Open Skies Pact Presents El Al With Nothing but Challenges

With unions set to ground flights to and from Israel, the country's flagship carrier must plan for streamlining while hoping a new investor and banks stay on board.

El Al Israel Airlines won some relief yesterday from the onslaught of competition it expects once the Open Skies agreement takes effect: The Finance Ministry agreed to cover nearly all its security costs.

But the carrier still faces serious problems in adjusting to the Open Skies era.

The treasury said it would deal with problems “that stem from its being an Israel company operating under special circumstances, which will be treated accordingly.” Translated, that means the treasury will cover 97.5% of El Al’s security costs, up from 80% at present.

Covering 100% of the costs would apparently have raised objections from the European Union, with whom Israel signed the Open Skies accord, as this would be considered an illicit subsidy of the country’s flag carrier. El Al said that even with last year’s government subsidy, its security costs ran to $33 million.

As currently drafted, El Al said yesterday, Open Skies will increase competition, bring more airline carriers into the market and expand total seat capacity, all of which will hurt Israel’s flagship carrier. El Al claims that Open Skies will not enable Israeli carriers to compete on an equal playing field with their European counterparts, due to the security outlays Israeli airlines are forced to make.

But despite this warning, El Al shares, which plunged more than 8% on Sunday after the cabinet approved Open Skies, recovered somewhat yesterday to end 2.5% higher at 54 agorot. Over the past five years, El Al stock has lost about 70% of its value − in part due to the recession in the international airline industry, but also due to its own low profitability.

Open Skies will gradually allow airlines to operate scheduled flights to and from EU countries without securing special landing rights or needing permission to increase the frequency of their flights. El Al has said it doesn’t oppose the pact in principle, but contends that it must be amended to address imbalances in the agreement.

While El Al’s claims were backed by its two smaller rivals, Israir and Arkia, others in the travel industry support Open Skies.

“Instead of whining, [Israeli] airlines need to become more efficient,” said Shahar Turgeman, CEO of the Daka 90 travel site. “I don’t whine when there’s competition. Every industry in the State of Israel has competition. I deal with it.”

But in fact, El Al does have serious problems to overcome to meet the Open Skies challenge. Stiffer competition from low-cost carriers like easyJet, which has announced plans to boost its number of flights to Israel, will almost certainly hit El Al’s cash flow, which averaged $114 million annually over the past three years. It will also make it harder for the airline to meet its debt obligations. Worsening finances could lead banks to call in or refuse to roll over loans.

The solution is for El Al to streamline further. At Sunday’s cabinet meeting, Transportation Minister Yisrael Katz complained that since the airline was spun off by the Israeli government in 2003, it has done no restructuring to make itself more competitive.

“El Al has 40 planes and 6,000 employees. Air Berlin has 200 planes and 9,000 employees,” Katz said, referring to the low-cost airline that is Germany’s second-largest carrier. “Based on [El Al’s ratio], Air Berlin should have about 30,000 employees.”

Katz didn’t mention that El Al’s owners inherited the company’s labor structure from the state when they took over the airline. And even if the state guaranteed the company’s pension obligations, the airline would still have to bear the pension costs of sending employees on early retirement.

It’s doubtful that El Al’s current liquidity would let it take such a step. The airline made provisions last year for laying off 218 employees, but the streamlining it has committed to will require many more layoffs − and it has just $75 million in cash on hand.

In addition, the competition from low-cost carriers could cause problems.

If El Al wants to prevent its market share from falling further, it must lay off workers, end unprofitable routes and create a low-cost division of its own by reorganizing its fleet and staff. Now that the government has agreed to pick up nearly all of its security costs, the carrier’s finances should be greatly improved. But even so, the prospects for such steps are poor without an injection of new capital.

That capital could come from the private equity fund FIMI ‏(First Israel Mezzanine Investors‏), which has agreed in principle to invest up to $75 million for a 46% stake in the airline. But that deal is conditioned not only on a new El Al labor agreement that is to FIMI’s liking, but also on an improvement in the carrier’s finances. El Al faces principal and interest payments of $342 million between 2013 and 2015. Thus the cabinet’s approval of Open Skies is liable to give FIMI cold feet.

Ilya Melinkov