Air France-KLM Stock: In Exclusive Negotiation With The Italian Government

After our recent publication on Deutsche Lufthansa‘s (OTCQX:DLAKF) (OTCQX:DLAKY) implication with the ITA Airways no-go deal, today we are providing an update on Air France-KLM (AFRAF; AFLYY).

As we already mentioned, the Italian Government had chosen Air France-KLM in partnership with Certares Fund and Delta over the Deutsche Lufthansa-MSC consortium.

This is an old story that already happened in 2008, when at the time there was a center-left at the Italian government and the sale was in the process of being finalized. Precisely on March 15th of 2008, Alitalia accepted the French-Dutch group’s proposal – an offer to exchange shares for 100% of the capital for a total consideration of €1 billion (including the debt obligation) and no major restructuring plan (only 2,100 redundancies). At the time, it was election time, and Mr. Silvio Berlusconi launched the slogan “Alitalia to Italians“. This was the electoral campaign’s slogan and the French withdrew. Air France-KLM was very lucky at that time looking at the numbers, Alitalia has always been a bottomless pit, which since 2000 has always lost money and has repeatedly had to rely on State intervention. To sum up, since 2008, the total costs have exceeded €10 billion (mainly public money).

MSC-Lufthansa’s proposition for ITA was lower than the one that was offered by the Certares fund consortium. And more importantly, the Italian Government has still 45% of the equity stake with two out of five directors on the board including the non-executive chairman to weigh in on the strategic choices of the company.

Moving on to the final structure it is still not clear at the moment. What is certain is that Air France-KLM’s room for maneuver is currently limited by the European Commission, pending the repayment of 75% of the state aid received during the COVID-19 health crisis. The group is not very far from this threshold due to its recapitalization and the investment of €500 million from Apollo Global Management. In the meantime, and according to multiple sources, Air France-KLM has reserved 9.9% of the shares of the Italian carrier; on the other hand, Certares will have at least 41.1% and Delta another 4%.

We were more in favour of the Lufthansa-MCS consortium. Why?

The German operator has a “multi-hub” structure, while the French has a model of strong centralization, in some way that reflects their own form of state. ITA could have represented a strong platform for flights to Africa – a hypothesis that is certainly not viable in the event of a union with the French, who are very strong in the segment. This might create internal friction with a capital structure that is not clear. More importantly together with the MSC group, ITA could have been a local champion in the cargo business, aiming to diversify its airways business model that relies mainly on tourism. This optionality is more limited in the Air France-KLM value proposition.

Conclusion and Valuation

In Italy, there are always the same issues. Even in this period, it is election time. If the preliminary sale can be signed by the current government, the closing of the transaction will be entrusted to the next executive. However, a big obstacle on the road to closing is represented by the center-right opposition. According to the polls, this is going to be the next Italian government and the party leader is already not in favor commenting that: “another piece of Italy that is going away, I’m ready to do everything I can to prevent it”. Unions were also more in favour of the Deutsche Lufthansa-MSC offer explaining that this consortium was more in line as an industrial partner. Even if the deal goes on, given the Air France-KLM investment, we assign zero value on the ITA Airways equity stake. There is high uncertainty about the next Italian political decision and we still confirm our neutral rating on the French-Dutch air operator group.