John Helyar). The Equity firms to play a role in the coming years as RJR transaction also benefited the investment Typical private equity opportunities, speculation and action swirls around mergers bankers and lawyers who advised KKR. These including those in aviation, fall into one of and consolidation in the airline business. advisors walked away with more than US$1 several categories: billion in fees. Leveraged buyouts and go-private Unlocking Value During the 1980s, high-profile airline pur- transactions, Blackstone Group got a quick return on suits included TWA (featuring Frank Lorenzo Spin-offs and carve-outs from larger invested capital after it bought Travelport — a and Carl Icahn) and Continental (with Frank companies, reservations conglomerate that owns a major- Lorenzo once again, and David Bonderman of Restructuring and recapitalization, ity stake in Orbitz Worldwide Inc. and Galileo Texas Pacific Group). Structured minority investments and and has agreed to buy Worldspan. Blackstone strategic stakes, bought Travelport from Cendant in 2006, using The Business Model Financing acquisitions, US$1.1 billion in debt to fund the purchase. Once a targeted company was acquired Venture capital for new enterprises. Seven months after the deal with Cendant by the private equity firm, the firm would As “venture capitalists,” private equity closed, Blackstone received a dividend equal to restructure it, implement a series of cost- firms may invest to create a new company or its debt. The company went on to file an initial cutting measures and usually sell off underper- expand a smaller company that has undevel- public offering for Travelport last December. forming assets. The new “leaner and more- oped or a strong potential to grow revenues. The IPO could raise US$2 billion. efficient” company could then be resold, often For example, Apax Partners provided financial A go-private example is Sabre Holdings®, at significant return on investment. backing for the creation of Vueling Airlines, a the publicly traded firm known for providing Now, 20 years later, the image of private Spanish low-cost carrier that was created in software solutions and consulting services to equity has changed dramatically. The private 2004. Apax Partners initially had a 40 percent the travel industry that was purchased last equity “barbarians” are now shrewd global interest in Vueling Airlines and sold its remain- year by TPG and Silverlake. investment managers and specialists whose financial backers are looking for high ROI Frequent Flyer Program Value from acquisitions, spin-offs, re-financings and restructuring businesses. They also help Market Estimated capitalization bail out ailing companies by pro- Airline Value of FFP of parent viding management services, guid- Air Canada C$4.3 billion C$2.9 billion ance and United Airlines US$7.5 billion US$3.4 billion advice as well Northwest Airlines US$6.4 billion US$2.9 billion as look- ing for American Airlines US$5.7 billion US$3.3 billion ways to increase British Airways £1.0 billion £3.4 billion share- Air France/KLM €2.4 billion €6.6 billion holder value. Lufthansa German Airlines €2.8 billion €8.0 billion P r i v a t e equity has become a fully Source: Bear, Sterns and Morgan Stanley, January 2008 fledged industry. Private equity firms Private equity firms have identified frequent flyer programs as hidden assets that can made headlines in the airline industry potentially be far more valuable to the firm if they were separated from the airline business. last year. They were identified as firms to bail ascend 29 industry Photo by shutterstock.com Private Equity Money During the last two decades, the global private equity market has experienced explo- sive growth. New sources of liquidity created from rocketing oil prices and the developing Asian economies, among others, has been put into the hands of private equity firms. Private equity has become an invest- ment option for many of the world’s largest investors, including pension funds, insurance companies, banks and university endowments. These institutions are committing an increas- ing proportion of their capital to private equity, which often out performs more-established investment choices available. Photo by shutterstock.com Private Equity Investments Private equity firms generally receive a return on their investments through an IPO, a sale or merger of the company they control, or a recapitalization. Their offering of unlisted securities may be sold directly to investors through a private offering or to a private equity fund that collects contributions from smaller investors to create a capital pool. Most private equity funds require signifi- cant initial investment, usually US$1 million or more, plus further investment for the first few years of the fund. Investments in limited partnerships, the Photo courtesy of Boeing dominant form of private equity investments, are typically illiquid — it is very difficult to gain access to money that is tied up in these long-term investments. Distributions are made only when investments are converted to cash. Limited partners typically have no right to demand that sales be made. Private equity firms can provide high returns, with the best private managers sig- nificantly outperforming the public markets. Private equity fund investments are for those who can afford to have their capital locked in for long periods of time and who are able to risk losing significant amounts of money. This is balanced by the potential benefits of annual returns that range up to 30 percent for suc- Photo by shutterstock.com cessful funds. Given the risks associated with private equity investments, investors can lose all their investments if the fund invests in fail- ing companies. The risk of loss of capital is typically higher in venture capital funds, which invest in companies during the earliest phases of their development, and lower in mezzanine capital funds, which provide interim invest- ments to companies that have already proven their viability but have yet to raise money from public markets. Major Private Equity Players The majority of investment in private TPG, one of the most prominent private equity firms in the world, has invested in several air- equity funds comes from institutional investors lines, including Continental Airlines, Southwest Airlines, Tiger Airways and Ryanair, giving it including public pension funds and banks and the most experience in the airline industry. financial institutions, which, together, provided 40 percent of all commitments made glob- 30 ascend industry ally according to data from London-based Prudent capital investment, research and of €305 million (US$452 million) on its stake Private Equity Intelligence Ltd.