Why A Global Private Airline Should Be The Next Step In African Aviation
Ethiopian Airlines is an example to the African aviation industry. Image: addisababaonline.com
Travelers to and throughout Africa have long grumbled about airline connectivity, but things have changed and perhaps it is time that African aviation had its own global private airline.
Years ago the complaints ranged from the long layovers in Paris when flying from one Francophone West African country to the next Francophone West African country to the long layovers in Dubai to cross the continent from East to West.
Such layovers informed the inside joke that airlines willingly took you to a language class abroad—French or Arabic depending on your preference—then brought you back to the continent to practice what you learned.
Today the airline industry in Africa is drastically different from a decade ago. The economic growth in the region and improved political stability underpin increased international traffic on the African continent.
Maybe it is time for a global (not state-owned) African airline
Estimates place Africa as the third fastest growing region in this category, trailing only the Middle East and Asia Pacific. Burgeoning economies and accompanying foreign investment speaks to this changing trend.
Traffic within the continent is equally growing. How does anyone cover almost 12 million square miles (or about 30 million square kilometers) of land? That size is three times larger than Europe.
The travel distance between major financial hubs within countries and across the continent cannot be understated. Add in the improving, yet still lacking, road infrastructure—largely unpaved—outside urban areas and the rather inconsistent rail connectivity and you see how air travel remains vital to business and general life.
All these factors should bid well for African airlines. Yet the many national and private carriers on the continent only account for about 5 percent of the world’s air traffic, as most traffic is handled by non-African airlines.
Turkish Airlines, by the end of the year, plans to operate routes from its Istanbul home base to 52 cities across Africa, compared to only 14 cities in 2011. Rival carrier Emirates Airlines operates around 30 routes, having cut one flight last year and reduced the frequency of certain routes.
African carriers, including South African Airways (SAA) and Kenya Airways (KQ), have made major plays for the African aviation market. Yet both SAA and KQ are struggling to stay above water.
SAA lost $98 million in 2016, having lost four times that number in 2015. KQ lost $100 million for its 2017 fiscal year and $260 million for the 2016 fiscal year.
So what does this mean for African aviation and investment in terms of opportunity?
Understanding the troubles with South African Airways
The gravity of the financial reality at SAA cannot be understated (and likely not solved) in the short term. The company has posted losses for seven straight years.
Management recently announced a strategy to address the airline’s challenges and make it profitable again in five years, with a positive cash flow by April 2018.
Acting CEO Musa Zwane and his team believe the turnaround plan addresses vital issues plaguing the firm, including liquidity, balance sheet, costs and revenue.
Seabury, the consultancy appointed to help develop the turnaround strategy, believes this turnaround can be successful, provided SAA maintains going-concern status which is backed by a state guarantee of $1.4 billion.
Critical management positions must also be filled. Seven CEOs in five years underlines the challenges at the management level.
The airline already projects a revenue shortfall of $373 million for 2016-2017 with a projected loss of $358 million for the fiscal year, which would be nearly three times the original $127 million forecast at the beginning of year.
The airline is also troubled with an inefficient fleet of planes and a bad route network mixed with a corruption and bureaucracy overhang. Observers struggle to understand how the government may recapitalize the company over the next couple years, despite a Treasury commitment to do so.
Maturing debt weighs on the balance sheet, considering SAA already acknowledged that currency volatility with its foreign assets and liabilities will cause nearly $68 million in losses. Do not forget that this is the airline that took out an ad in the newspaper in August 2016 asking for $1.19 billion in debt capital.
The Treasury recently paid $166.4 million to Standard Chartered to settle a loan. The bank then further refused to extend the loan. The Treasury is currently considering whether to provide an additional $745.5 million of capital at the request of the South African finance minister Malusi Gigaba to recapitalize SAA.
Alf Lees, the deputy finance spokesman of the opposition Democratic Alliance argues that the airline is effectively insolvent and should file for liquidation. With an election in 2019, such strong words will hang over SAA management for another year and half until polls have closed.
Throw in threats to strike over pay from the cabin crew and mechanics, and the turnaround strategy appears very fragile before it even begins. Some observers equate this to Alitalia during Italy’s financial struggles when the country still needed national air routes to be flown but lacked the balance sheet to properly support it.
The airline will likely have to shrink—adopting the Malaysia Airlines strategy—to reach profitability through a focus on its most profitable routes and a joint venture with another global airline.
Understanding the troubles with Kenyan Airways
News broke last week that a few banks were inspecting KQ’s aircraft for a potential repossession.
KQ leadership quickly cautioned speculators that the overseas banks would only repossess assets if the national airline could not restructure loans with local banks. But a civil action filed at the Kenyan supreme court in September have critics imagining the worst.
KQ requested that three banks—Ecobank, Equity Bank, and Jamii Bora—opposed to the debt restructuring process be compelled to restructure because it is “just and necessary to safeguard the rights and existence” of KQ.
The request goes on to highlight that KQ expected the restructuring to be completed by the end of August 2017 (a date that has now passed). If such restructuring does not happen, as KQ asserts, then claims owed to 12 local commercial banks will go unpaid and the interest of 17,000 other investors will be lost.
KQ’s trouble is also creating a local stir, as there was high expectation for a Nairobi to New York City (NYC) flight by the end of the year. The rumor originated in March this year and was approved in September.
But this financial disclosure likely undercuts financing for that expansion, especially from local banks who otherwise could probably find some profitability in a direct long haul from this major African financial hub to NYC.
The growing concern now is rather if Nairobi can maintain a reputation as a regional transportation and financial hub if the crisis further expands or remains ongoing for a significant period.
Any financial spillover could lead to a financial crisis with some banks, and further dampen the economic mood, currently dragged down by an elongated election process.
An airline as a profitable investment platform
A global privatized airline is not new…United Airlines and American Airlines, to name a couple, are still alive and kicking. But a global private African airline platform could be the next phase of aviation in Africa.
Critics will automatically reference Ethiopia Airlines as the global African brand.
It is #1 in Africa in revenue and profits. It continues to expand its route offerings as other airlines struggle.
In the fiscal year ending 2016, the airline recorded a net profit of $260 million compared $148 million in the fiscal year ending 2015.
Analysts attribute a significant portion of this success to the state’s ownership which does not require dividend payments and ensures low financing and labor costs (i.e., consider the 15 percent devaluation of the birr this week as a further discount to financing and labor cost).
Some analysts suggest that a free floating currency would quickly eat away at the savings on financing and labor costs. Coupled with market rate input costs, dividends payments would bring profits and earnings in line with other African airlines.
That aside, Addis Ababa, by the nature of being a national airline, is the sole hub and most flights require a connection in Addis regardless of distance. For example, the Lagos to Cape Town flight still passes through Addis, adding a few thousand miles to the travel distance.
Observers will also highlight the net loss of $434 million for the first half of 2017 for Turkish Airways, a major international carrier to and from Africa. It is 49 percent state-owned.
Yet the same issue remains with Istanbul as the hub and equivalently as the primary layover spot. And it cannot be ignored that Air France-KLM owns part of Kenya Airways.
This proves that private global airline platforms are not solely natural to the West, in particular the U.S., but rather already a global concept.
Creating it in the African context, however, does require some continental adjustments.
First and foremost, addressing a fragmented market, is vital. Establishing hubs in multiple countries is necessary to tackling this fragmentation. For example, a hub in the east, west, south and possibly north would be the first step.
Detractors will say this is not possible on a continent with 54 countries. But this could be achieved through a mix of construction and acquisition of planes and airport spots in already existing international hubs, most likely including Johannesburg in the south, Nairobi in the east, and Lagos (or Abidjan) in the west. Cairo would likely be the hub in the north.
Choosing the right hub helps to address the challenges with ground handling infrastructure.
The Kenya Airways Ground Handling Services, for example, is Safety Audit for Ground Operations (ISAGO) certified, operating both for Kenya Airways as well as about 20 other airlines that fly to Nairobi and Mombasa, thus lowering the entry cost as a global player because this is not something that needs to be created from scratch.
Second, route selection can be very specific to the region. No flying from New York to Nairobi (or Addis) to get to Johannesburg. U.S., Middle East, and European entry/exit points would likely include NYC, D.C., London, Paris and Dubai to start.
Houston may be an intriguing option, considering commodity interest, and Beijing may be another interesting option, considering Chinese interest in Africa. This global private African airline would fly to each country and, in most scenarios, partner with local airlines to extend further into country.
For example, someone flying from New York to Maputo would fly from NYC to Johannesburg, then fly Linhas Aéreas de Moçambique (LAM) to Maputo from Johannesburg.
The airline routes theoretically would emulate Emirates Airlines’ international routes, but eliminate the requirement that all connections flow through Dubai (or Istanbul with Turkish Airlines or Addis with Ethiopian Airlines).
The routes would also aim to further capitalize on the Ethiopian strategy of partnering with local airlines on connections in-country as a way of avoiding the uncertainty around managing local routes that have ebbed and flowed in volatility depending on the national economy.
A good example of this is Ethiopia Airlines’ partnership with ASKY Airlines based in Togo, an airline that launched in 2010 and already serves 23 destinations.
Speaking from experience, the flight from Ouagadougou (Burkina Faso) to Lome (Togo) and then onwards to Addis is simple and fluid (i.e., no worries about connection, ticket issuance, or baggage transfer).
Third, buying some current African aviation assets and airport spots already (or soon to be) on the market is an option for lowering capital costs. KQ and SAA will likely be selling some assets in the next 12 to 18 months, with or without recapitalization and restructuring.
SAA, as previously mentioned, will have to scale back flights and route offerings to become lean and profitable. KQ may follow suit. Egypt Air and KQ have already sold assets in recent years. Let’s not forget that the Asset Management Company of Nigeria (AMCON) recently bought Arik Air in Nigeria when it had troubles.
Fourth, creating an African brand is very important. Conceding national airline and airspace dominance will likely only succeed with a brand that partners with all African countries and promotes the continent.
Kudos to Ethiopian Airlines and the brand “Spirit of Africa”. The brand truly matches its growth and expansion. Matching that type of marketing may be the most costly (and challenging) piece.
Are we forgetting some things? Yes and no…a lot of other things have to be considered but only a few can be addressed here. Safety standards have to remain strong and meet global standards, thus enabling a global private African airline to partner with a national player.
In 2016, there were two fatal airline accidents in Africa and both were likely cases of terrorism, which speaks to the significant growth in safety standards across the continent.
There is definitely a discrepancy between treatment provided to non-African carriers and African operators.
More than 20 African countries have signed open skies agreements with the U.S. yet fully liberalized open skies remains a myth, particularly within the continent, such that non-African carriers currently transport over 80 percent of intercontinental traffic to and from Africa.
High costs associated with the sector have to be brought down….passenger charges at many airports in Africa vary between $40 and $120, compared to the global average of $25. Fuel costs are often two to three times the cost in Africa compared to global averages.
All the challenges aside, investors have to be wondering what the optimal privately owned aviation structure is across the African continent.
A significant portion of the travel is intercontinental and inter-country. Crossing borders remains less about ground transport and consistently about time saved and safety in the air.
Creating a global private African airline platform with patient private investors will sound like a pipe dream to many readers.
But consider the following: The International Air Transport Association (IATA) expects global airline net profits to be about $29.8 billion, compared to $35.6 billion in 2016. It also expect African airlines to record a similar loss in 2017 as it did in 2016 of $800 million.
Something has to change and only Ethiopian Airlines seems to have made some progress towards creating that change.
Kurt Davis Jr. is an investment banker focusing on the natural resources and energy sectors, with private equity experience in emerging economies. He earned a law degree in tax and commercial law at the University of Virginia’s School of Law and a master’s of business administration in finance, entrepreneurship and operations from the University of Chicago. He can be reached at email@example.com.
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