Bailout-or-Bust Dilemma Forces Lufthansa to Call in State Rescue

(Bloomberg) -- In mid-March, the world as Deutsche Lufthansa AG had known it for close to seven decades unraveled in the space of a week.

Italy’s government put the entire country into quarantine on March 9 as deaths from the coronavirus began spiraling out of control. Two days later, the U.S. announced sweeping travel restrictions from 26 European countries, cutting off the lucrative trans-Atlantic artery. Then on March 17, the German government issued an unprecedented global travel warning. Lufthansa, like much of the world’s airline industry, was indefinitely stuck on the ground, bleeding cash.

Chief Executive Officer Carsten Spohr quickly understood that if he wanted to save the company where he had risen through the ranks since 1994, he’d need to ask for help. After Germany unveiled a 600 billion-euro ($654 billion) economic aid fund, Spohr addressed his 135,000 workers in a video message, saying that he’d started talks with the government about “active support as soon as that becomes necessary.”

The German airline was uniquely equipped to pick up early warnings signs of the storm that would wreak havoc on the global economy. Early in the year, when the coronavirus looked like a local anomaly in a far-away province many people had never heard of, Lufthansa registered a growing stream of cancellations on its flights to China.

By the end of January, Lufthansa’s operations center at Frankfurt’s sprawling airport decided to cancel flights to the mainland cities of Nanjing, Beijing, Shanghai, Shenyang and Qingdao. Soon, flights to Iran and Italy followed.

Crisis Mode

A month later, the executive board was in full crisis mode, canceling pilot training, offering unpaid leave and unleashing a wave of cost cuts. State aid, long considered an ignominy that Spohr had derided as a competition-distorting ghost from the past, suddenly looked inevitable.

This story is an account of how Lufthansa and the German government reached a bailout accord, announced by Finance Minister Olaf Scholz on May 25. The 9 billion-euro package involves the state taking an initial 20% stake that could rise to a blocking minority of 25% plus one share in the event of a hostile takeover. The people familiar with the negotiations asked not to be identified discussing confidential deliberations. Officials at Lufthansa and the government declined to comment on the closed-door talks.

An hour’s flight east from Frankfurt in Berlin, Chancellor Angela Merkel was confronted with an increasingly agitated debate inside her government as well as her own Christian Democratic Union about how to help the airline. Her grand coalition with the left-leaning Social Democratic Party has always been an exercise in compromise, and ideological fault lines were now breaking into the open. There was little question that Lufthansa should receive help -- after all, the company is a globally recognized German emblem and helps lubricate the country’s export machine.

But from the get-go there was controversy inside the political factions over the conditions the state should attach to its support. Members of the SPD, including Finance Minister Scholz, sought direct control by taking a big stake and gaining seats on the supervisory board, the panel in Germany’s two-tiered corporate structure that signs off on all key executive decisions.

Past Battles

Merkel and Scholz are both battle-hardened, having worked in government during the financial crisis more than a decade ago. One of the lessons from that episode was that the government needed some form of veto power in the running of a stricken company to ensure that shareholders weren’t on the hook for losses. It’s a view that emerged as a red line for Deputy Finance Minister Joerg Kukies, a key negotiator in the talks. Merkel and her entourage had learned the hard way how a bailout could backfire after the rescue of Commerzbank AG left the state under water with its stock holding.

By the end of April, the first numbers were coming together inside the government. A state-backed bailout would likely require 9 billion euros in aid, and in return the government would gain a 25% stake as well as two seats in the supervisory board.

For Spohr, it was an offer he desperately wanted to refuse. For much of last year, he had agitated that perennially ailing Alitalia should be freed from the cold grip of the Italian state. Besides, the CEO had just emerged from years of painful negotiations with belligerent pilots and cabin crew over pay and benefits, a battle that routinely flares up in the aviation industry and would almost certainly be much harder to wage with the state as an interfering voice on the board.

Going Retro

That reservation was shared in parts of the government, where there was little appetite to wage battles with labor unions, a potential political minefield with general elections looming next year.

Broad-shouldered and with an engaging personality, 53-year-old Spohr took over the controls at Lufthansa in 2014. As an assistant to then-CEO Juergen Weber, he had witnessed the privatization of the airline, the last phase of which was completed in 1997. Now, almost two decades later, Spohr was being forced to readmit the state as the biggest shareholder.

While he had gained a reputation for a management style that at times bordered on the dictatorial, no one could doubt Spohr’s almost boyish passion for a company and industry that was now facing a period on life support.

Spohr’s temper flared when William Willms, a company strategist entrusted by the CEO to negotiate with Berlin, reported back late in April that the SPD insisted on taking a 25% plus one share stake. Spohr decided to consider the nuclear option, ordering Lufthansa staff to start looking at insolvency proceedings if the two sides couldn’t reach an agreement.

Air Berlin

With the collapse of Air Berlin Plc in late 2017 still fresh on everyone’s minds, there was little appetite in the government to witness the breakdown of the standard bearer of German aviation. Insolvency was not an option.

And even within Merkel’s camp, there was growing unease about taking such a big stake in a company. Unlike France, Germany has long sought to rid itself of direct holdings in companies, and those that remain, including Deutsche Telekom AG and Airbus SE, have often been the source of tension with management.

Spohr injected himself more directly into the rescue talks, shuttling between Frankfurt and Berlin, as well as Vienna, Zurich and Brussels, home to the local subsidiaries Lufthansa had bought up over the years to turn into the continent’s leading aviation group.

On April 29, he boarded a small Cessna Citation CJ1 for Vienna, where tense talks beckoned with Austrian Chancellor Sebastian Kurz and Finance Minister Gernot Bluemel. Spohr had little to offer on his five-hour trip, neither the hoped-for hard guarantees nor friendly words for Kurz, who sought assurance that the Vienna airport would remain a viable hub.

Two weeks later, Spohr touched down in Brussels to meet Belgian Premier Sophie Wilmes, herself fighting to maintain confidence in her crisis management as her country experienced high death rates from the coronavirus. As he shuttled between cities, Lufthansa’s white jets with the blue tails remained parked in neat rows in Frankfurt and Munich, from the Airbus A320 city-hopper to the giant A380 super-jumbo now indefinitely immobilized, their engines sealed with red covers.

The Lufthansa CEO sought out some of Merkel’s more liberal-minded parliamentarians to win backing for his case against the government taking a direct stake with veto powers. Merkel herself made a point of delegating much of the negotiations to Scholz and Economy Minister Peter Altmaier, a trusted aid who had previously been her chief of staff at the chancellery.

But while she kept her distance in public, Merkel was on top of all the financial details. The conundrum facing the chancellor: how to forge a deal that supports Lufthansa without politicizing its business decisions. Proponents of a 25% stake also saw such a holding as a possible shield against an unwanted takeover.

Brewing Protest

On May 4, members of the CDU’s pro-business wing protested against Altmaier’s and Scholz’s plan for a direct government stake. As an alternative, Thomas Heilmann, a close ally of Merkel, drafted a paper introducing the idea of using convertible loans instead.

Merkel realized that the resistance brewing in her caucus group put the entire Lufthansa aid project at risk, and she ordered Altmaier to reopen negotiations with the finance ministry to seek an alternative approach.

For the government, there was also the European dimension to consider. Already, rivals were up in arms by what they considered a blatant display of state intervention. Ryanair Holdings Plc CEO Michael O’Leary, never one to mince words, called Lufthansa “the drunken uncle at the end of a wedding, drinking from all the empty glasses.”

Ryanair has vowed to challenge the expected European Commission approval for the Lufthansa aid package, after already seeking to topple France’s $8 billion rescue of Air France.

With the state’s position locked between interventionist hard-liners and proponents of government neutrality, Merkel instructed her ministers to go back to the drawing board and find ways of owning a lower active stake, making a deal with Lufthansa possible. There was little time to lose. Already on April 24, the airline had issued a dire warning, saying that it risked running low on cash within weeks, with no option to raise fresh funds in the capital market.

Job Cuts

Now, almost a month on and with most of the 763 jets still on the ground, the situation was increasingly desperate. Other airlines were taking harsh measures. British Airways parent IAG SA announced 12,000 job cuts, and Emirates, the world’s largest long-haul carrier, is considering as many as 30,000 reductions, according to people familiar with the plans. Ryanair plans to eliminate 3,000 pilot, cabin-crew and office jobs, with remaining staff taking a 20% salary cut.

Spohr sounded increasingly concerned that the company would run out of road before a bailout fell into place. On May 19, the CEO again wrote to staff warning that state aid was ever-more urgent, coupled with a plea for a deal that wouldn’t clip the carrier’s wings in competition. Spohr also braced colleagues for a diminished Lufthansa post-crisis, with hundreds of jets remaining grounded over the next years.

The letter was directed in equal measure at the government in Berlin, where ministers and their deputies had finally managed to come around to a formula that sought to appease everyone. The trick was the introduction of a mechanism that would allow the government to raise its stake to a veto power should it become necessary, but otherwise remain at a 20% holding that limited its sway.

Blinking First

On the evening of May 19, Merkel met with Altmaier and Scholz in her chancellery to reach a deal that all political factions could support and that Lufthansa would accept. The next day, officials made contact with Lufthansa to iron out the last details. From there, almost a week passed before the deal was announced, with the clearance still required from European competition authorities.

In the end, Lufthansa got the aid that it desperately needed, but at the expense of turning back the clock on nationalization, with the state now by far the single-biggest shareholder. For the government, it’s a compromise between state intervention and giving key companies enough room to maneuver.

Merkel’s Role

Ultimately, Merkel prevailed by staring down Spohr’s threat of insolvency, letting the other side make the first move before piecing together a compromise that suited her best.

Whether the deal will survive legal scrutiny brought on by the likes of Ryanair remains another uncertainty in the high-stakes negations. One thing that the government made clear is that its investment is finite, and that it plans to retreat again, ideally with a tidy profit, considering it picked up its stake at a steep discount.

“When a state spends that much money, it has the obligation to make sure that this investment does not come at the taxpayers’ expense,” Scholz said after announcing the deal, the biggest aid package yet delivered by the government. But likely not the last.

©2020 Bloomberg L.P.