05 June 2007

Notes on a Russian overture

Aeroflot’s interest in buying Serbia’s JAT Airways is ultimately about European business, not murky geopolitics.

By Eric Jansson
Published by BIRN's Balkan Insight, 5 June 2007

With Kosovo’s political future up for grabs, a common temptation is to view every Russian overture toward Serbia through the lens of geopolitical intrigue. This temptation persists in business as in politics, since successive Serbian governments since 2000 have retained state ownership of large public enterprises, thereby preserving direct state influence over a giant portion of Serbia’s economy.

What does one make, then, of the overtures presently being made by Aeroflot, the Russian state-owned airline, toward its Serbian counterpart, Jugoslovenski Aerotransport, better known as JAT?

Returning from meetings on Russia’s Black Sea coast, Velimir Ilic, Serbia’s infrastructure minister, last week delivered the news: not only does Aeroflot hope to purchase JAT, it promises to invest lavishly, pay off the Serbian carrier’s sizeable debts and – here’s the political miracle – maintain JAT’s existing workforce of 1,700 employees.

The deal is not done, only proposed, but from the perspective of government ministers in Belgrade it must look sweet. Privatisation of public enterprises is on their agenda, but, with labour unions unwilling to give significant ground, the way forward looks difficult.

A job-saving deal over JAT could prevent some unneeded headaches while helping to preserve some of the political capital Serbia’s new government will need if it intends to move forward with the more urgent restructuring and privatization of bigger public enterprises like Elektroprivreda Srbije, the power utility, and Naftna Industrija Srbije, the oil company.

So, undoubtedly from the Serbian side, politics is in play – though much less Kosovo than the state budget.

However, to view the proposed deal as seen by Aeroflot and its owner, the Russian state, one must look beyond Serbia and the Balkans to the evolving dynamics of European economy, paying particular attention to the fast-changing airline industry.

Here one finds a dizzying variety of factors in play. These include the underperformance of big, traditional airlines based in slow-growing western European economies; the European Union’s “open skies” containment of its own most dynamic competitors; the novel reality of competition between Russian airlines operating internationally; the increasing scarcity of “virgin” markets in which emerging international competitors can establish new hubs; and a regional market left exposed by the failure of Balkan airlines to establish dominant market share in southeast Europe.

First, a look at big, underperforming western airlines – specifically Alitalia, in which the Italian state holds a 49.9 per cent stake. Alitalia is ailing, and Rome wants out. The Italian government aims to privatize 39.9 per cent of the carrier, if not its entire stake. Aeroflot, by contrast, is currently buoyed financially by booming demand for air travel in a swiftly-growing Russian economy, and in Alitalia it sees for the first time an opportunity to expand westward through acquisition.

For Aeroflot, an Alitalia deal would utterly dwarf any deal with JAT. Aeroflot’s fleet of 92 aircraft is smaller than Alitalia’s fleet, yet almost seven times bigger than JAT’s. Both Aeroflot and Alitalia are members of the powerful air carriers’ SkyTeam alliance, in which their combined capacity would be formidable.

With the Balkan market placed geographically between Moscow and Rome, Aeroflot as an owner of both Alitalia and JAT would be well positioned as a powerful force in Balkan air travel, internally and externally.

Under such circumstances, Aeroflot would be an indirect beneficiary of the conservatism and protectionism that, while fading, still characterises the western air industry.

Twelve months ago, the European Union signed a deal with countries of the western Balkans, setting in place preliminary agreements to establish a European Common Aviation Area, including non-EU member states, by 2010. However, the EU stopped short of extending its “open skies” regime to the western Balkans, even as it extends it to markets as far afield as the United States and, potentially, Japan.

The consequence is less competition in the Balkan skies, including non-entry for the EU’s most dynamic competitors, the discount airlines, some of whom have lobbied Brussels unsuccessfully for equal-terms access to the Balkan region.

In such a market, Aeroflot, a conservative company itself, sees a chance to compete – and compete it must, for other Russian airlines are pushing it to do so.

Last month AirBridge, a consortium led by Boris Abramovich, chief executive of KrasAir, a major Russian carrier, completed its purchase of Hungary’s indebted national carrier Malev. The purchase will give KrasAir a vital springboard for competition in central Europe, which Aeroflot thus far lacks.

Yet, with a western “outpost” in Budapest, KrasAir will find itself pressed hard by big EU airlines, for Hungary is “open skies” territory. By contrast, opting to compete from Belgrade, Aeroflot could hope to benefit comparatively from weak competition in the immediate surrounding region. Most major European carriers run just one route in and out of Belgrade, and none compete for the small but fast-growing Balkan market.

With Belgrade as a regional hub, an Aeroflot-owned JAT could be expected to exert greater commercial leverage than any other carrier in the region, while exploiting international outlets as well.

What’s in it for Aeroflot is money and market share, pure and simple. If such a deal goes through, Belgrade’s romantics may well speak of Orthodox brotherhood, but once again they will have lost the plot.

1 comment:

Dan said...

Hi Eric,

You write very interesting, accessible analyses on the yugo/ex-yugo economy. I've added you to the regular feeds on my news aggregator (bloglines). Thanks for the great intel and insights.

Dan in Denver U.S.A.