The way ahead

Abu Dhabi’s pullout from Gulf Air leaves the airline with a number of headaches, but also with an equally large number of possibilities.

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By  Neil Denslow Published  October 3, 2005

|~|hogan_m.jpg|~|James Hogan, Gulf Air's president & chief executive|~|Gulf Air is re-drawing its business plan once again after the emirate of Abu Dhabi announced that it was pulling out of the carrier over the next six months to focus its efforts on Etihad. The move will leave Gulf Air with just two owners, Bahrain and Oman, and it will force the carrier to shift from operating three hubs to just two. However, while Abu Dhabi’s pullout will certainly cause some instability at the airline, it may prove to be beneficial in the longer term. This was certainly the case when Qatar pulled out in 2002, as it allowed the airline to simplify its operations, while working with a smaller number of owners. Abu Dhabi’s decision to pull out of Gulf Air had been widely expected since it launched Etihad Airways two years ago. The emirate then stated its commitment to Gulf Air, but it was always unlikely that it would continue to support two competing airlines in the long term. However, although Abu Dhabi’s move was expected, the timing was not, especially as the emirate has just finished expanding its airport, including a purpose-built terminal for Gulf Air’s all-economy subsidiary, Gulf Traveller. The expansion also created a huge boost in capacity at the airport, and even though Etihad will begin receiving the planes it has on order in the near future, the airport is likely to see a dip in traffic numbers, as Gulf Air scales back its operations. What impact Abu Dhabi’s pullout will have on Gulf Air’s operations is also unclear, as the airline has declined all requests for interviews. Instead, it has issued a couple of press statements laying out plans for a task force to review operations over a 90 day period, which runs up to the end of the year, and also reaffirming confidence in the long term future of the airline. “For the wider Gulf Air family — our customers, our staff and our suppliers — the key issue is how we are run; and that will be business as usual,” said James Hogan, the airline’s chief executive, in one statement. “We will continue to build upon our successes, enhancing our brand and our services to reinforce our position as the leading airline in the region.” The best news for the airline recently has been Hogan’s decision to renew his contract. There had been much speculation that the Australian CEO would leave the carrier when his contract expired in the summer, and his name had been linked with the top jobs at British Airways and Aer Lingus among others. However, having now committed to Gulf Air, Hogan should provide a steady hand through the trying times that lay ahead for the airline. The effect of Hogan’s leadership and Project Falcon, his three year turnaround project, on Gulf Air can be clearly seen in the airline’s annual reports. After a number of loss-making years, the carrier reported a net profit of US $4 million for 2004. This figure did mask an operating loss, however, as the airline raked in $100 million in exceptional items. This mainly comprised the sale of its distribution company to Sabre and the sale of its spare parts inventory to Lufthansa Technik, as part of a wider maintenance outsourcing deal. The airline’s debt position is vastly improved though. In April, it reported that it had cut its debt levels by around 8%. The debt to equity ratio also stood at 2.4, below the limit of 3 that was set under the restructuring plan in 2002. However, the carrier’s debts still total more than $110 million. The impact of Abu Dhabi’s withdrawal on the airline’s finances will therefore be one of the main concerns. The carrier is on a much sounder financial footing than when Hogan arrived in 2002, but the loss of support from Abu Dhabi may well affect its credit rating, which would push up its borrowing costs. The airline has also received a number of cash injections over the years from Abu Dhabi and its other owners, most recently including a $238 million injection in 2002. This source of funds is unlikely to be available again, but there are no signs that the airline will have to repay the funds it has previously received.||**|||~||~||~|Abu Dhabi’s pullout also creates a number of operational challenges for Gulf Air, as flights out of Abu Dhabi accounted for a significant portion of its total passenger numbers. In 2004, for instance, the airline flew 472 international flights a week out of Abu Dhabi, carrying a total of 3.25 million passengers in and out of the airport. The UAE capital therefore accounted for around 40% of GF’s total passenger numbers. Bahrain contributed slightly more, while Muscat made up the rest at just under 20%. However, although Gulf Air will have to close its hub in Abu Dhabi, the airline will not necessarily lose all of its traffic, as many of its passengers would have transferred in Bahrain anyway. This will still be an option for travellers, but GF will no longer be able to fly direct out of Abu Dhabi. This may well persuade business travellers in particular, to switch allegiances, especially with Etihad no doubt stepping in to take over many of GF’s direct routes. The close of the Abu Dhabi hub will also create a major problem in regards to the future of Gulf Traveller. The all-economy subsidiary has grown into a significant and profitable part of Gulf Air’s overall business, serving a number of destinations, predominately in India and Africa. However, if the airline is forced out of Abu Dhabi, it will have to move its operations to either Oman or Bahrain. Both options are problematic though, because of the limited access India gives to foreign airlines. India is beginning to open its skies, but, at present, for Bahrain or Oman to accept Gulf Traveller, it would have to take slots from either Gulf Air or Oman Air and give them to the all-economy airline instead. Neither option is likely to prove popular, so Gulf Traveller may well have to be scaled back. Indeed, the overall fleet size of Gulf Air, or at least its future plans, may also have to be cut back as Oman and Bahrain are less popular travel destinations than the UAE. The future ownership of the carrier has also been called into question by Abu Dhabi’s withdrawal, despite statements of support from the two remaining owners. This is particularly true of Oman, which, like Abu Dhabi and Qatar, has its own carrier. However, Oman Air is a very different creature to Qatar Airways and Etihad Airways, as it has much more limited ambitions than its big-spending rivals. The Omani flag carrier has been talking about ordering Dreamliners, which does suggest a move away from being purely a regional feeder airline for Gulf Air, but in the main, the Omani government has shown no desire to turn Oman Air into a global player. Indeed, it is likely that Gulf Air will actually increase its operations in Muscat from now, simply because its fleet will have to be divided up between two hubs rather than three. As such, more long haul flights out of Muscat seem inevitable. They should also be more cost effective, as Gulf Air will now be able to concentrate its resources in two places rather than three. How to make the most of this opportunity is a key focus for the task force. “A two-hub strategy gives us the opportunity to review our network and bring in even greater business synergies in route planning,” said Hogan in a statement. “It also gives us the opportunity to review our business operations and our cost base to ensure the long-term future prosperity of the airline.” The reduced number of owners for the airline may also make it more responsive, as running the business will become a less ‘political’ job. At present, the carrier is torn between three different owners and getting a decision from the board can be complex job. “At the moment, Hogan spends most of his time travelling between the three capitals trying to get them to agree on things,” said one insider. “Once the first agrees, he has to get the second in line and then move onto the third, by which time the first has changed his mind.”||**|||~||~||~|With two owners, these problems should be reduced, as there will be one less shareholder to keep happy. However, at the same time, there may also be added friction, as it was previously possible to get a decision with just two out of the three owners agreeing. Now, however, any decision will effectively require unanimity rather than a simple majority. Another possibility in terms of ownership is some form of privatisation or an IPO, which has been discussed in the past. This would boost investment in the carrier and also further mark its transformation from a political toy in the past to a fully-fledged business. However, this seems unlikely in the short term at least, because of the instability caused by Abu Dhabi’s pullout. If the owners are planning an IPO, they will probably wait until the airline has adjusted to life with two hubs before going ahead with it. One deal that may go through, however, is a sale of Gulf Air’s stake in Gamco. At present, the airline owns 40% of the Abu Dhabi-based MRO, with the rest owned by Abu Dhabi. However, relations between Gamco and the airline at a managerial level are known to be frayed, which was one reason why the carrier opted to outsource its rotable component maintenance to Lufthansa Technik rather than to its 40%-owned subsidiary. Also, despite Gulf Air’s ownership stake, the MRO is playing a leading role in managing and developing Etihad. As such, Gulf Air may well now look to sell its stake in Gamco, which would also support its plan to pull out of non-core businesses. The airline could then either use Gamco purely as a maintenance supplier or shift its maintenance to Bahrain in cooperation with Lufthansa Technik, and, perhaps, DHL, which also has a hub in the island kingdom. Following the pullout, Gulf Air may also be able to work more closely with other airlines on an operational basis as well. The carrier has already signed codeshares with a number of other airlines in both the Middle East and elsewhere, and this cooperation is likely to increase. This is firstly because GF will be able to take a less political approach, but also because codeshares will be simpler to arrange, as they will need to cover two hubs rather than three. Other Middle East carriers may also be more willing to work with Gulf Air in the future, as they will see the airline as less of a threat in comparison to the bigger, more well-financed airlines elsewhere in the Gulf. This cooperation may also extend to equity investments in other airlines as well. James Hogan has made no secret of his desire for Gulf Air to play a leading role in regional airline consolidation, and the withdrawal of Abu Dhabi should make this more likely. Firstly, it should be easier to get board approval for any investment plan in another carrier. More importantly though, it would also now make more sense operationally for Gulf Air to take over another carrier, as it would be going from two hubs to three rather than from three to four. And if this new hub was somewhere farther afield, such as in the Levant or India, then it could add real value to the airline as well. Therefore, while Abu Dhabi’s pullout will clearly create some turbulence for Gulf Air in the near future, it is far too early to sound the death knell for the golden falcon just yet.||**||

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