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Easy does it

Investors love EasyJet's low-cost strategy. But is the British upstart flying too close to the sun?

By Hugh Filman
January 2002
Institutional Investor Magazine

No global industry has been harder hit by the September 11 terrorist attacks on the U.S. than airlines. Sabena and Swissair have plunged into bankruptcy. Most major U.S. carriers are relying on a government bailout package to stay aloft - none had been rolling in profits, and TWA Airlines had already gone belly-up. Many of Europe's state-assisted national flag carriers, ailing before the disaster, are taking desperate measures to survive.

So the decision by an upstart low-cost airline to launch a new share offering in late October seemed bold, to say the least. But "bold" sums up the style of Stelios Haji-Ioannou, the 34-year-old founder, chairman and one-man advertising department of London-based EasyJet. While much larger competitors like British Airways have cut routes and jobs to deal with the crisis, EasyJet, which serves only Europe, has kept its entire 26-plane fleet in the air. And thanks to aggressive pricing, the airline's passenger counts recovered within weeks to their pre-September 11 levels; other carriers' business continues to languish.

EasyJet wasn't the only airline to come to market shortly after the disaster. Australian carrier Qantas Airways was the first out of the gate, raising $230 million in early October to buy more planes. But Haji-Ioannou and his team pulled off their Ï97.5 million ($141.9 million) share issue, less than a year after EasyJet's initial public offering, with institutional investors vying to get on board - and with an innovative twist to the deal. "I think investors have woken up to the fact that there is only one business model that makes money in this lousy industry," says the chairman. "That's the low-cost model."

Indeed, while traditional European airlines are losing passengers and money, cut-rate carriers like EasyJet and rivals Ryanair Holdings and Go are taking off. Patterned on Southwest Airlines Co. in the U.S., EasyJet is filling its planes, making profits and sitting on enough cash to fight a long battle with Europe's wounded aviation warhorses. As a result, it stands to be a principal beneficiary of Europe's coming airline shakeout. Asserts Ray Webster, EasyJet's chief executive, "What September 11 has done is demonstrate the robustness of the low-cost sector against the traditional airlines."

EasyJet takes the minimalist approach to air travel. That means no travel agents, refunds or paper tickets; passengers must forgo such amenities as lounges, business class, frequent-flyer miles or free meals. About 90 percent of sales are made over the Internet, the remainder by phone. And EasyJet aims for a turnaround time of 25 minutes on the ground, so it can fly its planes an average of ten hours a day - compared with five or six hours for most airlines. HSBC Securities estimates that cost per available seat-kilometer is about 3.73 pence (5.37 cents) for EasyJet, versus 4.94 pence for British Airways and 5.36 pence for Air France.

The company bolstered belief in its no-frills strategy when it announced strong financial results for fiscal 2001, ended September 30: retained profits of £37.9 million - up 72 percent from fiscal 2000 - on revenues of £356.9 million. EasyJet's balance sheet showed a cash surplus of £161.1 million. And although its stock nosedived from £4.26 to £2.48 - well below its original issue price - immediately after September 11, it recovered more quickly than other airline shares when it became clear that the company was maintaining its routes, keeping its staff and filling its planes. (By late December the stock had risen to £4.88.)

Meanwhile, Haji-Ioannou and Webster watched full-service rivals like Aer Lingus Group, Alitalia, Iberia and KLM Royal Dutch Airlines cut back their operations. They decided that EasyJet was in a position to exploit the weakness of its competitors. They wanted to take over routes and airport slots abandoned by the larger, less nimble airlines. They also wanted to be prepared for any further turbulence, such as a sudden call to refinance an aircraft order. And they had to move fast to raise cash. As Webster notes, "This is not a good time to be running on empty."

The complex offering, managed by Credit Suisse First Boston and UBS Warburg, was a coup of canny deal making and market timing. Under British law, capital increases of more than 5 percent qualify for preemptive share entitlement: Existing stockholders have the right of first refusal for 21 days before new shares can go on the open market. To circumvent that requirement, Haji-Ioannou sold 19.5 million of his own shares, on top of 13 million that he was selling separately from the offer. He also agreed that he would immediately buy all the entitlement shares in the offering that weren't taken up by other investors, besides those to which he was himself entitled. New buyers could get shares with no waiting period because they were buying Haji-Ioannou's stock.

Thus the chairman essentially underwrote most of the EasyJet offer, avoiding three weeks' worth of anxiety during a volatile time in the market. "They obviously preferred to execute the transaction in as short a time frame as possible - witness the later crash in New York," says Simon Aird, who oversees primary transactions in equity capital markets at CSFB. "The structure was relatively innovative and was possible basically because of the unique relationship between Stelios and the company."

The share issue closed on November 1, after a four-day road show, and ended up nearly five times oversubscribed at £3.75 per share - up from an asking price of £3.63. "It was slightly more than we expected but not totally surprising in hindsight, because the story was very good," says Philip Ellick, a UBS Warburg banker specializing in U.K. capital markets. Before deducting for fees, the company raised £97.5 million. And Haji-Ioannou personally raised £63.4 million.

Not everyone in the investment community has bought into the EasyJet story. Chris Tarry, airline analyst for Commerzbank Securities in London, is unsure about the company's ability to secure the airport slots it needs. He's also not certain that EasyJet can keep capacity in the mid-70 percent range - its breakeven passenger load - as it acquires 22 more planes over the next three years. "What they've done so far they've done well," he says. "It gets a little more difficult from here on in."

One fund manager who decided against signing up for the share offer adds that although he's impressed with EasyJet's approach, he's not sure the company can maintain the growth rate it needs to justify its market capitalization of £1.2 billion, roughly half that of BA, which has 286 planes and 60,000 employees. "The stock price reflects the potential for future earnings," he notes. "Expectations are high, so there's little room to maneuver." (Nevertheless, EasyJet's price-earnings ratio of 31 compares favorably with Ryanair's 34 multiple and Southwest's 42.)

And EasyJet is not the only thriving low-cost operation in Europe. It has strong competition from Go, which has emerged as a solid no-frills player since it was spun off by British Airways in 2001, and from Ryanair, a bigger budget carrier that's based in Ireland. There's a chance that Go might begin competing for slots at London's Gatwick Airport, where it would receive strong consideration because, unlike EasyJet, it does not yet have a presence there. Ryanair is paring costs even more aggressively than EasyJet.

But the Irish carrier flies older aircraft into smaller airports than does EasyJet, which is now focusing on major airports such as Gatwick and Amsterdam's Schiphol and seeking slots at Orly in Paris to capture a growing share of the business market. "Thank God they [Ryanair] are in a different space, in the sense that they tend to fly to these middle-of-nowhere airports," says Haji-Ioannou.

The confident, high-profile chairman is a significant competitive asset for EasyJet. The son of a Greek shipping tycoon and a graduate of the London School of Economics, Haji-Ioannou launched EasyJet in November 1995 at age 28; he'd already started his own shipping company with family money. Haji-Ioannou - who prefers that everyone call him Stelios - was looking for a new challenge when he ran into a fellow Greek businessman on Virgin Atlantic Airways' inaugural flight between Athens and London in 1994. The businessman suggested that Haji-Ioannou consider investing in the airline, which is controlled by Richard Branson.

So he checked it out. "In the process I met Branson and said, 'This looks like fun - I'll start my own airline,'" says Haji-Ioannou. Soon he was visiting Boeing Co. in Seattle, where he learned about Southwest's wild success with discount fares in the U.S. market and decided that the low-cost approach was the way to go.

As it happened, Webster was examining Southwest's operations at exactly the same time. During his 27-year career at Air New Zealand, he had worked his way up from apprentice engineer to general manager of strategy, and he was developing a plan for a low-cost Australasian carrier that would take advantage of the proposed deregulation of the Australian market. "Stelios and I had pretty much seen all of the same people at Southwest in pretty much the same time frame," although the two men hadn't met, notes Webster.

When Australian deregulation didn't happen, Webster's plan for a low-cost airline was grounded. Haji-Ioannou, by contrast, had £5 million in seed money from his family - with more to come if things went well - and access to the soon-to-be deregulated European marketplace. He lacked a chief executive, but he founded EasyJet anyway. Webster started getting calls from London consultants telling him about Haji-Ioannou's fledgling airline. "Initially, I dismissed these calls because I didn't think anybody from Greece with a shipping background would know very much about starting a low-cost airline," Webster says. But he eventually contacted Haji-Ioannou, who was equally skeptical that a New Zealander would know how to run a European airline. They agreed to meet, although Haji-Ioannou insisted that Webster pay his own way to London. Twenty minutes into their meeting, Haji-Ioannou knew he had his man.

Webster's long operational experience has freed Haji-Ioannou to promote the brand. The chairman believes his public appearances were vital to getting EasyJet off the ground. "What I've learned from Richard [Branson] more than anything else is the power of personalizing the brand in the early stages," he says. "When you have a tiny company with a relatively small advertising budget - much smaller than your competitors' - the only way to pull it off is to put your face in front of the airline. The media tend to report more on people than on companies, so having a company with a face makes it easier to generate PR."

EasyJet has benefited from some aggressive publicity stunts. For example, Haji-Ioannou showed up on Go's 1998 inaugural flight to Rome with a team wearing boilersuits in EasyJet's signature orange, handing out leaflets and offering free flights. The stunt made Go, then British Airways' new, low-cost subsidiary, look like the copycat it was. "You need that third-party independent endorsement from the incumbent to actually say you've arrived," says Haji-Ioannou. He believes that once the market leader tries to put a start-up out of business, the new company has proven it's doing something right and can start exploiting its underdog image.

Besides maintaining a high profile, Haji-Ioannou has taken another leaf from Branson's marketing book. Just as the flamboyant Branson has slapped the Virgin name on everything from record stores to trains to mobile phones, so Haji-Ioannou is launching brand extensions. He has started a string of businesses, including EasyCar for online auto rentals, EasyMoney for credit cards, EasyValue for online shopping and EasyInternetCafé - all of them, like his airline, stressing value and simplicity. (Haji-Ioannou makes yield management the bedrock of his pricing strategy: Internet time at the café, for example, is cheaper on weekends and late at night than during prime business hours.)

But cross-branding comes with hazards. "The risk is that if one of these businesses fails - and it's inconceivable that Stelios can pick just winners - that will damage the EasyJet brand," notes Webster. Nevertheless, Haji-Ioannou plans to continue spreading his logo. His next venture is EasyCinema. "I think it's a fascinating space," Haji-Ioannou says. "Everybody's going bankrupt, and there will be a lot of opportunities to pick up real estate and really do a low-cost cinema model like the airline." He won't discuss specific plans, but customers might pay less for advance tickets than for last-minute seats, for instance.

Meanwhile, Haji-Ioannou and Webster would love to see EasyJet grow into a European version of Southwest. The airline that started with two leased planes now has 26 new Boeing 737s and is scheduled to expand to 48 by the end of 2004. Webster says the airline can easily shoulder any additional security costs in the wake of September 11, which he does not expect to be large. Stricter security in the U.S. has cost domestic airline operations there heavily, but carriers in Europe aren't taking the same financial hit. Security was already tight in most European airports - particularly in the U.K., where terrorist threats from the Irish Republican Army and other homegrown groups have been a concern for decades. The blowing-up of a Pan American World Airways jet over Lockerbie, Scotland, in 1988 prompted many European airports to implement even higher security. "We may have to require passengers to come ten to 20 minutes earlier," says Webster, "but it's unlikely to have a significant impact on our cost base."

Indeed, instead of pulling back after September 11, EasyJet has gone after more market share. On September 20 the airline marked down prices on all routes, and passengers came flocking back. In October the airline flew at close to its pre-September capacity - its 82 percent load factor for the month was barely below its 85 percent of a year before - and total passenger traffic was up 33 percent year-on-year. British Airways, on the other hand, cut 190 flights from its weekly schedule and eliminated 7,000 jobs in September as its passenger numbers failed to rebound. BA's remaining planes flew at 63 percent capacity in October, down 8 points from the same month in 2000. Most European discounters have recovered better than BA.

EasyJet has also stepped up efforts to capture the business market. The airline estimates that the number of passengers who fit its business profile rose from 35 percent in mid-2000 to 50 percent by the end of 2001. HSBC transport analyst Damian Brewer notes that with the economy sputtering, some business travelers are being forced to trade down from more-expensive airlines. Ian Murdin, business travel manager for London-based Nestlé UK, says his company has mandated that employees fly economy class for trips under six hours and that a growing number - himself included - are turning to EasyJet and other low-cost airlines. As a global company, Nestlé is particularly happy that EasyJet flies to major business centers like Geneva and Amsterdam. Murdin would like to see more mainstream destinations and more frequent flights.

Haji-Ioannou and Webster believe that there will be room for more than one low-cost carrier once the current crisis clears away foundering European flag carriers. "The worst thing that can happen at the moment is we have so many airline failures that EasyJet can't grow quickly enough to fill the void," says Webster. He envisions one day running a Southwest-size operation with 300 planes. But he believes that after posting 35 percent growth in its first year as a public company, EasyJet shouldn't expand by much more than 25 percent annually. "We need to make sure that we operate on time. We need to remain safe. We need to generate profits as well as growth," Webster says. For now, his airline is making that look easy.