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Lufthansa Buys Out Swiss

The supervisory board of Deutsche Lufthansa AG and the board of directors of Swiss International Air Lines AG late last month approved the business model jointly developed by both companies for the takeover and integration of Swiss into the Lufthansa Group.

The Swiss Confederation, the Canton Zurich, and other large shareholders support the transaction. So far, a corresponding approval has been obtained from more than 80% of the Swiss share capital. Lufthansa’s Chairman and CEO Wolfgang Mayrhuber and Swiss President and CEO Christoph Franz signed the Integration Agreement, which is said to be worth 310 million euros.

Swiss, created about three years ago after the demise of Swissair, and until now 20%-owned by the Swiss government, found it was forced to look for a buyer as it has been unable to operate at a profit since its founding. Economic data, however, shows that the airline made money during the past three months, about 16 million Swiss francs.

LufthansaAnalysts say Lufthansa will turn up the heat on European rivals when it takes over Swiss International Air Lines but returning the smaller carrier to profit is key. They said Lufthansa and top rivals Air France-KLM and British Airways increasingly look set to carve up much of Europe’s market, relegating smaller carriers to extinction or niche roles.

“It’s going in the direction that we have three powerhouses in Europe. Everybody else will either have to have a profitable niche or join one of these three,” said Bankhaus Metzler, an analyst for Juergen Pieper.

Air France set the stage last year with a landmark takeover of Dutch carrier KLM to create the world’s biggest airline group by revenues.

That deal used a holding company structure, allowing KLM to stay in Dutch hands and preserve its landing rights. Lufthansa and Swiss are looking at a similar approach, which would allow Swiss to keep its brand and operations at Zurich, a source familiar with the negotiations said.

Swiss travelers naturally would like direct flights from Zurich but Lufthansa could offer the next best option on many routes — fairly direct transfers via nearby Munich or Frankfurt.

“The whole Swiss nation are very keen on keeping their brand of course and keeping a hub function for Zurich,” said analyst Jan Herbst at Sal. Oppenheim. He said Lufthansa would have to trim overlapping services to make the merger a success.

Exane’s Van den Brul said Swiss would boost Lufthansa’s business by about 20 percent and create a mix of routes that would make life harder for struggling Alitalia, among others.

Swiss International Air LinesHe said with Swiss, Lufthansa would be able to offer flexible routes, so that an Italy-based traveler, for example, might fly to Munich and then back via Zurich.

The financial strength of Europe’s big three reflects cost-cutting done to counter a slowing market and tougher competition from budget carriers since 2001.

Those pressures toppled Belgium’s Sabena and Swiss forerunner Swissair and have pushed Alitalia close to the edge, ruining its chances of joining Air France-KLM. Lufthansa failed to seal an earlier deal with Swiss over a tie-up and some analysts see cause for caution this time as Swiss is still losing money. Swiss has openly said more needs to be done, warning another 800 to 1000 job cuts are needed to achieve operating profit.

Pilots have threatened to strike over the cuts, which are aimed at cutting operating costs by another CHF300 million ($260.2 million).

Analysts see risk for Lufthansa if Swiss reforms falter, but they note progress has been made.

The company has taken many restructuring steps. Swiss is a different story from two or three years ago,” said Bankhaus Metzler’s analyst Juergen Pieper.

“I think the risk (for Lufthansa) today is acceptable… The company (Swiss) is pretty close to profitable,” he said. Swiss has cut jobs and routes and cancelled plane orders to lower its costs, trimming its net loss to CHF140 million last year from more than four times that in 2003. Chief Executive Christoph Franz came from Lufthansa in April 2004.

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