Up in the air.

Cintra has finally been ordered to break up--but not everyone is pleased

Sound too good to pass up? Four major U.S. airlines think so. Before the end of this year, Mexico will place Mexicana and Aeromexico--the nation's two top airlines--on the auction block. As one may well imagine, a bidding war is likely to ensue.

HITTING TURBULENCE

During the past two decades, the Mexican airline industry has been flighty at best. In the early 1990s, the federal government sold the airlines to private investors. Five years later, however, the government had to take Mexicana and Aeromexico under its wings after an alleged US$61-million embezzlement scandal left both airlines heading for bankruptcy.

In 1995, the Federal Competition Commission (CFC) authorized Aeromexico's and Mexicana's creditors to create a holding company known as Cintra. At that time, Cintra agreed it would divest the potential monopoly once the airlines were deemed solvent. For many people in the industry, that came sooner than they would have liked. In October, the CFC ordered the holding company to break up after ruling that Mexico's number-one and number-two airlines were holding a monopolistic grip on the industry. As it is, Cintra controls about 80% of the domestic airline market.

The ruling quickly came under fire, particularly from pilot and flight attendant unions, who said the breakup would allow foreign investors to take over a greater share of the domestic market and would endanger job security. Moreover, they argued that the two airlines would face difficulty trying to survive on their own in an increasingly competitive sector. Strongly opposed to the decision, Aeromexico and Mexicana workers went on strike shortly after the CFC made its announcement, shutting down the Mexico City International Airport for two hours and demanding Cintra seek an injunction to block the ruling.

But it was not private investment that they were trying to halt, says Flight Attendants Association Union (ASSA) leader Alejandra Barrales.

"We've seen privatization (in the industry) and it was a disaster," she said in a telephone interview with BUSINESS MEXICO. "After that, we saw (the problems associated with) a mixture of private interests and the government. We are not against privatization, what we are seeking is to ensure that investors are willing to inject money into the airlines after they buy into them."

Although employees at both Aeromexico and Mexicana have been advised not to make official comments until the sales are final, one source at Mexicana claims Barrales' fears are unfounded:

"The IPAB (Banks Deposits Protection Institute) and the SCT (Communications and Transportation Secretariat) have made it clear that they are not just going to sell to the highest bidder, but to the company that is willing to invest in Mexicana and not just sell off the assets," said the source, who asked to remain unidentified. "(The buyer must have) a solid business plan that shows it is coming in to develop, not to destroy."

Barrales is not so sure. On several occasions, she has challenged the CFC ruling. In a recent radio interview, she accused CFC President Fernando Sanchez Ugarte of acting with personal interests and consequently jeopardizing the future of the nation's leading airlines. She says Sanchez's brother, Jesus Sanchez, works for a Mexico City law firm that represents American Airlines--a prospective buyer.

"There were several statements by American Airlines that it was interested in buying one of the airlines," she told the Mexico City radio program Monitoreo y Analysis. "Given the situation that Sanchez's brother represents American Airlines, we believe the CFC does not have an objective vision. We believe there is a conflict of interest."

Fernando and Jesus Sanchez flatly deny the allegations.

"I do not have a brother that works for an airline and there is no conflict of interest," he said during the program. "American Airlines will confirm what I am saying. The only reason Barrales has made these accusations is because she has no solid argument as to why the industry shouldn't be more competitive."

Jesus Sanchez says that his company represented Sabre, a reservations system that is under the same parent company as American Airlines, but that was before Cintra came into existence.

"It's completely absurd what Barrales is saying," he says. "Our dealings with Sabre concluded six years ago and I was not even involved in that contract."

One of the most important decisions, which could come as early as September, is whether the airlines will be sold together or separately. The most likely scenario is that Mexicana and Aeromexico will be sold off separately.

Banorte airline analyst Francisco Suarez says that could bring more economic hardship for both companies as neither airline is prepared to survive on its own.

"If the two airlines are sold off separately, their profit margin will drop," he says. "I don't think the time was right to break up Cintra."

The CFC disagrees.

"Both airlines are financially solid and they both belong to international alliances that offer them strong business opportunities," the regulatory body said in a statement. Furthermore, "the CFC's ruling to break up Mexicana and Aeromexico will promote competition in the airline industry, which the CFC considers an important factor in reducing fares, opening the market and offering better customer service," it said.

HOLDING PATTERN

Although it's all systems "go" for the sale, Barrales and others who are against the Cintra breakup hold one last card in their hand. In the upcoming months, Congress plans to call on the CFC, Cintra, the SCT and the IPAB to help lawmakers determine the proper course of action once the bidding begins.

Although Congress has no say on the CFC's ruling to split Cintra, legislators may push to modify the Constitution so that the airline industry could become exempt from competition rules. By deeming it a so-called strategic industry, the government anti-trust watchdog would be all but powerless against the commercial aviation industry. If any such bill was to pass, it may in effect cancel out the CFC's ruling.

Barrales, who is also is a federal deputy for the center-left Party of the Democratic Revolution (PRD), says lawmakers of all political stripes have hinted that they would support a constitutional reform, providing it offered the industry more long-term stability.

Banorte's Suarez agrees that a constitutional reform is necessary, but he fears that it stems from the unions' political interests. Still, he says he doesn't agree with the CFC's anti-trust ruling.

"In order for there to be a monopoly, two conditions must exist," he says. "First, the company must control a large percentage of the market. I agree that Cintra controls a large percentage of the market. Second, the company must be earning profits that are considered above normal. I think that part of the argument is very weak considering that the travel agencies and hotels are not willing to lower the commissions they charge airlines. The airlines are not earning as much as one might think."

JOINING THE PACK

Both airlines are members of international multi-carrier alliances. Mexicana belongs to the industry's leading consolidation, the 13-airline Star Alliance that transports 256 million passengers a year. Just last year, Aeromexico joined Sky Team, a four-airline affiliation that serves 174 million passengers annually and ranks third in airline joint ventures. With 69 jets serving 47 domestic and international destinations, Aeromexico has a slightly larger operation than Mexicana's fleet of 58 large aircraft that reach 45 cities.

United Airlines, a dominant Star Alliance partner and Delta Air Lines, which leads Sky Team in net earnings, are the two most obvious bidders. Both United and Delta, which operate many flights using code-share agreements with their Mexican partners, view the divestiture as an ideal opportunity to buy up a large chunk of the market. But American Airlines, which is always looking to expand its already broad Latin American market and has no Mexican partners, would like to gain a major stronghold in the market. Continental, with extensive Latin American routes, is also in the running.

The four U.S. airlines are eyeing a market with enormous growth potential. According to a report published by The Dallas Morning News, in 1999, 12.3 million passengers traveled between Mexico and the United States, compared to 8.8 million in 1995. Industry analysts say passenger volume between the neighboring nations is likely to become the largest bilateral market in the world.

Airline analysts say partners will receive first options in acquiring stakes in either airline. Foreign companies are limited to a 25% stake in each airline, meaning Mexican capital will hold the controlling stake. This is how the current ownership breaks down: IPAB holds 50.5% of Cintra, with the remaining stakes in hands of other government dependencies (roughly 10%), private share holders (20%), as well as Bancomer and Banamex banks (20%). With the approval of the other shareholders, Cintra contracted Merrill Lynch to carry out the sales of both airlines. Several regional airlines under IPAB's control could be sold in a package deal with the airline giants. Aeromexico may be sold with Aerolitoral while Mexicana may be sold with Aero Caribe and Aero Cozumel.

MESSY BREAKUPS

If the two carriers are sold off separately and forced to compete, average airfares are likely to drop at least 10%, which the CFC hopes will jumpstart more domestic air travel. According to the CFC, the domestic airline market currently reaches out to only 1% of the nation's travelers, and "passenger volume will increase with lower tariffs," it reported. "If the CFC did not order the breakup, the holding company would have few incentives to control pricing and offer better services.

But even if ticket prices come down, Barrales claims domestic air travel will continue to be expensive as long as taxes remain high.

"In Mexico, there is a 30% tax on airplane tickets compared to 13 to 15% in the United States," she says. "We think that plays an important part in pricing and it is another policy that we are reviewing in Congress."

The breakup of Cintra has raised more questions than answers. For union leaders, it is a question of securing a future for some 14,000 Aeromexico and Mexicana employees and the health of the Mexican airline industry. For the CFC, it's a question of breaking up a monopoly that has a stranglehold on pricing. As for the U.S. airlines, the most pressing questions are when and how much.

John Hecht is a Mexico City-based freelance reporter.

AIRLINES

For Sale: Mexican airlines with extensive routes and growing passenger volume. Opportunity to earn millions of dollars. Asking price: US$500 million each or best offer. Send all inquiries to Merrill Lynch Mexico. English spoken.

* Scouting out an airport

With only two runways that are technically impossible to operate simultaneously and passenger volume at the Mexico City International Airport reaching 21 million, few would argue that the time is not ripe to build the capital a new airfield. Instead, the debate has focused on where to build it. All signs point to Texcoco, a decision that is likely to spark protest from environmentalists and residents alike.

Although the Communication and Transportation Secretariat (SCT) is keeping its decision under wraps, Texcoco Mayor Horacio Duarte Olivares says his city is the most likely possibility. Its main trump card being its relatively short distance from downtown Mexico City. Tizayuca, the alternative location in the state of Hidalgo, is some 80 kilometers (50 miles) from the Zocalo, the heart of the city center, while Texcoco is only 34 kilometers (21 miles) away.

But unlike Tizayuca, building an airport in Texcoco has raised serious environmental concerns. Mayor Duarte says decades of hard work and government funding to restore the Lake Texcoco basin could go to waste as thousands of acres would be lost to make room for the new airport. Since 1971, 30 million trees have been planted in the region, which nature conservationists say has helped improve the air quality in the smog-infested Valley of Mexico.

Though Duarte welcomes the potential investment and employment opportunities that the project would attract, he says many residents fear over-development and a population boom. City planners estimate that Texcoco's population of 204,000 inhabitants would increase 15% annually. In just six years, it would nearly double.

"One of the most important questions that we are weighing," Duarte says, "is whether a development of this nature will offer people here a better life."

Engineers are also carefully studying Texcoco's spongy soil. Rapid sinking, they say, is a distinct possibility. Texcoco would be a costly alternative, requiring complex drainage systems and excavations 132-feet deep. To make matters worse, Texcoco sits atop a shrinking aquifer that will continue to drop precipitously for at least the next half century before the rate of collapse is expected to naturally slow.

The existing airport has been sinking an average of two feet a year since its construction in the 1940s. Every two years, engineers must backfill the runways' southwestern end to level them. Texcoco is likely to present similar problems.

Federal District airport authorities say a steady increase in traffic and passenger volume has left them few options but to build, and build fast. Theoretically, the airport can operate at a maximum capacity of 55 flights an hour. During peak season, that number shoots up to 78 flights an hour. The proposed Texcoco airport would operate with three runways at a maximum capacity of 151 flights an hour.

According to its most recent statistics, some 296,000 flights arrived and departed from the Mexico City International Airport in 2000, making it the nation's busiest airport. The airport ranks among the top 50 airports worldwide.