El Al Airlines, Israel’s flag carrier, has begun preliminary talks about merging with its tinier rival Israir as it struggles to compete with the low-cost airlines that have begun to flood routes in Europe and hurt profits, sources said on Monday.
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But a prospective deal may be undercut by a possible tie-up between Israir, and Arkia, a third Israeli carrier, sources said.
Meantime, however, IDB Development Corporation, Israir’s parent company, has retained Doron Sharabany, a partner in the accounting firm Ernst & Young Israel, to examine Israir’s balance sheet and ensure there is no hidden liability that could scuttle a deal.
An initial proposal discussed by IDB and El Al is based on a valuation of between $30 million and $40 million for Israir, an amount as much as 60% more than its shareholders’ equity. The merger would not involve any cash changing hands, but rather El Al allocating stock to IDB or alternatively Israir issuing stock to El Al.
Israir operates three airbus 320 jets to Western European destinations and two ATR 72s to Eilat, the southern Israeli resort town that El Al no longer flies to. It ended 2014 with a loss of 18.5 million shekels ($4.8 million) on sales of 841 million shekels, hit by the drop in travel after last summer's Gaza war.
Shares of El Al, which have risen 27% so far this year, rose 1.3% to close at 95 agorot Monday in Tel Aviv Stock Exchange trading.
El Al launched its own low-cost division called UP in March a year ago as the Open Skies agreement signed with the European Union caused a clutch of discount airlines, such as EasyJet, to begin plying routes between Israel and Europe. But UP has apparently not met expectations.
It was launched with routes to five European destinations and promises to expand, but no new routes have been added in the past year and it cancelled a tourism-plus class on UP aircraft for lack of demand. UP was one of the reasons El Al saw a 9% decline in revenue per passenger kilometer last year.
Analysts say UP has failed because of its uncompetitive cost structure, as a result of high labor costs for crews, a lack of managerial flexibility and high maintenance costs, all of which make it less attractive than real low-cost airlines. A merger with Israir would give El Al access to staff with lower salaries, especially pilots, and enable UP to operate profitably.
Merging with Israir would also help fill a gap in El Al Sun D’Or operations. Since the unit was denied a civil aviation license four years ago, it has become a packager and marketer, using Israir and Arkia jets for its actual flights in many cases. That cut deeply into Sun D’Or’s sales and profits, which fell to just $46 million last year from $89 million in 2010.
The main obstacle to the merger plans isn’t expected to be the Antitrust Commission but rather the militant workers committee representing El Al pilots, which won’t look kindly on any attempt to lower salaries or other expenses to compete with the low-cost carrier.
A merger would also be conditional on Israir selling Disenhaus, a travel agency and packager, to Ofer Chodorov’s Business Travel Center, or BTC, group for 50 million shekels. Buying Disenhaus as part of a merger would create a conflict of interest.