New Air France-KLM CEO must avert slow descent in France

By Victoria Bryan and Cyril Altmeyer

PARIS/BERLIN (Reuters) - Air France-KLM's (AIRF.PA) next CEO faces an unenviable task if they want to avoid the fate of Alitalia. The manager needs to deal with union resistance to restructuring at its core Air France brand, keep increasingly frustrated KLM staff onside and battle rising oil prices.

The Franco-Dutch airline on Tuesday named Chief Financial Officer Frederic Gagey as interim CEO as part of a transitional team, replacing Jean-Marc Janaillac, who quit earlier this month after he lost a vote on a pay proposal.

Air France-KLM, hamstrung by strikes that have cost it around 400 million euros ($477 million) this year, has watched from the sidelines as Lufthansa (LHAG.DE), IAG (ICAG.L), Ryanair (RYA.I) and easyJet (EZJ.L) have driven European consolidation.

"Because Air France has had problems at home, they've been less able to take advantage of the opportunities in European airline consolidation. It would have made perfect sense for them to go after Vueling or Air Berlin and they were not able to," said Samuel Engel, head of the aviation practice at London-based consultancy ICF.

German rival Lufthansa found a way out of its own legacy labor issues by setting up a separate low-cost airline, showing a potential path for Air France-KLM if it is able to get beyond its current impasse with the trade unions, said HSBC analyst Andrew Lobbenberg.

French unions have staged 15 days of walkouts since February, demanding a pay hike after six years of pay freezes.

"It needs to mimic the strategic development that Lufthansa undertook moving on from its initial Germanwings low cost business, which was tied to Lufthansa labor terms, to Eurowings which is an independent entity," Lobbenberg wrote in a note.

Air France-KLM could therefore consider buying an existing stand-alone business, he said, with other options being to start up a new carrier itself or use a Dutch platform.

ATTRITION

Back in 2005, Air France was riding high. Thanks to a deal to buy struggling KLM, it was the world's leading airline group by sales and it paved the way for rivals to follow with mergers of their own.

Fast forward a decade and the Franco-Dutch airline has fallen back to fifth place in terms of revenues, behind American Airlines (AAL.O), Delta (DAL.N), Lufthansa and United (UAL.N), which have all grown via mergers.

Industry experts fear it could face the same fate as Italian flagship carrier Alitalia - currently being propped up by the Italian government and seeking investors - unless drastic restructuring occurs.

"The most likely outcome is a slow decline, a slow attrition, like Alitalia," said a former Air France-KLM executive who asked not to be named.

KLM is now the more profitable part of the business, while years of slow progress in cost cutting at Air France have hampered growth at the French airline.

Looking within the Franco-Dutch group shows how the more efficient airline, KLM, has grown its fleet and maintained market share, even in the light of the rise of low-cost carriers at both Paris and Amsterdam.

The KLM fleet including Transavia has risen 20 percent to 208 aircraft since 2004, the year of the merger, ICF's Engel said. Meanwhile, the Air France fleet including aircraft allocated to new lower cost brand Joon has shrunk 8 percent to 227 planes.

"If you are Air France-KLM management and you're unable to restructure labor inside Air France, you do the rational thing, which is to shift as much capacity as possible into the Dutch entities," he said.

This decline was partly to blame for the ejection of Janaillac as CEO, said the former executive.

"The no vote reflected a deeper malaise, beyond that of pay; a malaise linked to the feeling of decline within the company," he said.

Still, KLM's CEO Pieter Elbers does not believe it is feasible for the Dutch airline to go it alone, he told Dutch public broadcaster NBO in an interview aired this week.

"If I had to go up against Delta Airlines all by myself with 200 airplanes, against their 1,300 airplanes, then it's nice to have a French brother next to me," he said. "He does have to be a strong brother, because then we can face that fine."

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(Editing by Alexandra Hudson)