The news came last week: the State announced its rescue plan for Air France, one of the first airlines to see the light of the COVID-19 storm.

Indeed, even if it will only take place in a few weeks, the nationalisation of Alitalia has already been decided for a month, South African will certainly file for bankruptcy, Air Mauritius is in receivership, the American airlines have already received a check for 50 billion dollars (25 of which are refundable), Norwegian has bankrupted four of its subsidiaries and Flybe went bankrupt in the early days of the crisis.

In this article:

• What was the situation at Air France before the crisis?
• No, the State is not providing new money to Air France…or not so much
• Why help Air France-KLM?
• What commitments for Air France-KLM?
• What route to profitability for Air France?
• The environment: nothing insurmountable for Air France
• But Air France-KLM will not repay its loans
• Nationalisation will not save Air France-KLM
• The loans will end up as a capital increase
• Towards a shareholder war?
• Air France-KLM on the brink of explosion?
• Air France-KLM can “easily” save 1 billion per year
• So what?

What was the situation at Air France before the crisis?

At the beginning of the crisis, Air France-KLM was on a positive trend with a return to profitability and above all a rationalised offer and a clear strategy since the arrival of Ben Smith. The airline could finally look ahead with the ambition of matching the profitability of its European competitors IAG (British Airways, Iberia) and Lufthansa Group (Lufthansa, Swiss, Brussels Airlines, Austrian) within 5 years.

The COVID-19 crisis affected Air France-KLM like all its competitors. To be concrete the group had a cash position of around 6 billion euros. At the level of Air France alone, we are talking about a loss of 25 million per day (which is comparable with the 1 million per hour mentioned by Lufthansa, which has a larger fleet and therefore should have higher fixed costs and announces a cash flow of 4.3 billion) and 69 days cash flow available. A simple calculation would give us a cash flow of around 1.7 billion for Air France, which is in line with the figures given by La Tribune.

But in any case, we might as well start by challenging an idea that has been spread too much on social networks: Air France was profitable and well managed, something we wouldn’t have said a few years ago. And as much as we at TravelGuys can understand state intervention when exceptional circumstances affect the entire market and lead to a reaction from all states, we would not find it acceptable if it were to be used to mop up mismanagement, as was the case at Alitalia.

No, the State is not providing new money to Air France…or not so much

Let’s turn to the aid plan announced by the Minister of Finance. It consists of two parts:

• 4 billion loan guaranteed by the French State (“PGE”) granted by a syndicate of six banks to Air France-KLM and Air France. This loan benefits from a 90% guarantee from the French State and has a maturity of 12 months, with two consecutive one-year extension options exercisable by Air France-KLM.
• 3 billion shareholder loan from the French State to Air France-KLM with a maturity of four years, with two consecutive one-year extension options exercisable by Air France-KLM.

Note that the plan still has to be approved by the European Commission, which should not be a problem given the context, far from the somewhat “borderline” arrangements made by the Italian State to save Alitalia at the time.

So contrary to what we have read here and there, no, the State is not “giving” 7 billion to save Air France-KLM.

Initially, the state guarantees a loan to be made by banks to the extent of 4 billion. It is therefore the banks’ money that will go to the airline (as it goes to many businesses under the same mechanism at present), not the State’s. The State will only have to pay if Air France-KLM does not reimburse, which will be discussed later in this article.

In a second phase, and this is true, the State will contribute 3 billion euros to the Franco-Dutch group. But again, it’s not a one-way ticket, it’s not a bailout in the strict sense. Why ? Because it is forbidden (see Alitalia). It is as a shareholder that the State lends to Air France-KLM (as will certainly the Dutch State in a few days). This loan must therefore be repaid or else the European Union will impose sanctions. It is of course possible that it could be converted into capital (as was done for Alitalia) and this is also a hypothesis that we will discuss later in this article.

So contrary to what you may read, no, the State is not writing a blank cheque for 7 billion. The cheque is only for 3 billion and it is not a blank cheque because it will have to be repaid and it is accompanied by engagements that will also be discussed later.

Why help Air France-KLM?

That’s a legitimate question and we’ll tell you frankly: we would have found it scandalous if, three years ago, the State had come to the aid of a business that was sick after 10 years of erratic, if not calamitous, management and the inconsistency of some of its employees. Apart from the case of Air France-KLM, it is quite simply the question of aid to large businesses that is now in question, while many people believe, often wrongly, that they can cope on their own, unlike the smaller ones, which are considered more fragile.

Structurally, the larger ones of course have huge treasuries compared to the smaller ones and a capacity to resist that seems far superior. Well, this is not the case: cash flow is commensurate with their size and fixed costs and does not allow them to expect to last much longer than a smaller business. I would add that an SME is much more agile and adaptable than a big liner that takes time to turn around and adapt.

Then there is the context of a global crisis and the need to think ‘globally’ on an economic scale. From what I read, Air France represents 350,000 direct and indirect jobs. Air France-KLM is the biggest customer of Roissy airport, which employs 90,000 people and generates some 110,000 indirect jobs. The domino effect is quite simple to understand. A large business that disappears (here we take the case of Air France-KLM, but this applies to all of them) means employees who lose their jobs, and therefore employees who go out to consume less, and therefore in the end small traders who will also be affected, and therefore their employees whose jobs will be in danger. This is all the more true when a business has a major local impact, such as Roissy: a lasting drop in activity at Roissy means that the whole region suffers. It is also the subcontractors who suffer and are in turn in danger with, once again, a knock-on impact on local business. If the airlines disappear, it is Airbus’ order book that melts and we are talking about hundreds of small and medium-sized subcontractors that will disappear, with a considerable impact on the local fabric in the Toulouse region, among others. Without wishing to be maudlin, Air France disappearing is the baker in the South West suffering.

Generally speaking, in the event of a global crisis, the best way to help SMEs and small businesses is to help their principals and the businesses where their customers work. One of the challenges for a business like Airbus, for example, today is not so much to produce for the sake of producing, but to get its suppliers to work, many of which are SMEs, to prevent them from disappearing.

Add to this the fact that aeronautics brings in 20 billion a year to the French economy, tourism 10 billion and that in a country that welcomes more than 90 million tourists a year, the collapse of the sector will spell the end for many small businesses, craftsmen and therefore their employees.

What commitments for Air France-KLM?

As mentioned above, this state aid is not a blank check. Engagements have been requested from Air France by the Minister of Economy and Finance.

The loans to Air France are not a blank cheque, we have set conditions: the group must once again be competitive and above all become the most environmentally friendly airline on the planet. #Le20H @TF1 pic.twitter.com/DuLE41lpqU

— Bruno Le Maire (@BrunoLeMaire) April 24, 2020

Bruno Le Maire therefore obliged the airline to engage on several points:

• Becoming more profitable
• To become the most environmentally friendly airline.

From our point of view, these requirements are mainly intended to reassure the general public who, apart from a few preconceived ideas, know nothing about the sector. Because frankly it sounds like Noddy talking to Care Bears.

These demands will not require a superhuman commitment from the airline, as these issues were part of Ben Smith’s roadmap regardless of whether the crisis happened or not.

What route to profitability for Air France?

This summer Ben Smith said:

“Air France’s margin in 2018 was only 2 percent, compared to 9 percent for KLM, 10 percent for Lufthansa, 12 percent for British Airways and 18 percent for Ryanair. A 2% margin at Air France is not satisfactory. Five points can be explained by the costs in France. But two points are due to the complexity and inefficiency of the airline. It’s up to us to tackle it. “

I don’t need to explain to you that profitability is the key to success Without it, there is no way to invest in a more modern and energy-efficient fleet, no way to rejuvenate or renew cabins to keep pace with the competition, no way to invest in the environmental transition, no way to invest in customer service etc. There was never a shortage of good ideas at Air France (until recently there was no shortage of bad ones either), the desire was there (well, when no one was holding back) but what was really missing was the money to do it.

We already detailed the plan proposed to investors this autumn. More modern and economical aircraft, a streamlined fleet, focus on the most profitable segments, simplify the organizartion… Everything is there. At least in a “non-crisis” context. Is the crisis putting the brakes on? Not as much as one might think.

The airline, in order to cope with the drop in demand, will remove from its fleet its least energy efficient and least profitable aircraft (A340, A380, A318/A319). With strong demand, it was necessary to fly them while waiting to receive new ones, even if they were less profitable and more polluting. This settles the issue and Air France and KLM will be able to make do with their most profitable aircraft to operate and those that have the least impact on the environment. The big A220 order comes at the right time for this (first deliveries in September 2021 unless, like Air Baltic, Air France asks to advance the delivery…). At the time there was some concern that these A220s might also replace A320/A321s in addition to A318/A319s. In a normal context one could ask whether it was a relevant decision to reduce capacity by changing aircraft, in the present context it is excellent news and there is little doubt about the answer to our question.

More interesting is the subject of simplification. Air France is a complicated machine that weighs down under the weight of a strong history and corporatist logics that are not without reminding us of castes at times. At one time, a person ‘close to the matter’, as the saying goes, told me ‘this is a business where too many people have the power to say no’. The problem with Air France is its agility, its ‘time to market’. We can dare to hope that the current context will make it possible to break down certain walls, certain rigidities in order to make the airline more flexible and agile. The context suggests that where there has been talk of concessions before (and Ben Smith and his team have demonstrated their ability to negotiate good deals) there will be a chance to wipe the slate clean.

Let there be no mistake: we will not save the Air France soldier by simply putting him on a drip. We are talking about amputations and transplants! In less graphic terms, this is the perfect opportunity to dynamise the organisation in order to rebuild it, ideally with a “start-up” spirit, which is essential when it comes to conquering the market again, innovating, testing things and learning quickly in order to change course or, on the contrary, to push things forward.

On the positive side, this is the ideal context for reinventing the airline and bringing it into the 21st century, as it will not get far in the future with its heavy legacy as a former state-owned business.

But more than for other airlines, if it is well managed, this crisis is a unique opportunity for Air France to reinvent itself and make up for lost time in other areas, as it will be able to erase 30 years of hesitation and procrastination in two years. The advantage of being behind in a race is that you have everything to gain when the safety car enters the track.

The environment: nothing insurmountable for Air France

After business, let’s talk about environment. The advantage in aviation is that the two go together. More efficient aircrafts means a smaller footprint. That’s the beauty of this industry, where even those who don’t care about environmental concerns naturally address them by investing in more efficient aircraft.

We don’t know what to think when Bruno Le Maire asks Air France to “be less polluting and emit less noise” because the wording is bordering on the laughable, but in fact he is merely reminding us of what was at the heart of the strategy of all the airlines before the crisis, if only because it is both a condition for and a consequence of better profitability. Air France’s environmental strategy existed before the crisis and will even be facilitated by its consequences.

This is for real efforts. For the deception it will be all the more simple that with a reduction of the fleet essential in a context of decreasing demand or even inaccessibility of certain destinations the reduction of the footprint of the airline will be mechanical, new planes or not.

I read here and there that the state would subsidise polluters. In this respect, it is time to point out that if we really wanted to do something for the environment it would be better to let everything fly that can fly and restrict clothing purchases, which are often impulse purchases for things that will only be worn for a short time before they are discarded. While aviation accounts for 3% of emissions, textiles account for 10% (and digital for 4 with a forecast of 8 in 2025). This should be borne in mind when rescuing businesses in these sectors and asking them for commitments, so as not to always point to the easy scapegoat.

But Air France-KLM will not repay its loans

But everything could not be so rosy: we can already announce that Air France will not repay its loans. Why ? Even if we postpone all the deadlines as long as possible, that means 4 billion to be repaid in 3 years and 3 in 6 years.

Let’s start with the 4 billion loan (maximum maturity 3 years). It was granted to Air France-KLM (the parent company) and to Air France without it being known in what proportion for each.

In 2019 the group’s operating result was EUR 1.1 billion. It breaks down as follows: 280 million euros for Air France and 853 for KLM.

These figures were obtained in a growing market, with high demand and operating at full capacity and they make a repayment of 4 billion impossible even in 3 years. So in a context where we are not even sure of operating at 60% of capacity by the end of the year and where a return to the pre-crisis situation is not expected before 2022, the miracle will be impossible.

The same logical bottom line applies to the 3 billion loan granted only to the parent company, since the State is a shareholder in it, not in Air France. It would have been repayable with the ‘before’ results and provided that there was no 4 billion loan to repay on the side. With capacity down, demand expected to be sluggish and another loan “on the side” you can forget about it.

In addition to this, there will be the future 3 billion loan to Air France-KLM from the Dutch government.

To make things clearer: At the end of the 2019 financial year, Air France-KLM’s net debt was €6.1 billion. They have just added 7 plus 3 to come. A debt that goes from 6 to 16 billion in one year with a turnover that can only plunge

So either the State is making a mess of things, or Air France-KLM has cheated it? In fact, not at all.

Nationalisation will not save Air France-KLM

Air France-KLM needs new money to get through the crisis and invest in its competitiveness. This is no surprise to anyone and has been known all along and will be the case for almost all airlines. On the other hand, depending on their state of health, some may be satisfied with a loan, while others may need to be recapitalised. And if Air France-KLM was better since Dr Smith was at its bedside, it was still a convalescent airline when the crisis arrived.

The advantage of recapitalisation is that it is money that is brought into the capital of the business that does not have to be repaid; instead of being repaid as is the case with a loan, the shareholder recovers part of the capital in the hope that the value of the shares will eventually rise.

This is one of the reasons why there was talk of nationalisation at one time, but in reality, nationalisation may not change anything at all.

To nationalise Air France, all the state has to do is buy out the other shareholders. In fact, in the case of a nationalisation, unlike a takeover bid, the State passes a law and the nationalisation is automatic. Instead of having to buy the shares of the other shareholders, he has to compensate them…at a price that he sets himself and that is rarely advantageous for the latter.

But nationalisation in the strict sense would not change anything for Air France-KLM. The capital changes hands but does not increase, there is no new money. What makes sense for Air France-KLM is an increase in its capital which may, in the end, lead to a nationalisation but not necessarily.

The group can decide to increase its capital, issue new shares which the state will buy and that’s it. But that’s without the other shareholders! Delta and China Eastern each hold 8.8% of the capital and the Dutch government 14%. If the capital increases, two cases are possible:

• The shareholders follow and contribute to the increase. In this case the planned increase takes place, but it costs the state less because the other shareholders also contribute.
• The others are unwilling or unable to follow, and the state contributes alone. Depending on the amount, this can lead to a mechanical majority without it being a nationalisation in the strict sense.

It was the ideal solution for Air France-KLM but it takes time and the clock was ticking. So they resorted to loans.

Les prêts se termineront par une augmentation de capital

Loans can indeed be an intermediate step to give time to prepare a capital increase and to take a step back and see how the context evolves. Because a loan can be transformed into a capital increase.

A perfect example is the Alitalia melodrama that has been going on for three years. As the airline could not repay the loans granted by the State and these could not be ‘waived’ on pain of constituting illegal aid, they were converted into capital. The State has therefore seen its stake in Alitalia’s capital increase by the amount of the outstanding loans, and this is legal because there is a quid pro quo for the money provided to the airline. What is illegal is the lack of a quid pro quo.

It can therefore be expected that the loans granted to the Franco-Dutch group will only be partially repaid and that the rest will be part of a capital increase. But the manoeuvre, if it is as logical as it is skilful, will not go without posing some political problems and this is also, in our opinion, the reason why the State is taking all its time to move forward on the subject.

Towards a shareholder war?

If all the other shareholders can keep up, all will be well in the best of worlds. If they can’t (it’s not clear what Delta’s and China Eastern’s cash position will be when the deal goes through) then the discussions are likely to be heated.

Delta has a history of influencing businesses in which it has a stake. This is why it did not come to the rescue of Alitalia. It is not certain that it will be happy to see its voting rights reduced.

The same goes for China Eastern. Unless the Chinese government sees this as a good opportunity to help the airline increase its stake in Air France-KLM, much to Delta’s displeasure.

But the worst is yet to come! The Dutch state, which holds 14% of the capital (compared to 14.3% for the French state), will not tolerate being diluted. We remember how it broke into the group’s capital like a cowboy because he complained about decisions that systematically favoured Air France. And what about nationalisation? Would KLM become a French national airline? Don’t even think about it!

Air France-KLM on the brink of explosion?

When talking about the operation that led to the creation of the Air France-KLM group, some people spoke of a marriage, but from our point of view it was above all an arranged marriage that was experienced as a rape by the Dutch. It is understandable, it is a matter of national pride. Imagine Air France taken over by Lufthansa and we’ll talk about it again…

The truth is that integration between the two airlines never took place. Synergies reduced to their simplest form. The French reproach the Dutch for going it alone, the Dutch reproach the French for their lax management and chronic deficits. This has been going on for 15 years, with the most recent episodes being the “savage” arrival of the Dutch state in the group’s capital and thepsychodrama surrounding the reappointment of KLM chairman Pieter Elbers. It is important to understand that the State withdrew from the capital of KLM in 1988 and to have to go back in the backdrop of a governance crisis shows the state of exasperation that has been reached. When the group was founded in 2004, it was the world leader in turnover. Since then it has been a slow descent and everyone likes to see the other as mainly responsible.

Many people like to say that if Air France had not saved it in 2004 KLM would no longer be there, or no longer in its current form, and this is true. But would a marriage with Lufthansa or another have been worse?

It can be blamed on an unbridgeable cultural gap, as this article admirably explains.

But the accusation that the French are lax is true. For years it has been KLM that has been driving up the profitability of the group even though it is smaller. As we have seen, in 2019 it generated an operating result of 853 million euros compared to 280 million euros for Air France. Legitimate reasons to grit one’s teeth when one is the good student and has to pay the bills of the dunce.

Air France-KLM can “easily” save 1 billion per year

As soon as the rescue package became known, things started moving in the Netherlands. The French are already being accused of wanting to use this windfall to avoid, once again, reforming themselves, to let costs slip away and some see it as a good opportunity to call for the dissolution of the holding company (i.e. the Air France-KLM Group) and settle for a simple collaboration agreement between the two airlines. Honestly, we think that this is a bit of a trial of intent and that some people are blowing on the embers of the fire in the hope that they will be able to get the best out of it, and it is hard to see how this could happen in the near future. It is hard to see KLM surviving alone today. On the other hand, we really believe in Ben Smith’s will to do what it takes for Air France to reach a level of profitability in line with its ambition. But it will take time to achieve a peaceful relationship within the group, if that ever happens.

On the other hand, what is true, and notwithstanding the sceptics, is that there is a way for Air France-KLM to save between 750 million and 1 billion per year! Considerable when we are talking about reimbursing 7 billion in 6 years! What is it? Simply by moving airline to the Netherlands, where the tax and social security systems are more advantageous. Perhaps much smaller loans would have been needed if this were the case.

So what?

In bottom line, this is not a simple loan granted by the State, it is the first brick of a capital restructuring of the airline. For what result? We honestly believe that Air France can take advantage of this crisis to finally reinvent itself and emerge from it having closed the gap with certain competitors (and we will soon explain why and how). But in the worst case, Air France-KLM could become a medium-sized group with almost exclusively regional ambitions, or even explode in flight.

Photo : B777-200 Air France in Sao Paulo (GRU) by Matheus Obst via Shutterstock

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