Apr 4th 2007
From The Economist print edition

The prospect of more open skies across the Atlantic is shaking up Europe's airlines

“CHICKEN or beef?” If you think the menu on transatlantic flights is limited, try choosing a European airline to fly across the ocean. European airlines are heavily outnumbered by American ones on most transatlantic routes. Passengers at some European airports, such as Barcelona and Brussels, have no choice but to fly with an American airline if they want to go non-stop. Regulatory restrictions on flights between the European Union (EU) and America are largely to blame. Now an “open skies” deal between the two, which will allow any airline from either side of the Atlantic to fly to any intercontinental destination from March 2008, is shaking up Europe's airline industry.

One effect of the agreement, which will be signed in Washington, DC, on April 30th, is to make takeovers more likely. Without an open-skies deal, any airline that bought a rival based in another EU state risked losing that airline's landing rights in America. Accordingly, on March 30th Texas Pacific Group (TPG), a ravenous private-equity firm, made a preliminary approach to buy Iberia, Spain's leading airline, for €3.60 ($4.80) per share. Spain is one of 11 EU states (Britain, Greece, Hungary and Ireland are among the others) not to have an existing bilateral open-skies deal with America. Passengers in these countries are expected to benefit most from liberalisation.

Acquisition talk is not restricted to Spain. The bidding for a controlling stake in Alitalia, Italy's beleaguered national carrier, edged closer to a result on April 2nd with the announcement of a shortlist of three bidders. (TPG is part of one consortium; Aeroflot, Russia's flag carrier, dominates another.) BMI, a British airline, is the subject of much takeover gossip, largely because it holds coveted landing slots at London's Heathrow airport, Europe's primary transatlantic gateway. A host of smaller EU carriers—Austrian Airlines, Scandinavia's SAS and Poland's LOT among them—are also being talked about as potential targets. “I've never seen it as active as it is now,” says Tim Coombs of Aviation Economics, a consultancy.

The open-skies deal is the main reason for all this activity, but not the only one. Deep-pocketed private-equity firms provide a new source of capital, although many analysts are sceptical that they can thrive in such a capital-intensive and cyclical industry. Nor does the open-skies deal mean that takeovers are free of opposition. Iberia's attractions include its strong Latin American route network, which is not covered by the EU-American pact. A non-Spanish buyer would have to make agreements with aviation authorities there and in other parts of the world. And whatever the rules say, European governments, Spain's and Italy's among them, tend to blanch at foreign control of prized national assets. (In Rome Aeroflot's bid for Alitalia has caused alarm in some quarters.)

The fight for Iberia is likely to be a long one. TPG has not yet tabled a formal offer and its mooted price is below the share price, which has soared since the start of the year on speculation of a bid. British Airways (BA), which already owns 10% of Iberia and has right of first refusal on another 30%, could stymie progress, join forces with TPG, or mount a bid of its own. Lufthansa, another of Europe's big beasts, is watching events in Madrid closely and may yet enter the fray.

If acquisitions prove too costly or complex, carriers can take advantage of the new regime in other ways, such as by adding routes to their schedules. But that depends on getting hold of take-off and landing slots, which are particularly scarce at Heathrow. Just four airlines—BA, Virgin Atlantic, American Airlines and United Airlines—carve up Heathrow's transatlantic slots between them. (Frankfurt divides about half the number of flights to and from America between twice as many carriers; see table below). Anticipating a wave of slot-trading, BA bought 51 weekly slots from BMI last week, consolidating its dominant position at Heathrow.

For its part, Virgin Atlantic is examining the potential for flights to New York from six continental European airports. Virgin is an unusual airline, with a strong brand, a record of taking on an entrenched incumbent and a proven ability to run standalone routes without a network of feeder flights. Other airlines lack its potential to operate outside their home bases, says Peter Morrell of Cranfield University.

The most intriguing possibility is the entry of low-cost carriers into the transatlantic market. The low-cost model is difficult to transfer from short-haul flights to long-haul ones. Long-haul economy fares are already pretty cheap. But there may be room for all-business-class operators to undercut established carriers on denser routes. Some airlines such as Silverjet and MAXjet already offer good fares on transatlantic services from London; the open-skies deal makes it easier for them to extend their services to other business hubs. And at the top end of the market, Lufthansa could expand the all-business service it runs with PrivatAir, a Swiss private-jet operator, to London.

The full effects of the new open-skies deal will take some time to materialise. Many of the benefits bandied about by the European Commission assume an end to restrictions on foreign investment in EU and American airlines. But America's limits on foreign ownership remain in place, despite the promise of future negotiations, and economic nationalism shows no sign of abating in continental Europe. Even so, the outline is emerging of a more normal industrial landscape, in which loss-making operators consolidate and profitable ones expand.