Reuters covers an ‘unsourced report’ from Italy’s Il Messaggero suggesting that:

• Etihad buys 30% – 40% of Lufthansa
  
• Then they consider merging after that

According to the paper, managers from both companies have for weeks been examining the possibility of Etihad taking a 30-40 percent stake in Lufthansa via a capital increase reserved for the Abu Dhabi state-owned airline.

In a second step, the two airlines would look at a full-blown merger to create a carrier with 97 million passengers a year, the paper said. It added the parties would meet shortly to speed up the talks.

Lufthansa, a critic and rival of Etihad, has been working with them as the UAE carrier has sought to shrink and bail out airberlin without running afoul of foreign ownership rules. airberlin is wet leasing 38 Airbus narrowbodies for 6 years — with 33 being assigned to Lufthansa Group’s Eurowings and 5 to Austrian. In addition they’ll begin codesharing and when that was announced last month it was hinted that it could be the first of ‘deeper links’ to come.

Etihad has made investments in several foreign airlines as part of its strategy to redirect traffic through its Abu Dhabi hub. At mid-year its stakes looked like:

• 49% of Air Serbia
  
• 49% of Alitalia
  
• 40% of Air Seychelles
  
• 33% of Darwin Airline (now Etihad Regional)
  
• 29% of airberlin
  
• 24% of Jet Airways
  
• 24% of Virgin Australia

Since that time its share of Virgin Australia was diluted to 21.8%.

These investments have generally been money-losing. Jet Airways has seen recent success, but the locus of control has shifted somewhat back towards India. Alitalia and airberlin are bleeding. Alitalia needs bailouts every few years but Etihad can’t take more equity, and may not be in a position to. They want cost concessions from unions and support from the government, neither of which is easy to get. And their problems aren’t limited to costs.

Currently Lufthansa’s market cap is about $5.6 billion. A 30% stake at current market prices (no premium) would be ~ $1.7 billion. This would be the biggest deal that Etihad has done. Etihad’s initial investment in Alitalia, by contrast, was 560 million euros.

It would come at a time that Etihad has been seeing its foreign airline investments perform badly, and with low energy prices holding back the region’s economy. The expectation has been one of retrenchment not expansion of these investments. Indeed, Etihad has just announced layoffs.

That an investment idea has been floated wouldn’t surprise me. While I’m not making a prediction, the amount and timing of such an investment seem to me to make its coming to fruition low probability. And the idea of an outright merger as this report suggests seems even more far-fetched.

(HT: @istrakhov)