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Ryanair Launches Air War In Europe

Posted: May 12, 2008 11:46 AM by Eugene Bukoveczky

Tickers in this Article: RYAAY, BA, DAL, NWA

It's been more than 60 years since the end of WWII, but it now looks like an air-war could once again erupt over the skies of Europe. This time however, the prize is not a military victory, but a financial one.

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Recently, Michael O'Leary, the outspoken chief executive of Europe's largest budget airline Ryanair (Nasdaq:RYAAY), announced that his airline would be halving ticket prices. The announcement comes at a time when soaring oil prices are squeezing margins for the global airline business, prompting bankruptcies of several regional carriers in the U.S. and forcing the proposed merger of Delta (NYSE:DAL) and Northwest Airlines (NYSE:NWA).

If it follows through, Ryanair's move could prompt a devastating fare war in Europe that could knock some of Ryanair's competitors out of the skies. One possible victim could be Germany's second largest carrier, Air Berlin. (For further reading on competition, read Competitive Advantage Counts and Economics Basics.)

Weaker U.S. Dollar Helping Ryanair
The strategy is not with risk to Ryanair; it's highly vulnerable to rising fuel costs itself. It recently went on record that it would not be tacking on a fuel surcharge to its ticket prices despite the fact that it currently has no fuel price hedges in place. However, well timed currency transactions designed to take advantage of the U.S. dollar's decline against the euro have helped the company offset higher fuel costs. While it reports its revenues in euros, about 60% of its costs for items such as planes, insurance and fuel are denominated in dollars. (To see how a rising or falling dollar can influence company profits, read The Impact Of Currency Conversions .)

Hidden Aircraft Value Could Entice A Takeover
O'Leary is also no stranger to reaping a huge payoff for the company from making bold and well-timed moves. In the wake of the 911 attacks, when the global airline industry also faced considerable stress, he placed a massive order with Boeing (NYSE:BA) for 100 new aircraft and options on 50 more at rock-bottom prices. Subsequent renegotiations and additions to the deal have increased the number to 150 planes on order, with options to buy another 70.

Now that strong demand for planes has lifted prices significantly, analysts have now calculated that the deal provides Ryanair with a hidden value of $3.6-4.1 billion, giving it a break-up value of $8.5 billion, which is $2.6 billion more that its current market value. Numbers like that have prompted a degree of speculation about the company being a potential takeover candidate, with a private equity player the most likely suitor. (To learn more, read Trademarks Of A Takeover Target.)

The Bottom Line
So far this year, Ryanair shares have lost about one-third of their value, roughly in line with the declines faced by the rest of the industry. The selloff had, in part, been triggered by company predictions that a "perfect storm" of higher fuel costs, declining traffic levels and falling fares could slash profits by as much as 50% in the fiscal year ending March 2009. Now that it has fired a first shot in a potential fare war, you'd have to assume that a sharp decline in profits this year is now a dead certainty. However given ample warning, its now likely that shares are fully discounting that outcome.

What they may not be discounted at this point is the enormous strategic gain that Ryanair could reap if it wins its European air offensive. That, plus the company's (below market) value to a potential acquirer, could see the stock regain some altitude from its currently depressed level.

By Eugene Bukoveczky

Eugene Bukoveczky is a freelance writer and investment researcher. He holds a CFA designation and has spent several decades working in the investment business in places like Toronto, New York, London and Dubai. He currently resides in Nova Scotia, where, when not writing, he devotes his time to chopping wood, growing his own vegetables, riding his bike to the store, and thinking about other ways to reduce his carbon footprint.

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