Lufthansa could stay in long haul race with Turkish Airlines link

Closer ties with Turkish Airlines could keep Lufthansa in the race for long haul flights to Asia and stem the flow of business to Gulf carriers.

A combination of the German airline, Europe's biggest by revenues, and the world's fastest growing carrier would create a group with about 600 aircraft, more than the three big Gulf carriers' combined fleet of 500 planes.

Westbound traffic is in decline, making eastward growth crucial. Turkish Airlines' Istanbul hub straddles Europe and Asia and is hours closer to Europe than Gulf airports.

While Lufthansa has not confirmed any plans for strategic negotiations, Turkish Airlines Chairman Hamdi Topcu told broadcaster NTV this month that talks on tie-up expansion with Lufthansa would begin in December.

"Lufthansa is really constrained now in terms of looking for strategic partners. It's running out of options. Turkish Airlines is still the best option at the moment, and probably its last," Cheuvreux analyst Peter Oppitzhauser told Reuters.

Lufthansa, whose passenger business is forecast to post an operating loss this year, is slashing costs and cutting jobs to cope with high fuel prices and stiff competition.

Middle Eastern carriers are building alliances and investing in new routes and new aircraft to divert a thriving traffic flow between Europe and Asia to their hubs and lure passengers with lower prices as well as better food and in-flight service.

Airlines will add 19 percent capacity on routes between Europe and the United Arab Emirates (UAE) in the first quarter of 2013, partly so passengers can switch planes there, according to UBS which forecasts 12 percent growth on direct Europe-China services. Capacity between Europe and the United States is expected to shrink.

European airlines, meanwhile, are cutting costs and shelving growth plans, hit by high fuel costs and weak markets.

UNFAIR ADVANTAGES

Lufthansa said Gulf airlines are aggressively expanding, by offering more seats to Europe and taking stakes in other carriers.

"It is a question of time before Europe's connections to other regions will be conducted only via the Gulf states," it said on its website.

Lufthansa, the only major European airline that does not have a Gulf partner, says the three big Gulf carriers enjoy competitive advantages through public subsidies and preferential fuel prices not available to U.S. and European firms.

The Gulf carriers say this is not the case.

Emirates, the biggest Gulf carrier in terms of fleet and number of routes, agreed in September to form an alliance with Qantas, with the Australian carrier replacing Singapore with Dubai as its hub for European flights from 2013.

Qatar Airways, the state-owned carrier vying with Etihad as the second biggest in Middle East, said in October it would join the oneworld alliance, which includes British Airways , while Air France-KLM , Etihad and Lufthansa's German rival Air Berlin agreed on flight code sharing.

"While nothing is decided or formally announced, a combination of Lufthansa and Turkish Airlines would make the Qatar-oneworld deal and the Etihad-Air France-KLM-Air Berlin code share agreement look relatively like child's play," market research group Centre for Aviation (CAPA) said.

Lufthansa and Turkish Airlines together could offer more flights and invest in newer and more fuel efficient aircraft, as well as have pricing power over their rivals.

"Obviously there won't be an equity tie-up in the near future but (the Turkish state) will have to think of something because (Turkish Airlines) will be privatized," analyst Alper Paksoy of BNP joint venture unit TEB Investment said.

Turkey's government appointed a banking consortium to advise it on the airline privatization last year.

Analysts said the two airlines could form joint ventures initially - for instance in catering, IT and maintenance -- and at some stage later agree a cross-shareholding. EU and Turkish laws on airline ownership are a barrier to any full merger.

The airlines could also expand their code sharing to more Asian destinations and share profits, the way Lufthansa already does with United Airlines for Transatlantic routes.

Lufthansa and Turkish Airlines already cooperate via code share agreements, and they have a 50-50 joint venture, charter carrier SunExpress.

TURKISH DELIGHT

Turkish Airlines' appeal to Lufthansa is clear, CAPA analyst David Bentley told Reuters.

Labor costs, which comprise a major portion of airlines' operating costs, are lower in Turkey, where air travel is becoming increasingly affordable for its 75 million population, mirroring other emerging economies.

Its revenue has grown at an average of almost 24 percent per year over the past five years, outpacing by far Lufthansa's 9.1 percent and Air France-KLM's 2.0 percent, according to Thomson Reuters data. During that time, its average operating margin was almost twice that of Lufthansa.

"Turkish Airlines has a good presence in regions where Lufthansa has low presence, like the Middle East, South Asia and the Mediterranean. It enables Lufthansa to diversify its offer without investing in new routes and aircraft," MainFirstBank analyst Loic Sabatier said.

The Turkish carrier is also close enough to Europe's cities to fly there with small single-aisle planes which are cheaper than wide-body aircraft and allow for higher frequencies.

An Istanbul-based analyst also said that passengers find it inconvenient to have a stopover in Dubai or Abu Dhabi about halfway through a 13-hour trip from Europe to Asia and would prefer having a short two or three hour flight and a break before a 10-hour journey.

At the same time, any deal would give Turkish Airlines access to Lufthansa's passengers from wealthy European countries, and a tie-up with an airline that has a good reputation on safety and quality would give its image a boost.

(Reporting By Marilyn Gerlach; Additional Reporting by Evrim Ergin in Istanbul; editing by Andy Callus and Anna Willard)