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Five Reasons the Airline Industry Could be Profitable

March 12, 2010

1 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction to airline industry  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

2 CONFIDENTIAL

L.E.K. Consulting is a leading global strategy consulting firm

Overview

Established in 1983 Clients include 25% of the largest 200 companies globally, as well as innovative start-ups and leading private equity firms Areas of expertise include: Strategy Transaction Services Finance Marketing and Sales Operations Organization Worldwide over 1,000 staff, led by 104 Vice Presidents in 20

• ffices

Global Network

L.E.K. company overview

Tokyo Los Angeles San Francisco London Munich Milan Mumbai Beijing Shanghai Singapore Melbourne Auckland Bangkok Chicago Paris Boston New York Sydney New Delhi Wroclaw

3 CONFIDENTIAL

L.E.K. is the #1 strategic advisor to the aviation industry

Airlines Airports Other Industry Players Investors Aerospace Manufacturers L.E.K. company overview

4 CONFIDENTIAL

L.E.K. is at the forefront of all the key strategic moves in the industry

Company Assignment Global News Coverage  Industry-leading Ancillary revenue strategy and implementation  Diagnosis of high-profile irregular operations event  Major strategy review of all aspects of its business  On Time Performance (OTP) Turnaround  World’s largest airline merger  Frequent Flyer program spinoff analysis  Maintenance division spinoff analysis  Support for acquisition of ACTS (MRO division)

Major Global Airline Blue Chip PE Investor

     

L.E.K. company overview

5 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

6 CONFIDENTIAL Note: *This deficit includes only international airports

Average Annual Global Economic Surplus and Profit Distribution across the Air Travel Value Chain (2003-2007): Net Deficit: $4B Net Surplus: $567B

(U.S. = $197B)

Net Surplus: $1B Net Surplus: $8B

(U.S. = $3B)

Net Deficit: $8B

(U.S. = $5B)

Net Deficit: $1B* Net Surplus: N/A

Airline Airport Customer Society Government Downstream Participants Labor External Factor Cost

While the airline industry generates an economic deficit, others in the travel eco- system such as government, customers, and labor are significant beneficiaries

Introduction

7 CONFIDENTIAL Note: * Top 5, excluding airlines with fewer than 8 years of data Source: CapIQ, Compustat, L.E.K. analysis

However, over the past 10 years there have been successful airlines that have generated significant shareholder value

$11.6B $201M $3.8B $204M $32.7B $212M $9.9B $84M $9.7B $69M

10-Year Average Annual NOPAT Less Capital Charge 2007 Total Revenue “Winning” Airlines*

Top 5 Airlines by 10-yr Average Annual NOPAT Less Capital Charge

Introduction

8 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

9 CONFIDENTIAL

Due to price transparency and intense competition, airlines have very limited ability to capture higher yields by increasing published fares

(2.1)% (1.2)% (1.0)% (1.0) 0.0 (2.0) (3.0)

Source: APGDat, Online survey of consumer marketing panel using average published fare of $354, L.E.K. analysis

Airlines generally cannot raise prices without losing revenue and market share; other revenue opportunities are essential

Ancillary revenue

Estimated revenue impact of higher fares for a leading U.S. carrier

% impact on total revenue

Published fare Published fare +$10 Published fare + $5 Published fare +$2

Illustrative

10 CONFIDENTIAL

Ancillary Revenue streams, such as baggage fees, have enormous ROI and rapid payback

Source: L.E.K. analysis

 100x ROI in first 12 months post- launch of an “unbundling” strategy for a Legacy  140x ROI in first 12 months post- launch of an “enhancement” strategy for an LCC  A L.E.K. engagement resulted in project pay-back within three days of launch  In addition, the incremental annual profit from one single “launch initiative” was US$70m Key Benefits of Ancillary Revenue High Margin Low Investment Required Not Competed Away Quick Uptake High ROI Rapid Payback

Ancillary revenue

11 CONFIDENTIAL

10 30 30 40 50 50 75 80 85 90 95 95 95 20 40 60 80 100

Bag Fees FF Mile Reduction Seat Select A B C D E F W X Y Z

Margins for Select Ancillary Revenue Products (Blinded)

Percent Basic Product Unbundling Premium Product Unbundling & Enhancements 3rd Party Product Enhancements

Source: Company financials, Press releases, L.E.K. analysis

Illustrative

And its not all about takeaways…products and services that enhance the customer experience, while not as high margin, still have very healthy economics

Ancillary revenue

12 CONFIDENTIAL

Off-vessel

Repackaged B2C Airport Lounge Packages Family Traveler Packages Child Traveler Packages Business Traveler Packages

Core Product

Enhanced Mix of B2C & B2B “Window Shopping” (On-line stores) On-line Gambling

2 2 2 2 4 4 6 7 4 1 4 6

Enhanced B2C Internet On-Board In-Flight Entertainment Food/Beverage On- Board Upscale Amenity Packs

2 2 2 5 5 4 5

Core B2B IFE/Web Advertising

5

Core B2C Baggage Fees Booking over the Phone Confirmed Seat Assignment Fee to Stand by Ticketing Fees Miles Rationalization Unaccompanied Minor

2 2 1 1 1 6 7 1 1 3

Experience Packages 1 Product 2 Flight Experience 4 Airport Experience 6 Mileage and Status 7 Customer Service 5 3 B2B

B2C B2B

Enhanced B2B Enhanced Advertising Consumer Trials

3 3

Enhanced B2C Premium Seating* Lounge Access Priority Baggage Priority Security Priority Check In and Boarding Elite Status a la carte Mileage Purchase Trip Protection Insurance Repackaged B2C Subscription Services for Amenities FF Gaming Bundles Entertainment Packages Enhanced B2B Vacation Packages 2.0

On-vessel Off-vessel On-vessel

Core B2B Traditional Advertising Hotel Partnerships Mileage Redemption Rental Cars Financial Services

6 7 3 7 3

High Realization Low Realization Current Implementation

Merchandising represents a ‘game-changing’ opportunity for the airline industry that is still in its infancy but requires a fundamental shift in the mindset and skills deployed by the industry

Illustrative

Ancillary revenue

13 CONFIDENTIAL

L.E.K. expects ancillary revenues to continue to transform the airline industry in the coming years

Source: Company financials, press releases, L.E.K. analysis

Product Unbundling Phase Product Enhancement Phase Repackage / Rebundle Phase B2B Phase Sample Products 2014 Revenue Expectation  Baggage fees  Seat selection  Booking fees  Internet on-board  Lounge Access  Priority security  Entertainment package  Business traveler package  Luxury vacationer package  On-board retail  Surveys  Focus groups ~$6B - $7B ~$2B - $3B ~$1B - $2B ~$2B - $3B

Non- customer focused initiatives

$40B - $50B

• f high-margin

revenue

~$23B - $26B ~$7B - $9B ~$4B - $6B ~$6B - $8B U.S. Global Ancillary revenue

14 CONFIDENTIAL

But for the airline industry to fully realize the benefits of ancillary revenue it must embrace the merchandising prowess of other industries

Retail Media & Entertainment Branded Consumer Airlines Ancillary revenue

15 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

16 CONFIDENTIAL

Motivation Actual Result

America West – U.S. Airways Northwest – Republic  Combination of two route systems with significant overlap could eliminate competition  Rapid operations and workforce integration lead to operating problems  Solidified Minneapolis, Detroit, and Memphis as key Northwest hubs  Addition of west coast hubs to Delta’s already-strong east coast system  Delta’s operations still remain concentrated on the east coast  Rescue TWA’s valuable international routes  Competition reduced and TWA’s assets acquired at a discounted value  Annual revenue and cost synergies

• f approximately $600 million

 Optimization of the merged route system  Expected cost and revenue synergies of over $1 billion annually by 2012

Source: Cathay Financial, Company financials, L.E.K. analysis

1986 1986 2001 2005 2008 1989

Key Pairings

Delta – Northwest American – TWA Delta – Western DOJ establishes stringent antitrust reviews Marks the transition of merger motivations from primarily eliminating competition to optimizing networks and reducing costs

Being a high fixed cost industry, the airline industry benefits from scale through acquisition just like any other high fixed cost industry

Industry consolidation  Delta has announced that steady state synergies are now expected to be $2 billion annually by 2012

17 CONFIDENTIAL Source: Company financials, L.E.K. analysis

3.3 0.4 0.3 0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5

Cost Rationalization Fleet optimization Network Presence "New" Delta Operating Income

L.E.K. analysis of the financial impact of Delta / Northwest merger

$billions 2.2 NW DL

2007 Operating Income

Estimated Annual Benefits of DL+NW Combination

L.E.K. took a conservative approach to its strategic support of the Delta/Northwest deal; Delta has since increased anticipated benefits to $2B+

Industry consolidation

Delta is now the largest market cap airline in the US, second in the world – clearly a sign that the financial markets believe in the benefits of consolidation

18 CONFIDENTIAL

Industry consolidation 20 40 60 80 100

BA EK WN AA UA / CO / LH / AC DL / AF-KLM

AC

QF

US

BA EK WN LH AA AF-KLM UA / CO DL

Current

AC

US

BA

EK WN LH CO UA AA AF-KLM DL

Share of worldwide RPKs for top 20 airlines (1/2009 – 11/2009)

Percent

SQ

CX

QF US

Other Top 20 Other Top 20 Other Top 20

Airlines’ long-term strategies should prepare for mega-carriers, which are already being “created” in the $20B+ DL / AF TATL joint venture

Source: ATW

Increasing Consolidation

For scale to be sufficient to enable a US carrier to generate sustainable economic returns, L.E.K. has calculated that it needs to be greater than ~$40bn in annual revenues – roughly equivalent to the merger of three traditional legacy carriers

19 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

20 CONFIDENTIAL

Greater Transparency / More Accurate Business-line Valuations Greater Transparency / More Accurate Business-line Valuations Sophisticated CRM/Direct Marketing Focused Management Sophisticated CRM/Direct Marketing Focused Management

+

Historically, a highly effective affinity mechanism with a large attractive demographic Historically, a highly effective affinity mechanism with a large attractive demographic Eliminates / Lessens Conglomerate Discount Eliminates / Lessens Conglomerate Discount

Significant Value Creation

Value can be created by separating loyalty programs from their parent airlines

Frequent flyer program

21 CONFIDENTIAL

Since its IPO, Aeroplan gross billings growth has been driven primary by credit card partners and by acquisitions

Notes: Forecasted gross billings according to Raymond James Ltd. company reports Source: Aeroplan Company Financials, Analyst Reports, L.E.K. Analysis

500 1,000 1,500 2,000 1,491 2009F 1,392 2008 1,421 2007 952 2006 852 2005 755 1,585

Gross Billings: Aeroplan Gross Billings by Partner (2005-2008)

$millions 2011F 2010F Air Canada CIBC Amex Other - Canada Other - ex Canada Sainsbury

CAGR% (2005-08) 11 2 28 6 11 23 N/A N/A CAGR% (2005-08) (2009-11) Total - Group Organic Growth (Canada) Inorganic Growth (ex Canada) N/A 6 7 8

Frequent flyer program

22 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

23 CONFIDENTIAL

 In order to reduce the fixed costs associated with capacity reductions due to parking of aircraft or lower utilization, airlines pursue strategies to make fleets more flexible, including:

• Leasing aircraft on a

consistent basis over time, so that the fleet fluctuates with capacity on an annual basis at a low cost (e.g. for its long haul fleet LAN has lease renewal

• ptions representing ~10% of

passenger capacity annually),

• Use of aircraft with low
• wnership cost, such as

Northwest/Delta’s continued use of DC9s

Mitigate downside risk

The airline industry is highly cyclical; airlines will continue to develop new strategies to mitigate downside risk

LAN airlines long haul fleet planning strategy (2007 - 18F)

Aircraft

10 20 30 40 50 60 70

Low Case Base Case

07 17F 08 09F 10F 11F 12F 13F 14F 15F 16F 18F

Illustrative

Source: Company annual reports, L.E.K. analysis

24 CONFIDENTIAL

Another way of mitigating the downside risk is to ensure that your cost base is structurally sustainable

 Manage factor costs so that you remain competitive versus potential disruptors in the industry e.g. labor

• costs. Singapore Airlines probably best example here:
• Flight Attendants on 5 year contract that is only

renewal on promotion to higher levels

• Flight Crew composed of percentage of ex-pats
• n expat “fixed rate” contracts without tenure

escalation clauses

Factor Costs

Mitigate downside risk

25 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

26 CONFIDENTIAL Notes: *Includes regional carriers; **L.E.K. static forecast Source: Form 41, CapitalIQ, BEA, CBO, L.E.K. analysis

The 9/11 terrorist attacks led to a permanent dislocation in the relationship of air revenue to GDP and the current recession is likely to do the same

0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00

U.S. carrier passenger revenue to GDP ratio (1991-20F)

Percentage

06 08 10 12 14 16 18 20

Forecast**

92 94 96 98 00 02 04

9/11 terrorist attacks and recession The combination of a global recession and improved video- conferencing technology could produce a 2nd permanent dislocation

Legacy only All (including LCCs)

Reinvention

27 CONFIDENTIAL Note: All entities without ownership stake specified are fully owned *Lufthansa announced plans to acquire a majority stake in Austrian Airlines and Brussels Airlines in 2008; ** Current 30% share to increase to 80% pending approval by the EU Commission Source: Company websites and annual reports, L.E.K. analysis

Operational Support Travel / Touring

49% Stake 49% Stake 56% Stake 25% Stake 51% Stake 20% Stake 81% Stake

Long-Haul Shuttle Economy Singapore Airlines Ltd Supporting

Code-share partners

Cargo

Airlines have successfully reinvented themselves by creating portfolios of companies to serve distinct customer segments; this reduces the threat of a competitor capturing an underserved segment and then expanding

Operational Support

Divested

Long-Haul* Shuttle Economy Supporting Lufthansa Group

80% Stake** 19% Stake

Cargo Travel / Touring

50% Stake 80% Stake**

Reinvention

28 CONFIDENTIAL

Characteristics of a Successful Portfolio Airline

• Separate clear and distinct brands
• Independent operations and management
• Separate cost base
• Separate labor arrangements
• Fleet optimized
• Free to compete with one another

For Each Service Offering:

• Tailored product
• Unique value propositions
• Overlapping network to allow optimized coverage of target segments

For Each Customer Segment:

Source: L.E.K. analysis

Reinvention

Implementing a reinvention effort such as a successful portfolio strategy requires separate cost structures, distinct brands, and clear segmentation

29 CONFIDENTIAL

Agenda

 L.E.K. Consulting

• Company overview

 Introduction  Why the airline industry could be profitable

• Ancillary revenue
• Industry consolidation
• Frequent flyer program
• Mitigate downside risk
• Reinvention

 Summary

Agenda

30 CONFIDENTIAL

So if it was that easy, why isn’t the industry more profitable?

 Well, there are financially successful airlines  The industry is full of optimists …. how many airlines’ 5 year plans incorporate the inevitable “black swan” events?  How many airlines have the rigorous contingency plans for the downturn?  Given the high fixed cost nature of the business its all about minimizing the down side so that it doesn’t swamp the upside  More than any other industry because the barriers to entry are so low its all about planning for change and being able to re-invent yourself… but how to do so in the constraints imposed by government and labor

Summary

Its hard but certainly not impossible

31 CONFIDENTIAL

5 reasons why the airline industry could be profitable

Summary

 Ancillary revenue  Industry consolidation  Frequent flyer program  Mitigate downside risk  Reinvention

5 4 1 2 3