Another rescue plan for Alitalia, does it stack up?

Some details of the latest Alitalia rescue plan have emerged

Italia Transporto Aereo (ITA), the state owned company which has been set up to relaunch Alitalia, recently shared some details of its new business plan with journalists in Italy.

Italian newspaper Corriere della Sera asked me to take a look at the plan and tell them my views on it. If your Italian is up to it, you can read the article that they just published on this link.

For the more linguistically challenged, here is what I told them.

What is in the plan and how realistic does it look?

As I understand it, the plan has been put together by the consultants BCG (originally I thought it was Oliver Wyman, but apparently their appointment was to review the plan on behalf of the government, so I have updated the article to correct this). Much of the PowerPoint presentation which was shared looks to me to have come straight from BCG. Obviously, it has been rebranded as ITA and translated into Italian. Well, mostly anyway. There were quite a few slides which had only been partially translated, giving clues to the origins of the material.

Since BCG are competent consultants, the grand plans for digitalisation, customer centricity, becoming data-driven and the application of machine learning to revenue management are all good stuff and hard to argue with. But how much of this has substance beyond the bullet points and consultant-speak is impossible to discern. There is nothing in the presentation which provides any clue as to how all this is to be achieved, or why the new Alitalia will be any better at this than the old one was.

Maybe all that has been holding them back is money? Alitalia has certainly been short of that for as long as anyone can remember. Chronically loss-making, it is said to have burnt through €8 billon of state money in the last four years. The latest plan, which requires approval from the EU under state aid rules, will see another €3 billion of Italian tax-payers’ money being lavished on yet another attempt to turn around the carrier.

So what is in the plan and how realistic does it look?

Fleet and network plans

There are no plans to try and change the business model of the company. The presentation is very clear that they see themselves as remaining a full service carrier. So the first big question about their plan is the scale of operation.

I’ve made some estimates of capacity levels based on the fleet figures they shared, plus what I’ve heard about which aircraft types they are planning to use. There is more detail on my assumptions in the next section.

Overall, I think the planned 2025 capacity level is about equal to the 2019 level, although a little more biased towards long-haul (long-haul 20% bigger, short-haul 10% smaller or thereabouts).

In 2021, they plan to operate about 40% of 2019 capacity, growing to 75% of 2019 levels in 2022. After that, they have a year of very strong growth in 2023 (20%), before settling back into more modest growth rates.

If Alitalia had been a healthy, profitable airline in 2019, that might not be an unreasonable plan, based on what might be expected in terms of a market recovery profile. Perhaps the 2023 growth rate looks overly aggressive. However, the main issue is that Alitalia was very far from being profitable or healthy in 2019.

Relative to the market conditions then, this is not a radical “right-sizing” plan, shrinking back to a profitable core. The network plan in terms of destinations looks very similar to what they have operated in the recent past.

As a result, the main initiatives to fix the losses have to come from writing-off debts, benefits from replacing the fleet, better commercial performance or non-fleet related unit cost reductions. The debt write-off is dealt with by the creation of the new company, which will leave the debts behind, to be paid off by the state. Let us take a look at the other areas, starting with fleet.

Fleet changes

It is obvious that a lot of their new plan is based around the benefits of new aircraft and this is obviously is a good time to get good deals from aircraft manufacturers. With an average age of 14 years, their existing fleet is a bit old (around 10 years would be more normal), so there is some logic here.

For the mainline business, they seem to have decided to concentrate on one short-haul narrow-body type, the A320. Currently, they have a mix of A319s, A320s and A321s. The 8 A321s are all over 20 years old, so it makes sense that they will go. 12 of the 22 A319s are 17 or more years old, so they will undoubtedly go too, leaving 10 younger A319 aircraft (8-10 years) which might be kept, or dropped for simplification reasons. Alitalia currently has 38 A320s, of which 28 are under 15 years old. The fleet plan in the presentation shows 43 narrow-bodies in 2021. That presumably includes whatever aircraft are planned for the Cityline business, which currently has 15 88-seat Embraer ERJ175 jets and five 100-seat ERJ190s. I’ve assumed they will go for maximum simplification and drop both the A319s and the ERJ190s leaving them with just two narrow-body types, the A320 and the ERJ175.

On the wide-body side, they show a fleet in 2021 of 9 aircraft. Dropping the 11 777-200ERs (all 17 years or older) and the singleton 777-300ER makes sense, as does losing two A330-200s which are over 20 years old. If they are keeping just the 9 youngest A330-200s (mostly 9 and 10 years old), that means that one leased 11 year-old aircraft and two Alitalia-owned 14 year-old A330-200s will exit the fleet too.

Based on these assumptions, the fleet in 2021 will be as follows, with 52 aircraft and three types, down from 114 aircraft and eight types in 2019:

Type	Number	Seats	Avg age
ERJ175	15	88	9
A320CEO	28	165	12
A330-200	9	257	9
Total	52	159	10

By 2025, the plan assumes growing back to 110 aircraft, of which 83 are said to be “new gen”, which means that they are new as they don’t have any new gen aircraft today. That means I think replacing almost all the A320CEOs with new generation narrow-bodies (probably A320NEOs), as well as adding another 32. There are also 9 “long-range narrow-bodies” planned, almost certainly A321-LRs. The wide-body fleet count goes up to 26, which I assume means keeping the 9 A330-200s and adding 17 new 787s or A350s.

The new Alitalia probably can’t easily switch to 737s on the narrow-body side, but a private company would certainly run a proper competition between Boeing and Airbus for the wide-body choice. That would help them to leverage a great deal on the narrow-body side too. Choosing the A350 for long-haul would help them to secure the best deal on A320NEOs for short-haul, or at least force Boeing to give them the sharpest possible prices for 787s. However, as a state-owned company, the politics of 787-related jobs in Italy may get in the way, worsening the deals they might otherwise get for both narrow-body and wide-body aircraft.

As you might have noticed, the plan involves taking a lot of new aircraft over a short period of time. 63 narrow-bodies and 17 wide-bodies over four years. That will be over €5 billion of aircraft, even allowing for decent discounts.

The presentation indicated that 39% of their aircraft would be owned in 2025. That means buying about 50% of the new aircraft and leasing the rest. So they need to finance over €2.5 billion of aircraft purchases, on top of assuming lots of extra lease liabilities. Yes, they will be able to borrow against those assets, but I think they will need a big chunk of that €3 billion of new equity just to fund the aircraft investment plan.

The new aircraft will of course be more efficient that the aircraft they replace, but big cost savings will be needed to cover the financing costs on the new aircraft, so there had better be profit improvement plans coming from elsewhere too.

Several slides of consultant-speak are devoted to things they intend to do to boost commercial performance, so let us look at the assumptions there next.

Better commercial performance

One slide shows that revenue in 2025 is expected to be €3,353 million, a reassuringly precise number. There is no further information provided, so it is hard to critique the assumptions, but it is possible to do a sense-check using Iberia as a reference point.

I started from Iberia’s 2019 results and adjusted for the size and mix of the business (long-haul, short-haul etc) based on the assumed 2025 fleet plan for the new Alitalia. I came up with a figure of €3,383 million for 2025 revenue. By the way, if anyone needs any business plans put together, I’m a lot cheaper than BCG. Just saying.

So, on the face of it, the business plan revenue assumption for 2025 looks reasonable, but using Iberia’s 2019 results as a reference makes a few implicit assumptions.

Assumption 1: The new Alitalia team can match what Iberia achieved in their successful restructuring, sorting out customer service, upgrading commercial functions and improving unit revenue

Iberia’s commercial performance in 2019 had the benefit of having being part of International Airlines Group for 8 years, which gave them significant revenue synergies and benefits from scale. Alitalia seem to recognise this and talk a lot about benefits that will come from a European strategic partner, although the plan only seems to assume a strategic alliance structure. In my experience, you just don’t get the same scale of revenue benefits from an alliance as you do in a merger, so that will be a tall order.

Assumption 2: The revenue generating capacity of the Alitalia network matches that of Iberia

Iberia, especially as part of IAG, has a leadership position on Europe to Latin America. Madrid is perfectly placed geographically to serve Europe to Latin America connecting flows. Spain is the largest market to the region. North Atlantic routes benefited from being part of IAG, the leading European player on the North Atlantic.

Rome is not well placed geographically for any of the markets they are trying to serve long-haul. Rome is also very much an inbound tourist market, which is intrinsically quite low yield and in which Alitalia doesn’t have much of a “home advantage” due to the high mix of inbound traffic. That is one of the reasons that they are critically dependent on getting the support of overseas alliance partners.

But they don’t have a great bargaining position to get a good deal from partners. They are unhappy with the deal they get at the moment from SkyTeam and seem to want to leverage a better one by threatening to switch alliances. Maybe this will work, but I doubt it.

In short-haul, Alitalia has a much weaker market position at Rome and Milan than Iberia does in the Madrid market. Ryanair is the national carrier of Italy these days and easyJet are very strong in Milan.

Assumption 3: The world of 2025 will look like the world of 2019.

Believing that 2025 unit revenues will get back to 2019 unit revenues is certainly a possible scenario, but this is probably closer to a “best case” scenario, with worse ones easy to imagine.

Overall, I’d say the revenue assumptions are at the challenging end of the spectrum, especially considering the fact that they are actually trying to be bigger in long-haul than they were going into the crisis.

So what about costs?

Non-fleet related unit cost savings

For an airline with famously bad unit costs, the publicly disclosed plan is rather short on detail. We do get some more consultant-speak:

“Efficient organisation and operating model, thanks to the introduction of digital levers”

“Lean cost structure, in line with market best practices”

“Digital native: digital revolution of the corporate and operations areas”

“Productivity aligned with the market standard”

Translations are courtesy of Google Translate. To be fair, the same can probably be said of where the Italian version came from.

If I was being asked to invest in this “new startup”, as they describe themselves, the lack of detail here would be a flashing red light for the credibility of the plan. Of course, cost reduction plans can be sensitive and the management may be reluctant to share these in public. But when the EU Commission comes to vet the plans, that is an area that needs proper scrutiny.

I did do another high level calibration of the figure of 9,500 which was given for employee numbers in 2025, down from about 11,000 today. Again, I’ve used an Iberia benchmark from 2019, adjusted for size. I’ve also adjusted the Iberia figures a bit to try and match the “perimeter” of the new Alitalia. Apparently, the new company will only be doing its own handling and maintenance at the main hubs. Iberia has a big third party handling and maintenance business, so I’ve excluded an estimate of the employees associated with those activities. That gives me a benchmark figure of 8,700 people, so to me the employee numbers look about 800 people or 9% too high, even to match Iberia levels of productivity in 2019. That would seem to me to be a minimum target, given Alitalia’s revenue challenges..

Overall profit targets

The new plan targets a 7% operating margin in 2025. Is that an acceptable level of performance?

I can certainly say from my time at IAG that if a subsidiary wanted to take on €5 billion of new aircraft, and was proposing a plan which delivered only a 7% operating margin by the end of the plan (EBIT of €235m p.a.), they would have been sent back to start again. Something more in the 10-15% range would be more what was required. To be honest, whatever the promised return, I can’t see any private sector investor backing a plan to invest €3 billion of equity in a company of Alitalia’s size and track record, even in good market conditions.

These are not good market conditions.

Getting to 2025

I’ve focused on the final year of the plan, partly because we have even less detail on the earlier years.

However, there will of course be a lot of losses and "start-up costs" to fund to get from here to the point at which they start making money, even assuming things go according to plan.

If the rumoured €3 billion from the state genuinely goes to the new company, that could be enough to fund the plan. But they also have a lot of liabilities and legacy issues which are being “left behind” for the state to pick up also. €3 billion won’t be enough to do both and so the overall bill for the tax-payer will be far higher.

One of the biggest issues is how the surplus employees are going to be handled. I understand that there are 11,000 employees today, which is 1,500 more than the plan assumes in 2025. A big reduction, but manageable over four years. But they will probably have 6,000 surplus employees next year. Who is going to pick up the cost of carrying that surplus for the next 2-3 years?

Management

I don’t know the new CEO Fabio Maria Lazzerini. I do know that his most recent airline experience was three years as “Chief Business Officer” at Alitalia and before that as “Direttore Generale, Emirates Italia”. The responsibilities at Alitalia were pretty much those of a Commercial Director and at Emirates it looks like he ran sales in Italy. Not exactly a “new broom” and perhaps light on experience cutting operational costs, but I certainly wish him every success.

I haven’t heard that they are planning on bringing in new management talent, but I am sure BCG will be happy to help for a fee.

In conclusion

I understand that this plan is, as ever, being driven by Italian jobs and politics. But I think you have to ask “why bother”? It would be much cheaper surely for the state just to shut down the airline and sell off the few remaining assets, which mainly consist of the slots at Linate and Heathrow. Maybe the brand has some value. It is certainly well known, although mainly for all the wrong reasons.

Other airlines would jump at the chance to back-fill any vacuum created if Alitalia were to be shut down. The benefit of shutting down Alitalia in current market conditions is that there is plenty of spare capacity at other airlines looking for new opportunities. Other airlines, who already have much lower costs, benefit from scale advantages and who have established alliance relationships in place will have a much better chance of flying these routes on a profitable and sustainable basis than state-owned “new Alitalia” is ever likely to do.

Sinking fresh investment into the black hole of Alitalia just seems like folly to me.