The nature of equity partnerships in the Middle East shift from Etihad Airways to Qatar Airways

A recent analysis by CAPA – Centre for Aviation in its Airline Leader magazine highlights that the nature of equity partnerships in the Middle East shift from Etihad Airways to Qatar Airways. Qatar’s pursuits are its oneworld members: IAG, LATAM (and, unsuccessfully, American Airlines). In comparison, Etihad sought airlines with typically depressed pricing in strategically relevant markets. (Qatar’s IAG and failed American investments would have been in very relevant markets.)

The change now for Etihad is that the depressed pricing represented an airline that could not turn around, with airberlin and Alitalia the starkest examples. Strategic benefits were questionable: Etihad routinely cited partnership traffic as evidence of success, but it was never clear if the partnership traffic was profitable. Etihad itself was break even operationally with no disclosure of net position when considering losses from investments.

Etihad has undergone a management change with the exit of James Hogan, who was CEO nearly from the start. Mr Hogan crafted Etihad’s equity strategy but he was also dealt a difficult hand from Etihad’s Abu Dhabi government shareholder. Strategic investments in airberlin and Virgin Australia became complicated by Abu Dhabi’s sovereign agenda that involved Air Seychelles and Air Serbia being taken under Etihad’s management (Abu Dhabi is close to the Seychelles and Serbia).

The recent sudden changes at Etihad were also the result of Abu Dhabi’s economy weakening from the direct and indirect impact from lower oil prices. At the same time, a new minister questioned Etihad’s equity approach.

Interim management has signalled investments were under review. In Jul-2017, Etihad sold its stake in Switzerland’s Etihad Regional (formerly Darwin Airline) to German private equity fund 4K Invest, which bought Slovenia’s Adria Airways in Jan-2016. Etihad Regional was perhaps the easiest investment to review and dispose of, but even then it took significant time. Nearby are bigger troubles: loss-making airberlin and insolvent Alitalia.

Etihad and Lufthansa reached a deal to transfer some airberlin aircraft to the Lufthansa Group. Although seemingly odd bedfellows, it is in Lufthansa’s interest to see a weakened airberlin survive rather than exit the market, which would pave the way for expansion from Ryanair and easyJet, which would pose a larger threat.

Etihad and Lufthansa are also growing closer on their own operations. This is mostly in ground based businesses, but for flying activities Lufthansa codeshares on Etihad’s Frankfurt-Abu Dhabi service while Etihad codeshares on limited Lufthansa services beyond Abu Dhabi-Frankfurt. Critically, Lufthansa is not cooperating on Etihad services beyond Abu Dhabi and thus has not embraced Etihad’s fundamental business model.

Etihad’s USD1.9 billion loss for 2016 mostly comprised one-off events, notably fleet depreciation, suggesting Abu Dhabi wants to clean Etihad’s slate for the next management. The one-off events and staggering size of the loss obscured further weak performance in the Etihad-branded operation. The loss did not include a share of losses from investments.

The financial future of the equity investments is yet to be determined but operationally the synergies are ending; most of Etihad’s investment and codeshare partners have ended flights to Etihad’s Abu Dhabi hub.

Qatar Airways is confronted by short and medium term challenges. Qatar’s regional neighbours – Saudi Arabia, Bahrain, UAE and Egypt – implemented a blockade prohibiting flights to/from Qatar and banning Qatar Airways from using their airspace to transit to another country. This created two layers of setback: the ability to access key regional markets and the longer flying times resulting from not being able to use the blocked airspace.

In early Aug-2017, some airspace alleviation (but not full restoration) was in progress through the work of ICAO. Except for Saudi Arabia, the countries that closed their airspace are signatories to the (“Two Freedoms”) International Air Services Transit Agreement signed at the 1944 Chicago Conference, which permits unrestricted overflight access. The blockading countries contended that closing airspace to Qatar was on national security grounds, beyond the Transit Agreement’s commercial realm.

Improved airspace access will reduce flying diversions, saving time and helping to restore Qatar Airways’ schedule. Most disrupted were flights to other Middle East countries as well as East Africa, which resulted in significant diversions around closed airspace.

The lasting impact is Qatar’s lost access to regional markets (airlines from those countries are also prohibited from flying to Doha). When the ban started, the impact on Qatar Airways was approximately 56 daily services (significantly more than the lost flights to Doha from the other affected airlines, combined). These services are short haul and often under an hour in duration, so the direct ASK impact was 3%.

The true network impact is higher since passengers were connecting to other flights, and often with very long flights. For point-to-point traffic, regional fares can be high. The blockade started in the low season for the Gulf, when regional services are cut back, but has continued through to what is normally a strong part of the year, thereby further increasing the impact. With the situation heavily political, there is limited room for Qatar to try to alleviate pain.

For the medium term, Qatar needs to find new partners in the US, a significant market for it. Qatar’s main codeshare partner American Airlines ended codeshares with Qatar and Etihad after Qatar sought to invest in American Airlines (an intent it has since dropped). The codeshares terminate in Mar-2018 although interlines continue.

Qatar has a partnership with jetBlue, although it is much smaller than Qatar had with American (or what Emirates has with jetBlue). Qatar likely needs to grow its JetBlue partnership while seeking further partners – and possibly investing in them. Until Etihad and Qatar form replacement partnerships, Emirates and jetBlue will have the largest partnership.

The loss of American Airlines’ partnership is a setback for Etihad and Qatar, although perhaps in the long run one of them would have forced out the other. It is an unwelcome development to add to an already busy time.

As Gulf airlines take on greater prominence, maintaining the network is not guaranteed. Growing is not as easy or low key as it used to be. The sheer push for growth is now giving way to more tailored market solutions.

This article was adapted from a feature that appears in the latest issue of Airline Leader – the strategy journal for airline CEOs. Visit Airline Leader to find out more.