Gabriel’s scarcity rent - it’s management stupid!

I often travel the route Barcelona Madrid (and backwards) for the day. By plane it’s rather tiresome and expensive: with an open fare you end up paying around 400€ for a 630 km flight (+ 630 km back).

Barcelona - Madrid is the world’s busiest route with 971 operations per week. The second one is Sao Paulo - Rio (894 per week) then Jeju/Seoul Gimpo (858 per week) and fourth is Melbourne/Sydney (851 per week).

In fact you have to go very low in the ranking to find another crowded European route. That would be Rome - Milan with less than 600 operations per week, which, by the way, is more than the most crowded North American continental route: Las Vegas - Los Angeles (553 per week)

Source: www.oag.com, data from September 2007

But things change. And this milk cow for the airlines faces its first serious menace ever: the high speed Spanish train service, also called AVE.

These brand new trains travel the distance of 630km (410 miles) in two hours and 35 minutes. Not too bad when it’s compared with the plane that takes roughly two and a half hours (not just flying but also spent in the check in and departure processes), and possibly more.

But, from an economic point of view, there are many hidden costs that must be taken into account. After all, what is it that you do in a plane? Well, you sit in a narrow seat, trying not to disjoint your legs, and pray that the person that will be sitting beside you is not extra overweight. In the train you have plenty of space. Being uncomfortable has a cost.

How much? Well, it depends on what you’re willing to pay to be more comfortable, of course, and how much your time costs.

How much are you willing to pay for that extra nap? Well, in a 45-minute-long flight, you’re going to have maximum thirty minutes of uninterrupted sleep. You won’t be able to sleep while you queue, while you’re being inspected at the burdensome security checks, while you wait your turn. But on a continuous 2 hours 35 minutes journey you’ll be able to.

As for opportunity costs, you won’t be able to do anything in the plane, apart from opening your laptop for half an hour. It’s completely wasted time. In the train you can use your computer as much as you want, use your phone, combine them and access the internet. Work, eat, talk, whatever you wish.

But externalities must also be taken into account. Environmental footprints can be four times higher for planes than for trains. That means that the train will always be more sustainable and, if we ever are to reflect the true external costs, energy efficiency will give the train an important lead over the plane.

Add those costs up: discomfort costs, opportunity costs, externalities and you will have a very competitive mean of transport. Which only means that competition has been increased, with a comparable service at a better price. In the end, consumers will be benefited from the additional choices, lower prices and the increased service levels that competition will bring.

That was what I was thinking when I decided to open the textbook I was carrying with me. The Managing Financial Resources module awaited me. Fortunately it was half way to Barcelona, 300 km per hour (186.41 mph), still an hour to go.

The subprime crisis has arrived. Yes, many anticipated so. That’s what happens when economy depends on expectations. They take some time to change and, when they change, they do it abruptly. Like those subprime mortgages that have transformed from “hot products” to “hot potatoes”.

Overall is not a matter of solvency but liquidity. I agree, tell that to those that will not be able to afford the mortgages, maybe up to 500.000 people in the US. But investors do not worry much about them. Investors just get scared and they stop pouring endless capital… until they start to do the same somewhere else.

Because companies still report record earnings and the price of gold has been rising non-stop. That means that the machine is still working.

But let’s not be too complacent. A wider crisis can still arise. If gold is “hot”, ABS are cooler than ever. ABS are asset-backed securities, financial products made up of mortgages and things alike that are covered by a real asset, such as your home. These are a way for banks to get cheap financing and externalise risks, because the default risk is transmitted by the ABS, while it wouldn’t be with debt, for instance.

If banks get increasingly difficult to finance, they will transmit this additional cost to companies and consumers. And that’s an entry point to generate a widespread crisis. Central banks should add additional liquidity to the system by lowering rates, but that seems unlikely given their current policies.

But, what about private equity? Now it will be more difficult for them to get cheap capital to finance, that’s for sure. But that doesn’t mean they have no future. On the contrary, they are now more needed than ever, because they are the ones to provide that leaning, that additional shakedown that companies needed in times of more expensive credit.

Remember, there’s much more to private equity than leveraged buy-outs, they have an important role in the markets, and that means they have an important role to play in this new situation.

PD: I read this morning in “The Economist” that the US were thinking of “relief measures” for the crisis. Then I changed to a Spanish newspaper and read about the Popular Party (centre-right and opposition and presumed liberal) to propose the right not to pay mortgages during a year for the unemployed. Alarmed by both news I couldn’t help the thought: regulation must ensure that the system is not abused but, let the market regulate itself. Although some regulations will be painful, it’s the most effective way we’ve come to know.

Subtle movements show greater undercurrents in the Spanish Airline’s ball. You’ll see several previous posts about this in Scarcityrent.com (Airline movements in Europe: British Airways and Iberia on hold, Airlines corporate hunt: British Airways and TPG finally join forces to buy Iberia, Iberia and its brides… where’s the value?)

But let’s review the latest movements and their meanings. Major strategies in the Spanish airline sector are wobbly now.

Iberia has decided to open its books to TPG. They were trying to win some time waiting for things to happen but it seems they have changed their mind. Why?

• There’s not a competing strong offer for Iberia. In fact shareholders wanted to sell right away. Now they fear they could be left out in the cold with a company they no longerwant. Lufthansa is cooler every day.
• Being privileged for being the Spanish flagship carrier in a heavily regulated sector, they wanted to wait until Spain’s next election, awaiting a possible change. But change seems more unlikely each day, so there’s no point in waiting. Maybe it’s even better not to wait because the forthcoming government might even be the same but stronger.
• They had the previous objective of raising the share price to 4€, whilst the prospective buyers valued a maximum of €3,6. Have shareholders renounced to that objective?
• In other European countries things are cooling down too. See Alitalia, left with no brides, or Lufthansa drifting away towards another option (see below)

Less risk means less reward too. Looks like shareholders are aiming at speeding things even at a lower price. That’s good news for both TPG and British Airways, and for a sector that needs consolidation and clarification. Many things depend on the management of those big airlines.

And meanwhile, Spanair, the second Spanish airline, is for sale too. SAS, it’s current owner, has decided to disinvest in the company. Gonzalo Pascual, the president of the company, owner of the Spanish touristic group Marsans is about to buy it, but some things have happened too:

• Lufthansa has expressed their interest to buy the company. Although of a smaller size than Iberia, this airline has the advantadge of being in the same alliance than Lufthansa: Star Alliance, while Iberia is in the wrong one: OneWorld, lead amongst others by British Airways, direct competitor of Lufthansa, with many flights shared with Iberia and, of course, shareholder of Iberia with a 10% stake. (and, maybe, unwilling to sell to their German competitor)
• TAP, Portuguese Airline, has expressed its interest too.

Of course that means that this €450 million Airline is about to increase its price. There’s nothing like competition. Good news for SAS, of course.

This man is the one that has the key. Gonzalo Pascual, beside SAS (Scandinavian Airlines Systems) executive Joergen Lindegaard, controls Air Comet, Pullmantur, Austral and Aerolíneas Argentinas, with heavy traffic across the Atlantic Ocean and a total fleet of 90 airplanes. Spanair is their natural ally, with an additional fleet of 65 airplanes and a lot of Spanish connections that can feed their intercontinental routes.

But, you there are always other possibilities, if the Spanair acquisition were to fail, why not buying Iberia instead? It would be hard and difficult, but Gonzalo Pascual is the one Spaniard that could. That would mean removing the foundations of the whole Spanish aviation sector though.

And this way this airlines’ love triangle gets more interesting. We’ll see what happens next

Smart move from British Airways. The hunt has resumed and two hunters have made an alliance: Texas Pacific Group and British Airways will go together.

That’s a good idea because private equity can cooperate easily with the British airline’s knowledge support. And there are synergies: Iberia has what BA lacks: a good connection with America, specially Central and South America. And TPG has what BA lacks: money. Apax wouldn’t fit in the agreement, though.

British Airways has many shared codes with Iberia, plus a 10% stake in the company, and call options to a 27% more from Caja Madrid (10%), BBVA (7,3%), Logista (6,7%) and El Corte Inglés (3,1%). But British Airways’ shares have not been very optimistic lately, as you can see in the following graph:

BA in London Stock Exchange (blue) compared to Dow Jones Index (red), not too bright 

(It’s not something about British Airways. EasyJet and RyanAir have been squeezing as much money from traveller’s pockets as they have been able to, but there’s a dead end right in front of them, and the Airline’s sector situation now is not that bright. Iberia and Alitalia are looking for buyers. Time for restructuring. But that’s not for today.)

Remember my last post on Iberia and why it had to keep being Spanish? Well, looks they’ve found the solution. TPG and BA would acquire a maximum share of 49% while the rest would be left for Spanish investors. They are also known:  Vista Capital (which includes Banco de Santander and his old ally Royal Bank of Scotland), Ibersuizas and Quercus (a venture capital fund also participating in another low-cost Barcelona-based airline: Vueling). That way they can protect their exclusive international flying agreements signed with the Spanish government. (those kind of agreements that you can’t acquire in the free market). Here is the post: Iberia and its brides… where is the value?

So it looks like British Airways is trading handling victory to TPG over Apax (and partners Hemisferio and Torreal) with his call options, plus knowledge and synergies with his network for a bigger chunk of shares without spending money. All of that without having to renounce to international agreements signed by the Spanish government on behalf of a Spanish Iberia.

European real integration: British airports more Spanish and Spanish planes more British

Well done BA!

I’ve had a busy days. Mondays are the worst. Always. The only thing good about mondays is that, once you begin doing things and before you realise, it’s already tuesday.

Today I’ve been meddling with many things. One of them was a group essay for a Spanish company that wants to export olive oil. I decided to contribute with a lot of statistical data and tried to get some conclusions.

Using the TARIC (Integrated Tariff for European Communities) code for olive oil: 1509, that you can find here, and searching in Import/Export databases from Spanish Chambers of Commerce here, it’s easy to find that Spain exported, last year, 1.778 million € in olive oil to the following countries:

Spain: exporting a lot of olive oil

Which is not surprising. Italy is the main market for olive oil exports. Being Spanish oil of better quality, and being Spanish brands less known than Italian ones, a big chunk of olive oil is exported to Italy, where it is repacked and exported again to third countries as an Italian export with an Italian brand. The US market is a good example: try to find Spanish oil. (Then, when you end up buying an Italian brand you end up carrying Spanish oil home.)

It’s a consequence of the rather recent opening of the Spanish economy to international markets. Spain as a brand is still not enough known. Fortunately, if you see series from previous years, Italy’s share of Spanish exports is less important as the country directly exports bigger quantities.

In any case, Spain leads the world’s exports of olive oil, with 1.778 million Euros. But, does it import olive oil too?

And the answer is yes: the biggest exporter also imports olive oil.

A 15% of the quantity exported… yes! Spain also imports olive oil. And surely they have learned the Italian lesson. Spain imports olive oil from Tunisia, Morocco, Syria… and surely repacks it, rises its price and sends it somewhere else. At least there’s a big chance that your Spanish oil is really Spanish, but no certainty at all.

But there is Italy too. Spain imports oil from Italy. I’ve crossed the data, relating volumes and values, and Spain exports oil to Italy more expensive than imports it!. In fact Spain pays more for Moroccan, Greek, Turkey or Jordan olive oil than for Italian oil. Funny.

You can see the prices in the following figures. Spain exports much more expensive than it imports. Fortunately.

Arbitrage: buy cheap, sell expensive. Olive oil too.

If you are one of the few people that read me (thank-you by the way) you’ll probably remember the post I wrote about the Spanish house bubble about to burst. Well, there are signs that its bursting is closer now.

In fact many European countries now fear that this burst could be contagious. Probably it will be.

Did I tell you about a constructor, Fernando Martin, and how he was paying above risk-free interest rates four times than what an American constructor would? Well, the markets are going down for real estate companies, and their shares are losing ground. Looks like there’s something changing, moving down.

For a country like Spain that has grown a lot based on house building, this is a big problem.

Many of these companies have been buying around: utilities, construction, airports. Many have just bought each other. Some with their own shares, but when that wasn’t enough, with fresh cash.

Where do you get fresh cash from when you need it? Well, institutional investors, banks… there are many ways. If you can do a leveraged buy out, or just go into debt, do it. Why would you pay with your own money when you can borrow at low rates and achieve higher returns? Sounds silly.

But there comes a time when you have to repay. And no gain comes without risk. Right now the prices may go down, but debt will stay the same. That means that companies will still need to sell at the same pace. Pressure to sell means pressuring the prices down.

But now there’s a wider gap between offer and demand, a gap still getting wider. Now it won’t be so easy to repay debt. The weak are in peril, with value going down and risk going up. That means trouble.

Astroc going up, up, up… and now down

Real state companies owe 250 billion € to the Spanish financial system. That is one fourth of the gross national product. The risk naturally spreads into banks. And they also had the risk of lending to subprime consumers, remember? Add both risks and the situation, naturally, gets more risky. Add the correlation between them and then it gets even more risky.

Nothing radical has changed from some days ago. Only investors mindsets. But investors are like that: either they hate you or they love you, sometimes enthusiastic, sometimes they just panic. No inbetweens.

But what do we need to see prices fall? Just a price-falling mindset. It’s all in our minds.

Do not panic yet. If real state companies have trouble to repay the banks still have the guarantees. They can still sell them. But in most cases the guarantees are their own plunging shares. They may be worth less than they owe, they can’t even be sold without pressuring prices down more. Ooopss.

(Fortunately, there’s more to Spain than the real state sector, and the Spanish financial sector is very strong. Moody’s still keeps our AAA… for now.)

Iberia is for sale. After years of flirting with British Airways, now it realises that there’s not enough satisfaction in that relationship. Shareholders want to sell. And B.A. is not ready to take that step. Too many doubts. I’m sure that with a good price for that 10% they have they’d even get out.

The second bride is Lufthansa. Lots of cash and need for expansion. Alhough Iberia is in the wrong alliance. But Iberia would be a big step towards South America for Lufthansa. Conte and Mayhuber, the two bosses, denied yesterday any approach. Sometimes denial is the previous step to marriage. Although German firms have not been very lucky lately buying in Spain.

And then there is Texas Pacific Group. Good news for eficiency, bad news for workers. Iberia needs a deep refurbishing and that would mean a lot of lay offs. Many of Iberia’s workers are only worried about preserving a way of life that is already dying in most of the old flagship carriers. They have managed so far to keep their privileges while receeding to Madrid and their most profitable flights with South America. But, with a private equity firm, that would no longer be possible.

A private equity firm could drive a lot of value from Iberia, something that main shareholders didn’t feel like doing because it was not politically correct. They’d be so pleased to go home with their capital gains…

But, investors be aware, there are two risks hanging over the company.

The first, it’s most profitable route, a nice route from Madrid to Barcelona and back that until now has managed not to be canibalised by competitors, is about to get new and powerful competence: the high speed train. Probably it will cut its passengers in half, and profits with them.

And last but not least, Iberia needs to be Spanish. The routes they operate to South America and give Iberia a specially high strategic value have been built from agreements between the Spanish and South American governments. One by one, brick by brick, unsurprisingly, Madrid’s hub has been constructed from agreements based on Iberia’s spanishness and Madrid’s capitality. There would be not enough reasons to keep that exclusivity for long with skies being more open each day and with an Iberia decreasingly Spanish.

Right now there is an ongoing discussion in Barcelona. A new airport terminal is being built that will be able to handle around 30 million extra passengers. But there’s something to be decided: which companies will be located there.

Barcelona’s airport is the eight in Europe considering the passengers that use the installation. That means it’s close to medium cities like Munich or Milan. But, being similar in size, there’s a big difference between Milan, Munich and Barcelona: the number of intercontinental flights.

Of course, in order for the airport to grow it will need more infraestructure. The third runway is already built and the new terminal will give it the capacity it needs to grow and expand.

But the proximity to the recently expanded Madrid Airport is a problem for Barcelona’s aspirations to be a hub. One of the main aviation alliances, One World, has already a hub there, and being at 700km (45 minutes by plane) makes it unlikely for this alliance to have more intercontinental flights in Barcelona. From an economic point of view they’d rather have them in Madrid. To complete the picture, this alliance includes Iberia, the old Spanish flagship company, and has the highest market share in Barcelona: around 40%, and steady, not decreasing but not growing either. In fact this alliance has no plans to have any international flights in Barcelona anytime soon and it’s moving towards a low cost profile.

There is a second alliance: Star Alliance. They are growing at a high pace, and they already have a market share of aproximately 20%. The spanish flagship of this alliance is Spanair, that is also an important Spanish carrier, growing quickly and aiming to overtake Iberia in a not too distant future.

This alliance looks like the only chance for Barcelona’s airport to position itself as an international hub. On the other hand this alliance also has a hub in Frankfurt, which won’t be substituted but complemented by Barcelona’s growth. So there’s an upper limit to Barcelona’s possible expansion with this alliance.

So, should the new terminal be allocated exclusively to Star Alliance?

Many people do believe so. It looks like the only alliance that has the possibility and will to bet for Barcelona. So I can agree partially on that: it’s important to have the best parts of the new terminal allocated to the alliance that has the most interesting prospects.

But why not share the terminal between the two alliances Star Alliance and One World? Many people refuse that thinking that One World just wants to be there to disturb Star Alliance plans for expansion. Or many people just want that based on an irrational approach to the rejection to expand Barcelona’s international connection from One World.

But, from an economic point of view, and beginning of a situation of a new terminal with only one alliance: Star Alliance and with excess capacity. Does a second alliance positioned there leave us better off or worse off?

Maybe the right concept to grasp would be “Pareto efficiency”: we reach the most efficient situation when we are not able to improve any participant’s situation without leaving another worse off.

And without worsening the behavior of Star Alliance, we can improve easily the situation of One World just allocating them the spare capacity of the new terminal (discounting of course future growth), as long as it doesn’t worsen the operation of Star. And we can do that defining the correct precedences and procedures.

Of course Star Alliance would be benefited if we threw out the other alliance to the existing -and worse- installations. That would give them some extra market power… but what for? To have an advantage over competition.

And to give one player advantage over another instead of fair competition always leaves the consumer worse off. And that’s not the objective. Free competition is good for Barcelona’s airport on the long run. That’s the point we should go to.

Why? Because even not having interconental flights, even his leaning to the low cost profile, One World is the market leader in Barcelona, providing the airport with most of its connections. And that gives high value to the airport. And it will drive even more value with the combination of another alliance’s hub in the same location. The two hubs will even be able to interchange passengers, helping build the critical mass of passenger an airport needs to have intercontinental connections.

Because it’s not the politicians who make the intercontinental flights. They can obstruct or help them, but it’s the market, and the consumer’s demand, that will establish new long range connections. And the market works best when all the players are given the most opportunities with a clear set of rules and without discriminations of any kind.

That’s, in my humble opinion, the best way to ensure a healthy growth for Barcelona’s airport.

These days there’s a debate on which companies will use Barcelona’s airport new terminal. Lots of political buzz and fuss around it. Catalonia distrusts the Spanish government. What should be an economic decision, or at least a rational one, provokes all kind of passionate speeches. Seems like the Catalan society as a whole needs to fight against an imposed solution but, how can that be if the decision has not even been made? Why does everyone here assume that the outcome will be the worst possible for Catalonia and Barcelona?

Seen from outside it’s difficult to understand why the catalans are so wary about things like that. Why should they be?

Distrust in the Spanish state, or Kingdom of Spain as the official name states, is something congenital in Catalan people. Two forces have always strived in spain: uniformity and diversity. Their force, unmatched by reason, have spilt so many Spanish blood. Sixty five years ago that war ended with uniformish Spain prevailing over the other, repressing it for more than forty years.

The silent and diverse spain couldn’t speak their language. Castilian Spanish was imposed over Catalan, Basque and Galician languages that accounted more than 30% of the Spanish population. All historical evidence of their existence was simply erased: books destroyed, libraries burned, public files taken away, students reeducated, teachers purged.

Democracy arrived twenty five years ago. Fortunately it came with no bloodshed, but, on the other hand, it also came with a great dose of amnesia. The two Spains were walking together by the hand, but one was hurt and humiliated, the other was not.

What democracy didn’t change was the rationale of the uniformist and centralist decisions from Spain’s central government. Specially under José Maria Aznar rule -yes, that person that was close to Bush and Blair in Açores photographs before the Iraq war- the priority of the central government was to concentrate everything in Madrid, spending the more the better in the capital’s infrastructures and forgetting about the rest of Spain.

And the other Spain? The other Spain managed to decentralise part of that power, using autonomous communities, recognised in the 1978 Spanish Consitution. Autonomous communities made their own Statutes -sort of local Constitutions- and began asking for political and economic power. Some of them were brand anew, some of them recovered historical rights and sovereignity that had existed for centuries.

First decentralisation wasn’t enough for that second Spain. And amnesia couldn’t last forever. Right now the second Spain is recovering their dead, still buried anonimously beside communal roads, where “red” spaniards were shot and forgot. Right now those autonomous communities are renewing their Statues and claiming for more power.

And all this with a bipartisan system that identifies one political party with centralism and uniformity, and the other one sometimes with centralism, sometimes not. New Statue for Catalonia approved in 2006 by popular plebiscite has been at the center of the political fight. For the Popular Party -that never assumed their defeat against the Socialist Party- sees in this confrontation a way to return to power.

A way to return to power based in the old tale of the two Spains. The political calculation states that supporting the centralist Spain they can get a lot of votes in many Spanish regions, while loosing support in others. They say they do that for love of Spain -that is the centralist Spain-.

But the question is, will both Spains be closer together this way?