The events of 1996 form the latest in a series of epic years for commercial aviation in Mexico. Late in June the owners of the country's two largest carriers exchanged the shares in their respective airlines for new stock in Corporacion Internacional de Aviacion (Cintra), a holding company that became the common owner of both Aéromexico and Mexicana.
Thus ended 'the survival phase,' so named by Alfonso Pasquel, Aéromexico's president, who sees Mexican aviation now entering a new era of redefinition and progress. But what will common ownership mean for two airlines which have been rivals for 62 years? And if they fail to combine forces, are they destined to repeat the traumas of the past three years? In this new world of Mexican aviation, no one can be sure.
Change has come on a whirlwind to Mexico's airlines. Privatisation, promptly followed by deregulation, ushered in a period of chaos as low-fare entrants exploited weaknesses in the incumbents. Four months before Mexico's new competition law took effect, Aéromexico completed an ill-timed takeover of Mexicana in February 1993. Over-leveraged and unprepared, both Aéromexico and Mexicana slid deeper into debt.
Then, in December 1994, Mexico experienced what is now called 'La Crisis'. The value of the Mexican peso plunged 71 per cent, producing widespread defaults, unemployment, and inflation that was running at 86 per cent in the middle of last year. 'People outside of Mexico don't realise how bad things were,' says Fabian Bachrach, who represented lessor GPA in Mexico before starting International Aviation Partners as a leasing consultancy to Latin American airlines. 'It paralleled the 1929 crash on Wall Street,' Bachrach recalls.
The plunge in traffic and balance sheets forced Aéromexico and Mexicana into major restructurings. 'Mexicana was effectively bankrupt,' concedes the airline's current president, Fernando Flores. Both airlines grounded or returned excess aircraft, boosted utilisation, made peace with traditionally intransigent unions, cut the number of employees, renegotiated all aircraft leases, and capitalised over US$1 billion in debts owed mostly to four banks: Serfin, Bancomer, Banamex, and Banco Mexico. Aéromexico completed this herculean effort last year; Mexicana took until March of this year.
With both restructurings completed, Cintra incorporated in May and the shareholders of each airline began the process of trading in their old airline stock for new Cintra shares. When that exercise was completed at the end of June, with 95 per cent of all shares converted, Aéromexico relinquished direct ownership of Mexicana, and Cintra listed on the stock exchange.
Both airlines claim to be doing better now, but they have been slow to release current financial data. Aéromexico's most recent disclosures only cover the first half of this year, while Mexicana's latest results are only for the first quarter. Both show improvements over a year earlier, but that is like comparing the dead of night to dawn. Following the peso's devaluation, the first half of last year was one of the darkest in Mexican aviation.
Other indicators are mixed. Aéromexico's costs per available seat mile have dropped from 6.4 to 6.3 US cents this year, while Mexicana's have crept up from 7.6 to 7.9 cents. But yields at both airlines are better due to less fare discounting. With a projected US$700 million in foreign sales this year, both carriers should earn more in dollars than their dollar-denominated debts and expenses, protecting them against the effects of further erosion in the peso's value.
But their individual challenges are still numerous. These include the implications of Mexico's inflation rate, which is still running at over 20 per cent; its effect on interest rates and costs; their relatively old fleets; their recognised need for better balance between leased and owned aircraft; adapting to the planned privatisation of Mexico's airports; withstanding the onslaught of more US capacity; and the issue of how to fit into the families of global airline alliances.
Aside from such worries, Aéromexico and Mexicana confront the unique uncertainty of how to conduct themselves under common ownership, and what kind of future that ownership may produce. 'We hope to learn from the experience in Chile,' says Flores of Mexicana, referring to the common ownership of LanChile and Ladeco, but he concedes that Mexico's major airlines are flying in largely uncharted skies.
The ground rules for Cintra's ownership of both airlines were set late last year. Under Mexico's competition law, the holding company needed the approval of the Federal Competition Commission (CFC) before it could take over both airlines. The CFC cleared the deal as a way for the two carriers to 'attain adequate levels of efficiency' and for the creditor banks, which swapped their airline stakes for equity in Cintra, to attempt to recover the capitalised debts - the same debts which the banks had swapped for their original equity in the two airlines.
To 'safeguard the independence' of each airline, however, the CFC required the two carriers to keep separate accounts and independent management, and to 'cooperate in preserving and improving the competitive environment.' The CFC warned that if they did not compete, it would reserve the right to order a partial or total dissolution of Cintra's acquisition at any time.
Both airlines have interpreted the CFC's ruling to preclude agreement on fares, capacity, or routes. 'Complimentary and friendly competition,' is the way Aéromexico's Pasquel describes current relations between the two airlines. Each carrier's management is free to make unilateral changes. But both seem cautious about any major role revisions, whether unilaterally or through consultation.
Before Cintra's takeover, Aéromexico was the airline of choice for Mexican business travellers and it remains so with its frequent flyer programme, airport business lounges, and focus on inflight service. Mexicana's niche overlaps somewhat, but its emphasis is on international tourist traffic and discretionary domestic travel. Aéromexico controls 39 per cent of the domestic market, compared with Mexicana's 31 per cent, while their respective share of the Mexico-US market is 18 and 21 per cent.
The only differentiation of route networks has come through their regional subsidiaries. But in practice even the domestic market coverage has become homogeneous, as Aéromexico now codeshares with Mexicana's subsidiary Mexicana Inter, as well as its own, Aerolitoral. And Mexicana does the same in reverse. Aerolitoral operates in northern Mexico, while Mexicana Inter serves the so-called 'Mayan routes' of southern Mexico and the Yucatan peninsula. This geographical division existed before the takeover and competition officials appear to have tolerated the reciprocal codesharing deal.
The CFC has also allowed the two carriers to develop operational synergies. As Salvador Apodeca, the CFC's economist and assistant to its president, explains: 'Our concern is with competition affecting consumers and situations where the two airlines have the market power to restrain competition.' So he reasons joint purchases of aircraft insurance or supplies are no concern, because those market are global and the combined purchasing power of the two carriers will not affect competition there.
Nor has the CFC shown much concern about Aéromexico and Mexicana starting joint training, maintenance and ground handling, or pursuing uniform policies on human resources or labour negotiations.
One reason for the CFC's indifference could be that such 'back office' cooperation is still in its infancy. The joint ground handling initiative has drawn the CFC's attention only because of its potential to discriminate against other carriers. But in most of these 'common' areas, Aéromexico and Mexicana lack enough commonality to wield much power. On the maintenance side, for instance, the carriers lack any fleet commonality which would produce any real savings. Mexicana's planned acquisition of B757s will be the first common aircraft type in both carriers' fleet since both disposed of their DC-10s.
But, the CFC notwithstanding, further cooperation does not appear to be on the agenda. Each carrier has brought its own distinct culture into Cintra. Aéromexico is a private company that bought the assets of the old state-owned Aéromexico after its 1988 bankruptcy. By contrast, this year Mexicana celebrated its 75th anniversary, with most of that time under government ownership.
Melvyn Roig, director of the new joint training centre, notes that some Mexicana employees have been with the airline as long as 50 years. Corporate cultures couldn't be more different.
Not surprisingly, both managements remain preoccupied with the success of their own carrier. This is in part due to the CFC's directive to Cintra to retain each carrier as a separate profit centre, but the innate sense of looking after one's own interests helps ensure the managers adhere to this directive. Add this to the recent preoccupation of each airline with survival, restructuring, and now profitability, and the search for more areas of commonality does not receive high priority. Both presidents enthusiastically describe efforts under way to improve their own airline, but increased cooperation hardly seems to be on either's agenda.
Indeed, the two airlines appear to be evolving in ways that could frustrate more cooperation. Aéromexico has a strategic alliance with Delta Air Lines that includes codesharing on a growing number of Mexico-US routes. At presstime, meanwhile, Mexicana was holding talks with United Airlines about a similar alliance. Linking up with different US partners hardly forms the basis for a joint US strategy.
Further, Aéromexico installed a sophisticated computer system last year to manage internal operations, which will further widen the gap between work practices at Aéromexico and Mexicana. Pasquel says Aéromexico is now changing from a vertically integrated to a horizontally managed company; Mexicana is still adjusting to the recent drastic downsizing from 14,000 to 5,600 employees.
This begs the question whether priorities will change when the banks ultimately divest their Cintra interests. Initially, the CFC wanted to limit Cintra's joint ownership of Aéromexico and Mexicana to three years. It backed down under lobbying from both banks and airlines. Indeed, there is no time limit on Cintra's current holding of the two carriers, but Mexico's treasury department has limited the banks' ownership of Cintra to five years. The banks, which own 70 per cent of Cintra, could sell sooner with the consent of other shareholders.
Sources close to Cintra confirm that the banks have no interest in retaining a longterm stake in the holding company and are already pondering their exit strategy. Ernesto Martens, appointed by the banks to turn the airlines around, reportedly sees this as his chance to end his long career, as one of Mexico's most prominent and respected industrialists, on a high note.
The Mexican government's long term intentions are less clear. With a 21 per cent stake, it is Cintra's second largest shareholder. Juan Barges, civil aeronautics director, said in late July that the government may sell its shares 'at any moment.' But there is no sign of anything happening yet.
Opinion is divided over how the government will proceed. Some analysts predict the current government will sell before the next national elections due in five years, and will time its exit to gain political advantage. Others suggest the government might retain a minority stake, such as it as done with some railroads, to exercise future influence.
Whatever the government chooses to do, it appears certain that Cintra will have new owners in less than five years. Currently, foreign ownership is limited to 25 per cent, but this could change. A level of 49 per cent has been discussed as a new foreign ownership limit in airlines, so far without noticeable dissent. 'This is not like Pemex,' says Mexicana's Flores, referring to the government's recent retreat in the face of political opposition to the proposed privatisation of Mexico's petroleum industry. Unlike attitudes in other parts of the world, Flores claims 'there is no nationalistic sentiment about aviation.'
Cintra and its airlines are still too preoccupied with producing profits to give much thought to their next potential owners. But the presidents of both Aéromexico and Mexicana recognise that things may change. New owners could mean a new focus, and this would then raise questions about the government's willingness to revisit its requirement to keep the airlines separate.
The CFC has not specifically addressed the question of a merger. Its decision on Cintra only dealt with the issue of joint ownership. Yet, it doesn't take much to predict what the commission's view would be given that the two carriers control 70 per cent of the domestic market. If Taesa or Aérocalifornia, Mexico's third and fourth largest airlines respectively, were to grow into viable alternatives, or the barriers to entry drop and other rivals emerge, the CFC may change its view. But on current domestic market shares, an Aéromexico-Mexicana merger would simply concentrate too much power.
Internationally the story could be different. Tacitly the CFC has signalled its approval for cooperation by posing no objection to the Alas de America (Wings of America) project under which Aéromexico, Mexicana, and AeroPeru jointly offer connecting services from the US through Mexico to Lima and beyond. This cooperation started with Aéromexico's purchase of a 47 per cent stake in AeroPeru three years ago and has expanded into a full alliance that includes codeshares and a combined international route network. Washington has limited codesharing on North American sectors to 60-day approvals because of complaints from one US carrier about problems in Peru, but the Mexican airlines see great potential in Alas de America for expanding traffic within Latin America.
Cintra now holds the equity stake in AeroPeru and plans to use the Alas de America brand for more than flights. Already, the joint Aeromexico-Mexicana training programme is branded under that name.
CFC representative Salvador Apodeca is unwilling to speculate how his agency would consider any merger of Aéromexico's and Mexicana's international operations. But market conditions and the CFC's approach in other sectors suggest a merger is a strong possibility. In the Mexico-US market, the two carriers have a combined market share of only 39 per cent.
In the banking sector, the CFC has used strong foreign competition to justify mergers at home. When one Mexican bank recently proposed to acquire another, the CFC did not challenge it, reasoning that the North American Free Trade Agreement opened Mexico's financial markets to more cross-border competition and that 'forming larger banks may . . . be a strategy to face competition from foreign banks. In fact, in most countries where financial sector liberalisation has taken place, smaller banks have merged.'
This reasoning could easily apply to competition between Mexican and US airlines, especially as American and Continental dominate routes between the two countries.
But Aéromexico's Pasquel dismisses the prospects of a merger. 'That's going too far into the future,' he says. He takes pride in more immediate accomplishments. 'In the worst crisis of this country, the two main airlines are performing well.' He credits Mexico's government for building a solid foundation following the enactment of the competition law and last year's civil aviation code, and implies that Mexico's major airlines cannot consider merger until they have first built up their strength.
Mexicana's Flores is less circumspect. 'My personal view is that Mexico needs just one big airline, whether it comes from a merger or creating different roles for the two carriers.' But after more than 60 years of a dual airline policy, he concedes a merger of Aéromexico and Mexicana would be 'a big event' in Mexico. How soon could it happen? 'It is a possibility in two, five, or ten years,' Flores replies, 'but not now.'
Source: Airline Business
