City demands a creditable deal

It is only within the last decade that that the city has started to take the travel industry seriously.

The failure of Court Line in the 1970s and the collapse of ILG in 1991 left investors with the feeling that the industry was unable to get the balance right between supply and demand and that other sectors were a far safer bet.

“I think basically the City didn’t really understand the industry, ” admits Merrill Lynch first vice-president, Bruce Jones. “They would pass their travel agent and see lots of discounts and didn’t understand that it didn’t necessarily mean a company was in a mess. It took the market time to realise that selling the last few seats at a discount was not the same as selling whole aircraft at a discount.”

It took the successful growth of Airtours under chairman David Crossland to make the City change its mind.

“Airtours’ first bid for what was the Owners Abroad was liked by the market, ” said ABN AMRO director Andrew Monk. “It was the first sign of consolidation and the market likes consolidation.”

Airtours then bought Scandinavian Leisure Group in 1994; sold almost a third of the company to Carnival Cruise Lines in 1995 and decided to buy its own cruise ships. The market was sceptical about Crossland’s decision to buy the ships, but loved the SLG deal and felt that her was a man they could back.

“There was pretty mixed management in the leisure sector and David Crossland stood out,” said Jones. “If you were giving a 1990s award for best management then Crossland would win it, no doubt. First Choice chief executive Peter Long would also be in it along with David Michels from Stakis and Gerry Robinson from Granada. But after that you’d be struggling.”

By 1996 the City was also more convinced that the whole sector was starting to value profit over market share. After the disastrous summer of 1995, when an excess of supply over demand led to widespread discounting and falling profits, capacity was cut for 1996 and the industry seemed to have learned its lesson over price wars.

“It wasn’t just Airtours that was profitable, all the major players were doing well,” said Monk. “The whole industry has attracted the backing of financiers. It’s also benefited some of the smaller players, who wouldn’t have been bought if the big boys had not been backed.”

The City’s affair with the industry has been severely tested this year. A flat market and the performance of market leader Thomson Travel Group has sent share prices crashing and investors heading for more stable environments.

Thomson issued two profit warning and former chief executive Paul Brett reacted hysterically to Airtours’ bid for First Choice, claiming he would flood the market with cheap holidays.

Brett paid for that comment with his job, but the old fear that operators would put market share above profit reared its ugly head. Currently winter and millennium bookings are poor and analysts are not rushing to advise clients to invest in the sector.

Jones said: “The sector has taken a step backwards this year.

“Trade in leisure shares has been flat. The market is cautious about rising interest rates. On top of that, Thomson floated at 170p in May 1998 and you have to wonder whether it will reach half that price. Then you’ve had two profits warnings. It revives memories of getting it wrong and the penalties for that are high.”

Monk added: “When Brett spoke, with all this “we are going to put capacity on” and “we are going to stay number one”, it was a disaster. The City didn’t want to hear that.

“The Thomson problems are 90% Thomson’s, not the market’s. If you look at Airtours, Canada is the black spot, not the UK.”

Both analysts believe Thomson has been slow to react to market change in the 1990s and has lacked the innovations of rival Airtours.

“Thomson has got a wonderful brand, but if you don’t look after it you will lose your position. Thomson is like Sainsbury’s and Airtours is like Tesco. Ten years ago, Sainsbury’s was untouchable, but now it has been overtaken.

“Thomson has done absolutely nothing in terms of innovation in the 1990s. It’s only done one brilliant thing and that was its flotation – that was a masterpiece.”

As Travel Weekly went to press, Thomson has yet to decide whether to give acting chief executive Roger Burnell the job on a full-time basis. But the analysts believe that Thomson will struggle to raise money in the City for vital investments unless they appoint a new man.

Monk also believes that the European Commission’s decision to block Airtours’ bid for First Choice has put a dampener on the shares.

“It is basically saying there will be no more consolidation and the City likes consolidation, so that hasn’t helped the shareholders.”

Jones believes millennium sales have been a flop because people refuse to pay high prices to celebrate the event.

“If you look at the consumer, he is much more careful about value. It’s like the eclipse – people would not pay ridiculous prices for holidays at that period,” said Jones.

Monk added: “Clearly the millennium isn’t brilliant, but Thomson wrongly thought it was going to be great.”

Jones is a bit more optimistic about 2000. “After a year of flat volume, the economy will improve and there should be a 2%-3% increase in price and volume.”

Monk expects operators will be sensible about capacity next year after tough trading in 1999.

“I usually never believe tour operators about capacity, because they all lie like hell, but I think Thomson will have to cut capacity. Airtours will say it is unchanged, but put some on if it can, because it is quick on its feet. Out indications are that Thomas Cook will also be pretty stable.”

Jones doesn’t believe there is any magic solution to return the industry to favour in the City.

“It’s a question of grafting away and waiting for the investment to return. The City wants to see an improved performance.”

Monk said leisure companies need to continue acquiring. Expansion is likely to be overseas following the EC’s block on Airtours’ bid for First Choice.

“It’s a deal-driven sector,” said Monk. “The market likes deals, and that’s when you get an increase in the value of shares.”

Monk also believes vertically integrated companies will switch focus to concentrate on acquiring abroad in the new millennium.

“In the 1970s, people were building tour operators,” said Monk. “In the 1980s it was airlines, because without seats, you didn’t have a tour operation. In the 1990s, it was distribution, because without a high-street presence, you couldn’t sell your product. In the next decade distribution will be far more open with the onset of digital television and the Internet and the focus will be on accommodation and content.”

“If Airtours could buy Majorca, I’m sure they would have done.”

Jones agreed: “Suddenly Preussag in Germany has been more forward in controlling accommodation near the beaches.

“It’s a European game now,” added Monk, “If Preussag buys a hotel rather than Airtours, it might put only Germans in there and the UK consumer is going to be the loser.

“The question is, “Can Airtours beat Preussag?” – not can Airtours beat Thomson or First Choice? I think only two players – Preussag and Airtours – have the capacity to be truly global players. The others have slipped too far behind.”

Monk thinks UK corporate deals will continue, but on a smaller scale.

“You’ll see little deals, but they won’t be occupying Crossland’s thoughts. There’s plenty to do in North America and Europe.”

Both analysts have a lot of respect for First Choice chief executive Peter Long, who took over the company at a difficult time and has steadily improved its fortunes to the point where it is on course to make £60m profits this year.

However, they feel that following the EC’s decision to block Airtours’ takeover of the company, First Choice has several issues to solve.

“Strategically, First Choice has got to think where it is going,” said Jones. “There’s a question over distribution. At the moment it is trying to have the best of both worlds by building its own retail chain and then being everyone else’s number two.”

Monk added: “Distribution is a problem for the company, but over time it will become less of a problem.”

Jones expects First Choice to strike a deal with a European firm.

“It’s in danger of being number four in the UK, without any continental Europe appeal. I think it will do some sort of deal or alliance.”

Monk added: “First Choice obviously thinks that because it tried to do a merger with Kuoni. I don’t like the way joint ventures or alliances work – you either have to own or merge.

“I think First Choice needs to change. It has a good UK business, but it has a business in Canada which adds no extra value to the group. It needs to sell the Canada operation and invest in things that add value, either buying a European business or buying accommodation.”

Monk believes British Airways, which is on course to lose £200m in the year to March 2000, has got huge problems.

He claimed its Oneworld alliance is not as effective as other airline alliances and said BA’s policy of cutting back economy seats and concentrating on premium traffic is fatally flawed.

He said: “Currently Star Alliance is taking Oneworld to the cleaners. Star Alliance is really co-ordinated and has great benefits for members.

“I think there are a lot of problems with BA, but the concept of going for margins and reducing your turnover is absolutely suicidal. BA must be off its rocker. In today’s industry, every company is trying to maximise their turnover because they know at the end of the day in a low inflationary environment, margins will not hold.

“If they continue, the days of BA being a global leader will very rapidly be over.

“Most people fly BA because their company has cut a corporate deal or they are collecting Air Miles for free holidays. Those are not great reasons. Someone could come along and offer a better deal or tax Air Miles so they are not worth having.

“BA has to completely change its policy. [Chief executive]Bob Ayling does change his mind, because he painted all the tail fins nice colours and then decided that was a waste of time. But I don’t see a U-turn in the BA policy coming. If I saw it, I’d be a buyer of the share, but at the moment I continue to be a seller.”

The 1996-98 period was a golden time for the hotel industry, with companies notching double-digit growth increases each year.

But by 1998, investors were getting nervous, believing the bubble would soon burst and the shares started to fall.

This year, the market performed well in January and February, but has since been static, leaving the sector out of favour in the City.

Jones said: “The hotel companies are all performing badly.

“It’s as flat as a pancake. I haven’t known the hotel sector to be as dull as this for 10 years – no-one is interested in the shares.

“Hoteliers have just got to graft away and offer good deals to entice people back.

“But looking ahead there is a big link between UK gross domestic product and hotel profits. So if the economy is good next year, then that could be good for profits.”