Italy's Largest Airline Is Looking for Investment

As U.S.-based airlines continue to reap the benefits of a more stable industry and greater pricing power, another airline drama is playing out is Europe. The financially unhealthy Italian flag carrier, Alitalia, is looking for outside investment. And depending on which company does so could play a large role in the future of European air travel.

2013 troubles
Alitalia has been an unhealthy airline for a long time, requiring millions in cash injections from the Italian government prior to its 2008 restructuring. The new Alitalia became owned by various private investors and Air France-KLM (NASDAQOTH: AFRAF  ) , which took a 25% stake.

Last year, brought more troubles for Alitalia, as the airline ran into a cash crunch. Despite comments from Air France-KLM signaling an interest in Alitalia, the two carriers couldn't come to an agreement on cost cuts and debt restructuring at Alitalia. The Italian carrier was kept alive with a 300 million euro rights offering that diluted Air France-KLM's stake to 7%. The French carrier responded by writing off the entire value of the Alitalia stake.

Another airline arrives
The rights offering was a short-term measure so Alitalia still needed additional funds. Etihad Airways, flag carrier of the United Arab Emirates, joined in discussions with Alitalia about a potential partnership and investment.

For state-owned Middle Eastern airlines like Etihad, expansion is on their agenda. While other Middle Eastern carriers have decided not to pursue Alitalia, Etihad is thinking about using an investment in the airline as a gateway into the European market.

Airline complaints
Events surrounding Alitalia have ruffled feathers among other European airlines before. International Airlines Group (NASDAQOTH: ICAGY  ) , parent company of British Airways and Iberia, complained to the European Commission that the 2013 rights offering for Alitalia was illegal, since it was largely being funded by the Italian government. IAG noted its opposition, saying that the rights offering is "protectionist, undermines competition, and favours failing airlines that have not got to grips with economic reality."

Not surprisingly, the latest potential tie-up between Alitalia and Etihad has received criticism from rival carriers. Deutsche Lufthansa (NASDAQOTH: DLAKY  ) is calling for the European Union to block the tie-up on the grounds that Etihad is receiving state aid. While European carriers do have a strong interest in keeping fast-growing Middle Eastern airlines out, it could be tough to do. Etihad has already been able to purchase stakes in Air Berlin and Aer Lingus in the past, showing a reluctance by the EU to block such investments.

SkyTeam effects
Air France-KLM enjoyed a close partnership with Alitalia more for Alitalia's route network than for its unimpressive financials. With both airlines being members of SkyTeam, Air France-KLM can book passengers on Alitalia flights, and vice-versa. With Italy being a major tourism destination, access to Alitalia's route network is quite valuable.

Fortunately for Air France-KLM, this codeshare is likely to continue after an Etihad Airways investment. Alitalia would still benefit from Air France-KLM's larger international network to bring in passengers. Past events by Etihad also indicate that the codeshare would be able to continue, since many other airlines Etihad has invested in have maintained their codeshares.

This is good news for Delta Air Lines (NYSE: DAL  ) , which has mostly sat on the sidelines through these events. As a SkyTeam member, Delta is the only major U.S.-based airline able to act as a member of this alliance and book passengers directly onto Air France-KLM and Alitalia flights. Delta has left the European situation to the European carriers. and it appears to be working out fine without any funds from Delta.

The bottom line
Alitalia needs more money, and having been unable to reach a deal with Air France-KLM, the Italian carrier is pursuing a tie-up with Etihad Airways. With Etihad being a state-owned airline, this tie-up has attracted calls from Deutsche Lufthansa to block the deal.

It would be tough to see how this deal could be blocked entirely, considering Etihad has made similar investments in other European airlines. However, if the deal goes through, Air France-KLM and Delta Air Lines should still be able to benefit from Alitalia's network through the SkyTeam codeshare. Going forward, investors should keep an eye on whether the Etihad investment is completed and what, if any, concessions the European Union will require.

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