(Adds minister's reaction)

The European Commission has expressed doubts over whether proposed 'compensatory measures' by Air Malta are sufficient to justify state aid as part of its restructuring programme.

In a detailed report issued today, the  EU says it has some 'major concerns' about whether the optimistic forecasts on long-term viability are realistic; whether the proposed capacity reduction involves genuine compensatory measures; and whether aid given by the government violates the 'one time last time principle' in view of a capital injection carried out in April 2004.

The report confirms that as a compensatory measure for possible distortion of competition, Air Malta has offered a capacity reduction of 20% including the surrender of certain profitable or potentially profitable routes. The report says that slot pairs that would be surrendered by 2013 at coordinated airports such as London Gatwick, Manchester, Amsterdam, Frankfurt, Geneva, Catania, Stuttgart, London Heathrow and Munich. Through the withdrawal or reduced frequency, other airlines would be able to benefit from potentially increased load factors and, or, yields.

In its report the commission says that  the restructuring plan, the duration of which must be as short as possible, must restore the long-term viability of the firm within a reasonable timescale and on the basis of realistic assumptions as to future operating conditions.

The restructuring plan forecasts the profitability by 2016 to be on a similar level as the profitability of major carriers.

COMMISSION DOUBTS LONG-TERM FORECAST

"The Commission has doubts whether these optimistic forecasts are realistic to achieve, especially in view of the following:

The Commission doubts whether the significant impact of the ancillary revenues both in-flight and pre-flight of at least EUR [9 to 11 million] p/a is realistic, especially whether the expected take-up rates reflect the growing price consciousness in consumer behaviour mainly on short range flights. In particular, the revenues through catering and on-board sale seem to be too optimistic.

"The Commission doubts whether the assumed cost reduction through contract management can be achieved since the negotiations are still at a very early stage for some of the contracts. Therefore, Malta is invited to give an update on these negotiations and the expected savings.

"The Commission doubts whether the assumed market growth of 5.9 % is still realistic. The annual growth survey of the Commission of 23 November 2011 shows that the economic recovery has come to a standstill and that low levels of confidence are adversely affecting investment and consumption due to the current sovereign debt crisis and the situation in the financial sector together with a slowdown in the global economy. The impact has been particularly acute in the Euro area. As a result, GDP is likely to stagnate in the coming year and overall growth in the EU is forecast to be as low as 0.6 % for 2012. In contrast to Malta's assumed growth in GDP of 2.2 % in 2012, the latest economic growth figures by Eurostat  forecast a growth in GDP in 2012 of only 1.3 %," the Commission said.

The economic slow down also affects the countries of origin of the foreign passengers flying to Malta, especially from UK (0,7 % growth in 2012) and Italy (0.1 % growth in 2012).

"The Commission doubts whether the assumed yield is still realistic to achieve. In a press release dated 7 December 2011, the International Air Transport Association (IATA) gives a negative outlook for profitability on the European air transport market. Higher passenger taxes and weak home market economies have limited profitability in Europe. European carriers are forecast to generate a collective profit of just USD 1,0 billion, down from the previously forecasted USD 1,4 billion, and an EBIT margin of 1.2 %.

"The Commission doubts whether the assumptions for the base case scenario on inflation are realistic. The Restructuring Plan only includes known price increases such as salaries; otherwise cost inflation is not included. However, e. g. the European Central Bank expects inflation rates for the Euro area of 2,0 % (2012) and 1.9 % (2013)."

The Commission invited third parties to give their view whether the envisaged results at the end of the restructuring process, in comparison to figures of its competitors, ensure long-term viability in the market environment of the air transport sector.

The Commission added that as regards the scenario analysis, Malta has not provided an analysis of the overall impact on the profit and loss situation for both the best and the worst case scenario. Furthermore, the standard deviation analysis is not clear enough and has to be explained in more detail; especially Malta has to demonstrate how and on what basis the standard deviation is calculated. 

COMPENSATORY MEASURES

With regard to compensatory measures (for state aid) the commission said such measures must be taken in order to ensure that the adverse effects on trading conditions are minimized as much as possible. In this regard, closure of loss-making activities which would at any rate be necessary to restore viability would not be considered reduction of capacity or market presence for the purpose of the assessment of the compensatory measures.

"Since the overall capacity reduction of 20%  also contains loss making routes whose closure is necessary to restore viability,"there are serious doubts whether the overall reduction can be regarded as compensatory measures" the commission said.

It noted that Malta proposed to discontinue or reduce capacity on certain routes which were profitable, or have potential for profitability with the right management and commercial attention and investment.

"The total ASK change related to the routes explicitly earmarked as compensatory measures amounts to  14 % to 18 % of the 2010 overall capacity. The net capacity reduction related to these routes — i.e. capacity change related to the routes explicitly earmarked as compensatory measures minus the capacity increase by additional routes and expansion of existing schedules — amounts to ASK which corresponds to 5 % to 7 % of the 2010 capacity."

In contrast, the commission said, Malta offered an overall capacity reduction of 12.5 % to 15.5 % for "profitable" routes plus a capacity reduction of 5.5 % to 7.5 %] for "marginal" routes to be regarded as compensatory measures. These numbers conflict with the ASK figures provided for the routes explicitly earmarked as compensatory measures.

"The Commission invites the Maltese authorities to clarify this incoherence. The Commission notes that for the route Malta–Verona the contribution margin and the load factor are missing although this route should be counted as a compensatory measure.

"The Commission has doubts whether these routes are profitable. All the routes earmarked as compensatory measures have a 2010 contribution margin below the 47 % to 57 % threshold. The contribution margin of some routes is even negative."

The commission noted that Malta argues that, in order to exclude loss-making routes, a positive contribution margin, regardless of passing the [47 % to 57 %] threshold, is sufficient. Even if the Commission followed Malta's approach, the report says, the capacity reduction would amount to only  8 % to 10 % of the 2010 capacity.

"In any case, the Commission has doubts whether this approach is appropriate as it does not ensure the coverage of fixed operating costs and administrative overheads by the retained bundle of routes."

Malta, it added, argues that some routes which are not profitable today have potential for profitability with the right management and commercial attention and investment. Therefore, Malta provided a contribution margin forecast for FY2014. However, some of the routes will still remain below the 36 % to 44 %, the relevant threshold in FY2014. 

The Commission noted that only capacity data until FY2013 had been provided and it invited the Maltese authorities to also submit information on the route network development as of 2014. The capacity reduction carried out until 2013 may not be significantly counterbalanced by future capacity increase.

Beyond the capacity reduction, Air Malta proposes the sale of non-loss making assets as compensatory measures. This includes its subsidiaries Shield Insurance Co. Ltd. (an airline insurance company) and Osprey Insurance Brokers Co. Ltd. (an airline insurance broker).

However, according to  R&R Guidelines, the compensation measures should take place in particular in the market where the firm will have a significant market position after restructuring.

"The market where Air Malta has and will have a significant market position is the Maltese air transport market. This does not apply to the insurance sector. Therefore, there are doubts whether the sale of Shield Insurance Co. Ltd. (an insurance company) and Osprey Insurance Brokers Co. Ltd. (an insurance broker) can be considered as compensatory measures."

NEW AIR MALTA FEES

The Commission said that following the approach of many low-cost carriers, Air Malta would charge fees for ancillary services. These will include:  differentiated service fees of between €10 and €15 to encourage people to book online; additional bag charge fee of between €35 and €45 for any second or subsequent bag carried by passengers; seat reservation fee of between €9 and €11; a loounge access fee of between €9 and €11; and a paid catering service.

MALTA'S LOCATION

The Commission said Malta's peripheral geographical situation causes problems with respect to accessibility to the rest of the EU and as a result the country is extensively dependent on air transport. This is important as in the case of Malta, air travel is the only viable mean of business passenger transport apart from being essential for other vital services, including medical related travel. Against this background, an own contribution of 45.5 % may be appropriate in the present case.

"However, the own contribution must be real, i.e., actual, excluding all future expected profits such as cash flow."

As regards the sale of subsidiaries, the Commission said it is not clear whether the sales will be carried out by an open, transparent and non-discriminatory procedure. The values should have been established by independent evaluation. However, these evaluations have not been provided to the Commission. The Commission invited Malta to submit further information about the envisaged sale procedure and to provide the mentioned evaluation reports. 

ONE TIME, LAST TIME STATE AID

Finally, the, the commission said, state  aid must respect the condition that it is "one time, last time". A company that has received rescue and restructuring aid in the past ten years is not eligible for rescue or restructuring aid.

It noted that in April 2004, before accession to the EU, Malta carried out a capital increase of EUR 57 million. This measure was not considered as rescue and restructuring aid by the Maltese authorities who considered the capital increase to be compatible with the market economy investor principle (MEIP).
The Commission was informed about this measure at the time in the context of pre-accession cooperation. Since the measure was granted before Malta's accession to the EU, it was not necessary for Malta to seek the Commission's approval prior to implementing the capital increase in 2004.

"However, in line with consistent Commission practice, the Commission will take account of restructuring aid granted prior to accession for the application of the "one time, last time" principle in subsequent cases of restructuring aid."

"The transaction in question involved the transfer by the Government of real property (land and buildings) to Air Malta under a long-term (63 years) lease agreement in return for obtaining additional shares in Air Malta. This real estate had been formerly held by Air Malta under rental agreement.

"At that time, the Maltese authorities considered that this capital increase did not constitute State aid because it had been carried out in conformity with the MEIP at market price, that the private shareholding in Air Malta had not been diluted by the capital increase (i.e. the minority shareholders had participated in proportion to their shareholding) and that the transaction was not related to rescue or restructuring Air Malta which was not a firm in difficulties at that time."

The Commission said it was necessary to  establish whether Air Malta received an economic advantage, which it would not have obtained under normal conditions. 

"The Commission considers that the 2004 capital increase might be in conformity with the MEIP, in which case it would not constitute State aid and should not be taken into account for the application of the "one time, last time" rule. It invites the Maltese authorities and third parties to provide comments." 

RESTRUCTURING PLAN'S COST

The total cost of the restructuring plan is €238 million, of which €66.2m will come from the sale of land (which is already in process); between €9m and €12m from the sale of subsidiaries; between €9m and €12m from the sale of engines; between €20m and €25m in bank loans and €130m in government equity - including the €52m given to the airline last year.

MINISTER'S REACTION

In his first reaction to the report, Finance Minister Tonio Fenech said he was confident that with the new management in place, the restructuring plan and the negotiations undertaken with the unions and financial institutions, government will be given the go-ahead to pump in money and save the airline.

When asked about the Commission's concern that the restructuring plan's targets were too optimistic, Mr Fenech said that the first six months of the current financial year (which ends in March) showed that the turnaround had started.

"This is a sign that a complete turnaround is possible," he said.

The minister said that the publication of this report was an important and normal step in this process and he expects the Commission would complete its evaluation by May or June if the number of submissions is reasonable.

Mr Fenech was speaking in a video conference from Brussels after a marathon meeting of Eurozone finance ministers yesterday that was followed by  another meeting of EU finance ministers this morning.

See full report in pdf below