EasyJet goes for it, but will cost be high?

ALEXANDER CAMPBELL / LONDON

First major move in no-frills sector consolidation, although DBA will be challenge

EasyJet will have a lot of work ahead if it secures its acquisition targets Go and British Airways' subsidiary Deutsche BA (DBA). Days after the news leaked out earlier this month that EasyJet was in talks to acquire rival Go, the low-cost operator announced it has also taken an option to buy DBA.

Although its interim results show that it has the cash, turning DBA around could be difficult. What's more, both Go and EasyJet are set to sign large aircraft deals in the next few months.

Both have delivered favourable results: EasyJet last week announced a first-half profit before tax for the first time - £1 million ($1.47 million) from sales of £194 million - although it admits yields are "softening" as fares are cut to keep passenger numbers high. Go's results for the year to 31 March 2002 are also good, with operating profits rising threefold to £17 million on £234 million turnover.

Taking over former BA subsidiary Go would give EasyJet a third London hub at Stansted, in addition to its main hub at Luton and its expanding secondary hub at Gatwick, and would double its size. All three bases will be kept on indefinitely, says the airline.

EasyJet says that this consideration stopped it buying Go when BA offered it for sale in 2000. At the time EasyJet was going through its own flotation, and "the challenge for management of the flotation and the expansion would have been too much", according to EasyJet.

EasyJet's keenly anticipated order for around 75 aircraft will go on hold until the take-overs are complete, the airline says. The figure was "only a notional number", and, with Go's pending order for a similar number, could rise to 150 aircraft. But the deal will wait "until we know what sort of airline we're buying for", and the purchase will be for a single aircraft type. EasyJet says the chance of buying larger aircraft with over 150 seats is "very small", despite some press reports to the contrary.

DBA relaunched earlier this year (Flight International, 19-25 March), and cut fares on its domestic services from its Munich hub. However, three EasyJet managers "schooled in the low-cost model" have started examining DBA operations to bring costs down. For example, ticket sales must move to the internet.

The airline has some good features, according to JP Morgan analyst Chris Avery:" As well as its network geography...it is an efficient producer," getting plenty of value out of aircraft and crews. "The problem is on the revenue side." An attempt to compete with Lufthansa on domestic routes has not been working - the low-cost strategy seems a better bet to Avery. But turning a high-cost carrier into a low-cost airline is difficult.

At least the DBA take-over will be affordable. A deposit of €5 million ($4.6 million), a €600,000 monthly payment until the option is exercised, and a final payment of €30-39 million (the quicker the option is used, the smaller the final payment) could all be met out of the airline's cash reserves, which stand at some £382 million. A €50 million price tag may seem cheap for a 16-aircraft company, but, Avery points out, "all [the aircraft are] on short operating leases - so if you stand still the asset walks away".

But the take-over of Go could be another matter. EasyJet chief executive Ray Webster was touring City institutions last week, probably to drum up support for a rights issue to back the take-over - at a price rumoured to be around £400 million. The price has yet to be agreed, and majority owner venture capital group 3i may decide to take all or part of the payment in EasyJet stock, in which case the changing price will delay a deal. Anticipating an influx of newly issued stock, the City has marked EasyJet stock down, with the shares falling almost 20% over a few days late last week. EasyJet chairman Stelios Haji-Ioannou may also place some of his family's 58.6% holding.

Although the take-overs will make EasyJet bigger than current low-cost leader Ryanair, Webster does not believe they will compete head to head: his strategy of focusing on the business market contrasts with the ultra-low cost destinations, aimed at the price-sensitive leisure traveller, served by Ryanair (Flight International, 9-15 April). While the split in the market could prevent an all-out price war, Ryanair will still feel the pain of its eclipse. Webster insists that the elimination of Go as a competitor would not force air fares up, as it is the "low fares that drive our volumes".

Source: Flight International