European Aviation Consolidation: Lufthansa’s Risky Acquisition of ITA

Lufthansa’s recent acquisition of a 41% stake in ITA, Italy’s national airline, for €325 million ($350 million) has sparked considerable debate among investors and industry analysts. Once known as Alitalia, ITA has struggled financially since its inception in 1946, turning a profit only three times. Despite various privatisation and renationalisation efforts, including a rebranding in 2020, ITA remains a financial quagmire. The Italian government injected approximately €3.5 billion into the airline during the COVID-19 pandemic, a lifeline of around €300,000 per employee.

The airline industry views the acquisition as one of the most challenging propositions in European aviation. Low-cost competitors like Ryanair and Wizz Air have capitalised on ITA’s instability, intensifying the competitive landscape. Tobias Fromme of Bernstein, a brokerage firm, highlights the inherent difficulties, calling it a "challenging proposition."

So why is Lufthansa pursuing this deal? The German airline sees not just a struggling airline, but a strategic opportunity in ITA's market presence. Italy, one of Lufthansa's largest markets, and ITA's routes to Africa and South America, could be a perfect complement to Lufthansa’s existing routes to North America and East Asia. Furthermore, Lufthansa’s ownership of Air Dolomiti, a smaller Italian airline, provides a familiarity with the Italian market. Additionally, there is a strategic imperative to prevent ITA from falling into the hands of a rival.

European aviation is experiencing what could be its final wave of consolidation. Air France-KLM, EasyJet, IAG, Lufthansa, Ryanair, and Wizz Air control 71% of intra-European flight capacity. Lufthansa's competitors are also active in the merger and acquisition space. IAG, for instance, is eyeing an 80% stake in Air Europa, Spain’s third-largest airline, pending EU approval. Similarly, stakes in SAS and TAP Portugal are on the table, with Air France-KLM and IAG expected to bid for the latter.

This consolidation trend has drawn the attention of the European Commission, the EU's executive body, which is wary of reduced competition, leading to higher fares and less consumer choice. The ITA deal is under scrutiny, with a decision expected by July 4th. Both IAG and Lufthansa have proposed concessions to allay regulatory concerns. Lufthansa, for example, has offered to relinquish around 40 slots at Milan's Linate airport and to delay integrating ITA into its transatlantic joint venture with United Airlines for two years.

However, these concessions could potentially exacerbate the already existing financial strain on Lufthansa. The German carrier is already facing investor skepticism, as reflected in a slump in its share price following rumors of EU approval. Additionally, Lufthansa will have to navigate the complexities of working with Italy’s government, which will remain ITA’s largest investor initially. Although Lufthansa will have the option to buy the rest of the company later, this prospect may not reassure its investors.

In summary, Lufthansa's acquisition of ITA represents not just a high-stakes gamble for the company but a potential game-changer in a rapidly consolidating European aviation market. While the strategic rationale is clear, the financial and operational challenges are formidable. Only time will tell if Lufthansa’s bold move will pay off or if it will indeed become a significant burden for the company.