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How come there are two agreements with Etihad?

How the European Commission cancelled the key reason for the strategic partnership between Serbia and Etihad

The Agreement (i.e. the Transaction Framework Agreement) presented by the prime minister Vucic at the press conference on Thursday, August 14th, and then published on Government’s website – is not the agreement signed by Serbia, JAT and Etihad 11 months ago.

This would remain secret if the mayor of Belgrade hadn’t “slipped up” explaining why the Transaction Framework Agreement is dated July 31, 2014. Namely, the new Agreement on changes and amendments to the Investment Agreement was signed on that day, and the FIRST INVESTMENT AGREEMENT was signed on August 1st, 2013.

No matter how hard Sinisa Mali tries to persuade the public that those two documents – Transaction Framework Agreements of 2014 and 2013 – are the same, I can definitely say that these two documents are essentially different. (The only true point is that the Agreement signed this year doesn’t change the provisions of the last year’s Agreement regarding investments and money).

And the “main culprit” for these differences is – the European Commission.

What is this essential difference?

It is a fact that the Arabs no longer have the absolute right to independently manage Air Serbia and appoint managers of the firm in which they hold the minority ownership (49%).

And that was the key reason for the strategic partnership and signing of the Agreement between the Republic of Serbia, the Abu Dhabi-based Etihad and the dying JAT on August 1st, 2013.

Sinisa Mali admits that the change, which he considers irrelevant, is about the management over Air Serbia and the procedures of the company’s Management and Supervisory Board.

Well, yes, but this change is extremely important.

Sinisa Mali used the euphemism “suggestions” to describe something which was an explicit demand of the European Commission to the Government of Serbia – as a minority owner, Etihad can’t independently and completely manage Air Serbia. Mali then continueed to wind up the public by saying that “the European Commission, in a way, did us a favor, by reducing the participation of Etihad in the management”, and, then, finally, admited the point: “Etihad now doesn’t have the right to decide and can’t appoint its management and its CEO, but only give suggestions for preparation of the business plan”.

What is this, if not a key change of the Agreement, since it completely changes the essence of the strategic partnership between the Government of Serbia and Etihad established on August 1st2013?

Fromlast spring to this April, Serbian and Etihad’s officials competed in singing praises that “one of the world’s largest airlines will bring its management and assume full control over the new Serbian airline, which it will transform into a regional leader.”

So, for example, on April 12th, 2013, a blog called Tango six writes, and B92 cites it, that “Etihad wants to set up its operational management which would effectively run JAT. Within the management structure, Etihad should have a CEO, CFO and COO. Daily and operational management of the company, personnel policy and all the details that were once under the jurisdiction of Serbian politics will be completely left to the Etihad management for at least five years. ”

On July 13th, 2013, Politika wrote, based on “anonymous sources from the Serbian government” that it is “very important that the new company will not be managed by any executive from JAT, or anyone appointed by our Government. They will all be Etihad staff. ”

On August 1st, 2013, Tanjug reported that “Etihad has signed a five-year contract with the Government of Serbia on the management of Serbian national airline.” That dayEtihad CEO James Hogan said,according toTanjug, that “Etihad will take over the management of the company starting from October 1st.”

The first deputy prime minister AleksandarVucic assured the citizens of Serbia that Air Serbia is in the hands of the management which will be appointed by Etihad, one of the best airlines in the world.

And indeed, according to available information, the management of Air Serbia was chosen and appointed by Etihad; business plan, flight schedule, opening of new routes, training of pilots and cabin crew… it was all in the hands of Etihad and everything was made in Abu Dhabi.

But the Serbian government kept secret from its citizens and taxpayers the fact that on August 2nd, i.e. one day after the ceremonial signing of the strategic partnership, the European Commission sent a bitter letter to the Serbian air traffic controller –the Civil AviationDirectorate. Sinisa Mali admitted this in a statement to Tanjug on October 16th: “The Civil Aviation Directorate received a warning letter on August 2nd from the European Commission, Directorate General for Mobility and Transport, which states that the new company could lose its Open Skieslicense because the management of the new company is in the hands of a company which is not from the EU.” Acting as an advisor to the First Deputy Prime Minister, Sinisa Mali said to Blic that “there is no point at which Serbia violated the ratified Open Skies Agreement. Air Serbia also remains majority owned by Serbia, and the government has a majority in the Management Board. Etihad‘s participation of 49% of equity of Jat Airways is in accordance with the contract and provisions regarding general rules for provision of air transport services in the EU.”

And so it was until April 2014, when the European Commission called the Government of Serbia to Brussels to explain why Etihad, as a minority owner, has full control over the management of Air Serbia. It is interesting that the Serbian delegation was led by Sinisa Mali, in an unknown capacity, at that time mayor of Belgrade, but no longer Vucic’s advisor. At the “hearing” regarding the ownership and management model of Air Serbia he explained everything, but didn’t convince the hosts, so they asked him to document everything he said with papers from Belgrade. “The EU Commission for Aviation asked us to provide details,” admitted Mali the other day in an interview with B92. And the real contract between Serbia and Etihad from August 1st, 2013 was sent to Brussels “for observation”.

Thus began the European Commission’s official investigation of the strategic partnership between the Government of Serbia and the Abu Dhabi airline Etihad, due to suspicions that it is not in compliance with EU rules on ownership and effective control over the management of airlines. Conditions of ownership and control over management are separateand both must be met in order for the airline to receive an approval for traffic rights and to maintain its “EU citizenship” (i.e. to remain a member of the Open Skies Agreement). Etihad’sequity stake in Air Serbia (49%) was not contested, but the effective control over the management of the Serbian airline was, since Etihad has a minority stake. The European Commission asked the Government of Serbia for clarification and detailed information about Etihad’s influence over the management and control of Air Serbia.

The investigation was completed when the European Commission sent the Government of Serbia their “suggestions”, as Sinisa Mali put it. Those “suggestions” were in effect orders, and the Government of Serbia compelled with them and changed the essence of the strategic partnership with Etihad. “We then analyzed these objections in May and adopted them in June,” admitted Mali.

So, for example, the new Transaction Framework Agreement from July 31st, 2014, published on the government website, in the chapter “Board of Directors and Corporate Governance in Air Serbia” says that “Etihad will have the right to appoint four of the nine members of the Board of Directors of AS, one of whom shall be the vice President, and that the Serbian government will have the right to appoint five out of nine directors, one of whom will be the president.”

The strategic partnership adventure between Serbia and Etihad, which, as a renowned global company, should have appointed the CEO and other management and independently run Air Serbia, was concluded as follows: “Etihad now has no voting rights, but can only give suggestions for the preparation of a business plan,” said Sinisa Mali on August 15th, 2014 (in an unknown capacity “regarding” Air Serbia) to B92.

The government’s premature baby

What would I make of JAT if I could have imposed such obligations to Zoran Djindjic’s or Zoran Zivkovic’s government? What great things could I have achieved?

They say that this is how Predrag (Drasko) Vujovic complained to his friend in some Belgrade inn, when they “combed through” the Transaction Agreement between the Republic of Serbia, Etihad and Air Serbia. That Vujovic is the legendary JAT director whom Prime Minister Vucic indirectly mentioned at the press conference when he emphasized that JAT’s last positive results were in 2003. Until then, JAT was led by Predrag (Drasko) Vujovic. When Velimir Ilic drove Vujovic away, the business collapse of JAT started and lasted until last year. Each new director after 2003 was a party apparatchik of one of the parties in the ruling coalition, who wasn’t sent to the JAT to improve its operations. On the contrary.

And what is it that is in this Agreement and that Vujovic lacked in order to enable him to lead JAT “to great things”?

If you read the Agreement, it becomes clear immediately.

So, simply put – subsidies. Government subsidies.

And there are a lot of those subsidies in the Agreement between Serbian government, Air Serbia and Etihad from July 31st 2014. If you explicitly enumerate all the financial obligations of the Government of Serbia, Air Serbia requires a donation of $97 million, plus three more items that add up to a yet unknown amount.

In paragraph 2.5 the Republic of Serbia is obliged to provide $42 million, including benefits, for the needs of Air Serbia in terms of lack of working capital – cash, until December 31st, 2016. In addition, the Serbian government has committed to help Air Serbia with an additional $40 million to reduce its operating costs in 2014 and 2015.

Serbia has an obligation to fund the improvement and capacity increase of Catering ($10.1 million) and Su-Port ($4 million).

The funny thing is that, for example, the Serbian budget will pay the total amount for severance of redundant workers (i.e. not only the legal minimum), and that obligation of the state exists even for future layoffs until the end of 2016.

The general impression, when you read the whole text, is the “spirit of the Agreement” which is dominated by obligations or “orders” to the Serbian government (80%).

Such brazen orders to the government of any country are unprecedented (airport, Directorate, tax administration …). Even if there was such a commanding tone somewhere, is it not communicated in a written and binding form. The first association is that such a tone could (but not necessarily would) be a good reason for terminating the Agreement by the “second party” if the “first party” fails to fulfill the obligations/”orders”.

An extreme example are the paragraphs of the Agreement which state that “the Republic of Serbia (RS) acknowledges that Air Serbia (AS) will require constant support of the RS regarding the financial stability of the Company”. Then, “the RS investments in JAT and ongoing obligations of the RS to AS will be in the form of duties and obligations, including a combination of equity, loans and other financial support and / or financing arrangements, as may be mutually agreed upon.” And finally the meaning of the word “benefit” is explained: “The intention of the Parties (of the Agreement) is that any funding being provided by the RS be provided by the RS as RS Government, and not in its capacity as shareholder of AS and to be executed in a way that the funding is not considered an increase in equity, nor a liability of AS “.

If anyone has missed the point, here it is: The Serbian government should constantly give money to Air Serbia and no matter how much it gives, it will not cause an increase of the state’s capital in the company, and the company doesn’t have an obligation to return that money.

Such form of state’s “support”, i.e. that volume of subsidy is not allowed by rules and standards of the European Union. It will be interesting to see how the Government of Serbia will manage to defend itself against the demands from Brussels to stop subsidies for Air Serbia.

That’s it regarding the obligations in cash. But the “orders” the state of Serbia has to carry out don’t end there.

Paragraph 7.5 requires the Government of Serbia to participate in the purchase of slots (places for “landing” of aircrafts) at some foreign airports. Well, this desire could be particularly interesting for aviation authorities in the EU, and risk Serbia a few more slaps from Brussels.

Line maintenance (paragraph 7.8) indicates a tendency to take over JAT Tehnika (of course, without paying), where once again the government should pay $14 million for the purchase of equipment that will be used – by you know who. It would seem that this is the reason why the previous (successful) manager Srdjan Miskovic, who, until now, insisted that Air Serbia pays its arrears to JAT Tehnika, was silently replaced.

But certainly the most dangerous, the most suspicious and the most intriguing part of the Agreement is the one in which Etihad (as a minority partner) gives orders and commitments to the Government of Serbia to secure a monopoly over the airport Nikola Tesla for Air Serbia and Etihad. We already saw the danger of creating such monopolies during the last two months, when two low-price companies – German Wings and Wizzair – simply left the Belgrade airport due to unequal business conditions. Is that a precursor for the departure of other airlines?

Then, the Agreement clearly states that the Serbian government will write off Air Serbia’s last year’s debt of $13 million for services of the airport Nikola Tesla. It will be interesting to see how “happy” large foreign airlines like Lufthansa, Swiss, Austrian, Turkish Airlines and others will be about this write-off.

Furthermore, the Agreement openly shows that Air Serbia demands discounts from the airport Nikola Tesla and that those subsidies should be provided by the Government of Serbia. Air Serbia and Etihad also demand – a separate terminal, a separate cargo area and the right to engage in business activities previously practiced by the Airport (freight and transfer of passengers of foreign companies), special parking for its passengers at the airport, the state’s participation in the costs of reconstruction, a discount of 50% on taxes and property transfer from the airport to Su-Port (in order to enable it to perform activities it is now not licensed for).

And why is all this necessary?

The answer lies in – “the spirit” of the Agreement. And it points to a strong desire of Etihad to take over the Nikola Tesla airport with the help of the Government of Serbia, and not to buy it.

What could be the effect of this monopoly?

Foreign companies could leave because they will no longer be able to do business at the Nikola Tesla airport, and when they know that anything they ask from the Serbian government, the same will have to be provided to Air Serbia.

And finally, there’s a one interesting residue from our (socialist/self-management) past. The Agreement requires the Serbian government order all public employees to fly with Air Serbia. If I remember correctly, something like this didn’t exist in JAT even during the worst period of central planning.

But it doesn’t end here – the state has to pay for employees’ airline tickets through Etihad’s system and a special agency Eagle Travel has already been established, based in the former JAT’s offices in Vojvode Dragomira Street in Belgrade.

It will be particularly interesting to observe the reaction of many travel agencies because there will be no free competition when all passengers are required by the Government to buy tickets at Eagle Travel.

There’s this plan

Over a year ago (since today), and one month before the Agreement on strategic partnership for the establishment of Air Serbia was signed on August 1st, the Government of Serbia presented a document entitled “JAT Airways, strategic Plan 2014-2016 ” on June 26th 2013.

That is what it says on the front page of the document which was sent to the author of this article.

Officially, this paper is still a secret, although much semi-official information has been circulating.

The still unknown detail is whether the government only “took note” of this document, or discussed it and, perhaps, made some decision (that is to say, rejected, accepted or suggested some changes).

Before it arrived at the ministerial cabinet of then Prime Minister IvicaDacic, the Strategic Plan was speculated to be a draft-stage but serious project, based on spun information that was published from time to time in order to prepare the public for the subsequent final strategic business partnerships.

So, at the end of March, the Ministry of Finance and Economy (on March 27th 2013) issued a statement quoting theFinance Minister MladjanDinkic, who was then paying a working visit to Abu Dhabi, that “the Memorandum of Understanding on strategic partnership between Etihad and JAT should be signed in mid-April in Belgrade. We agreed that their management will come to Belgrade in mid-April. They will start a detailed analysis of JAT business at the beginning of April. I believe that we will have good news as early as mid-April and that we will finish the negotiations on the strategic partnership between JAT and Etihad within the next two months. ”

A very active portal at that time Tango six announced (on April 13th, 2013) that after the meeting of the Serbian minister of financeMladjanDinkic and Etihad’s CEO James Hogan in Abu Dhabi, started the due diligence scan of JAT which will last between four and six weeks, and that specific agreements will be signed afterwards.

Then, on June 3rd, 2013, the news agencies Beta and Tanjugpublished that “the CEO of JAT Airways VeliborVukasinovic confirmed that Etihad experts are intensively analyzing the operations of his company.”

Tanjug then revealed that Etihad Airways, the government of Serbia and JAT Airways had signed on June 17th in Belgrade the Initial Memorandum of Understanding authorizing the examination of opportunities for investment of Etihad’s equity into JAT.

Who conducted the due diligence scan of JAT? And who, after completing the scan, proposed the “Strategic Plan 2014-2016”?

The answer to this question is not easy, because the information is still very scarce.

A short oral survey I conducted among several insiders of Serbian aviation community came down to one answer: “I only know that the document was not prepared in JAT and that domestic experts didn’t work on it – not the Faculty of Economics, Traffic Engineering, no one from the aviation industry, no one from JAT or from the Directorate of Civil Aviation, or independent consultants, or anyone from the Ministry of Transport and the Ministry of Finance.”

We could only indirectly conclude, based on the spirit of the analysis and tone of the proposal, that the “paper” was developed in Abu Dhabi, but it is unknown if someone from Serbia assisted in this work.

Is the document authentic?

When you pair the data from the Strategic Plan and the Agreement on strategic partnership between Serbia and Etihad (published on the website of the Government of Serbia), it can be concluded that they are not “identical twins”, but that they have many similarities and overlapping digits, which gives ground for trusting the authenticity and credibility of the Strategic Plan. There are many elements and facts publicly communicated and published in the past year, suggesting that the Strategic Plan has served as a platform from which, after June 26th, 2013, JAT began its transformation into Air Serbia.

At the risk of any accusations against the credibility and doubts about the authenticity of that document, some of its details are worth looking into.

For instance, “Strategic Plan 2014-2016” analyzes, scans and simulates the assumptions, organizational structure, investments, capital expenditures of transformation of the Serbian national airline (at the time called JAT Airways) and predicts its three-year business on 11 pages (from page 44 to 55).

The authors of this document believed  that the issue of “reshaping flying network of JAT in order to: take maximum advantage of the geographical position of Belgrade, strengthen JAT in the local and regional market and maximize connectivity with Etihad in Abu Dhabi and its partners in Europe…” should be addresses immediately.

Key assumptions ofthe transformation of the company include: “modeling by using the software of the company Seabury APG (the most advanced analytical tool of business solutions for airlines), the introduction of average tariffs in the industry according to the Seabury calibration and full code share with strong relationships with Etihad’s partners…”.

The renewal of the fleet is then proposed, with the following suggestions: “To use the power of Etihad in negotiations with Airbus to ensure the elimination of JAT’s debts, but it can not be done at the expense of the fleet or the economy that are sub-optimal”; and then a significant remark is recorded: the Serbian government must be responsible for all remaining debts (to Airbus for the agreed purchase of aircrafts from 1998).

The proposal of the new organizational structure of the airline is then drafted and, at one point, it says that “the number of layoffs will vary from 545 to 900 or more and that the government of Serbia will bear all costs of layoffs, which are estimated at up to16 million dollars.”

The authors of the Plan believe that JAT will benefit from “the capabilities of the system and relations of Etihad Group with key suppliers, that management over JAT network will be centralized by Etihad to ensure maximum connectivity and revenue, that JAT will have alliances and code shares with key companies of Etihad Group, that JAT will get preferential rates on large orders of aircrafts made by Etihad Group and that Etihad will provide significant support in the current negotiations in the dispute with Airbus”. 14 aircrafts A319 are planned to be procured from Airbus.

The Strategic plan also deals with the forecasts of business results. But before that, a small digression.

Over the year, various officials have spoken very highly about the results of Air Serbia’s operations.

So, for example, on March 25th, 2014 Air Serbia’s Managing Director Dane Kondic said that “Air Serbia has a great business plan,” and on April 2nd, 2014, he said that “the Serbian national airline has achieved impressive success in less than five months”.

Then, on April 3rd, 2014, Etihad CEO James Hogan said in Vienna that “the former national carrier JAT, is today, under the name Air Serbia and thanks to Etihad, making a profit for the first time.”

Then the Prime Minister AleksandarVucicsaid at a press conference on August 14th that Air Serbia will make a one million euro profit this year.

By the way, on May 6th, 2014, Air Serbia announced that “JAT Airways made a 73 million euro loss in the last year,” and on July 8th, 2014, the website of the Business Registers Agency published that Air Serbia (and not JAT Airways) made ​​an 8.3 billion dinars (80 million euro) loss in the last year. As a reminder, at the end of 2012, JAT management planned a loss of 20 million euro in the business plan for 2013.

And now back to the “Strategic Plan 2014-2016” which also says something on the planned business results.

Here’s how it looks.

The attention is immediately drawn to page 52 where the projected loss is written in red:  $46 million in 2014, $30 million in 2015 and $23 million in 2016. Total loss – 99 million dollars.

True, it is planned that the loss should be reduced by 37 million dollars by using the mysterious “Business Improvement Initiatives” in 2015 and 2016, but no details were provided on how the authors of the Plan mean to do this. If it really “looks silly, but works”, it could be (for example) introduced as a subject at Megatrend University.

Furthermore, the authors of the Plan argue that the Serbian airline will significantly improve its efficiency and profitability – they planned the growth of certain key performance indicators in the aviation industry: RPKs (revenue passenger / km), RASK (revenue per available seat / km – from 29.5 to 32.7 – the higher this indicator, the more profitable the company), CASK (cost of available seat / km – from 33.8 to 32.7 – the lower this indicator, the more profitable and efficient the company is) …

However, the most intriguing part of the Strategic plan is the one where the price of restructuring and recapitalization of the Serbian airline is calculated.

The total planned cost of that, when it’s all added up, amounts to 511 million dollars.

And that includes three items: historical debt, demand for working capital (in 2013) and future business (2014, 2015 and 2016).

Historical debt (297.4 million dollars) includes “debt and creditors of the Government of Serbia” (233.7), restructuring costs (23.5) and covering for losses for the period April-December 2013 ($40.2 million).

Requirement for working capital in 2013 is 53.1 million dollars.

As for the business in the future, according to the Plan, the Serbian airline needs a total of 160.6 million dollars for three years. Part of this is share of Etihad’s capital ($40 million), a deposit for a new fleet of Airbuses (6 million) and the missing funds (114.6 million dollars).

Of the total funding for the three-year financing (511.1 million), the plan is to finance JAT with 460, JAT Catering and Su-Port with 12.3 and Line Maintenance with 26.5 million dollars.

Insted of the end:

One remaining question still tickles the Serbian taxpayers’ imagination: did some government (or any other) authority adopt the “Strategic Plan” (if it existed)? And is anyone (institution or individual) overseeingwhether the strategic partnership and business of Air Serbia are developing according to this or some new business plan?

Translated by Marijana Simic

Pešč, 26.08.2014.