Key fact

Fuel accounted for 15 per cent of Sama’s costs in March 2007; by mid-2008, this figure had jumped to 40 per cent

Source: MEED

Saudi Arabia’s Sama Airlines grounded its planes and closed its doors to business in August, after four inglorious years in the Middle East low-cost aviation sector.

The airline had racked up losses of $266m, despite receiving a SR200m ($53.3m) government loan to assist with fuel costs and SR500m-worth of additional funds being pumped in by shareholders to keep the business afloat.

In a statement, chief executive Bruce Ashby said that anticipated government assistance had failed to materialise, pushing the company deeper into the red. “We also tried to find strategic investors who are ready to invest in the company and [provide] the necessary liquidity to enable Sama to operate,” he added.

Preferential treatment for Saudi airlines

Four months on, there is no sign of a benefactor stepping forward. The company’s website carries only an email address to apply for refunds. The airline’s offices in Riyadh are empty.

The company is reported to be unable to pay staff compensation or even their final wages. Sama has been struggling to pay salaries on time since late 2008, and it now looks as if employees may lose out again. It is a sorry end to an enterprise that began with such promise less than four years ago.

Rumours have circulated that regional aviation giants Saudi Arabian Airlines (Saudia) and Qatar Airways are considering buying Sama. Both have deep pockets, but it will be a brave company that tries to turn the business around. It would be a cruel irony if Saudia was to buy out Sama to launch its own budget carrier; the preferential treatment enjoyed by the kingdom’s national airline is one of the main reasons the low-cost operator was driven out of business.

Saudi Arabia should be ideally placed to corner a large share of the low-cost market around the region

Debt-laden and overstaffed, Saudia is a classic example of a national carrier in an emerging market, propped up by the government to keep the flag flying. The kingdom’s massive oil wealth has meant that its losses could easily be sustained and this removed any incentive to set the business on a commercial footing.

The airline is one of Saudi Arabia’s biggest employers, with the workforce continuing to swell through good times and bad. Moreover, the natural advantage bestowed by the country’s oil resources saw Saudia granted a massive subsidy on its fuel – less than 20 per cent of the market value.

Wishing to make air travel available to all, the Saudi government also imposed a fare cap on domestic flights and set out obligatory routes, connecting major cities to far-flung corners of the kingdom. Even though these flights were often empty, Saudia could absorb these costs while it stood alone in the domestic marketplace, with Riyadh willing to pick up the tab.

On international routes, Riyadh and Jeddah were never going to compete with Dubai or Doha as a regional hub for intercontinental travel between east and west. However, the kingdom can rely on a huge influx of pilgrims each year, who are less concerned that the service offered on Saudia was not up to the standards being set by other Gulf carriers.

This imbalance in the domestic market only became a real problem when Riyadh granted licences to low-cost airlines Nas Air and Sama in early 2006. In Sharjah, Air Arabia had already shown that the European budget model could be deployed successfully in the Gulf. The government and the national regulator, the General Authority of Civil Aviation (Gaca), were keen to capitalise on the kingdom’s natural advantages and expand into the low-cost market.

The two Saudi start ups received their licences in May 2006 and talks began straight away on removing the fare cap and Saudia’s fuel subsidy to level the playing field. It was agreed that Nas Air and Sama would each be obliged to fly a share of Saudia’s compulsory routes, or public service obligations (PSOs). But talks on removing Saudia’s competitive advantage were still unresolved by the time the two new carriers were ready to launch in early 2007.

With hindsight, the two airlines should not have launched with the fare cap still in place, yet both were given assurances by the government that the issue would be resolved promptly.

Saudia was about to begin its own long-awaited privatisation that would re-establish the business as a viable commercial enterprise. An impressive timetable for turning the national carrier around was set out. All three carriers would soon be competing with each other and their Gulf rivals on an equal footing.

Privatisation flounders in Saudi Arabia

Saudia’s schedule for privatisation did not take long to unravel. The company had hoped to sell off a stake in its catering business by late 2006, with the cargo division ready for privatisation in February 2007, followed by ground support by March 2007, and maintenance and training in May that year. The airline itself was to be privatised in the first quarter of 2008.

Instead, it was early 2007 by the time bidding on the catering business started. A joint venture between local tourism and leisure group Al-Hokair and the French company Newrest secured a 49 per cent stake in the division for $220m, but did not take control of the business until September. With Saudia’s privatisation floundering, the national carrier was unable to support itself without government funding.

Meanwhile, the low-cost carriers were finding the going tough. Oil prices rose sharply in 2007. Unable to offset mounting fuel costs due to the fare cap, Sama was absorbing huge losses, particularly on the PSO routes, which were often almost empty. “We recognise that these are lifeline routes, but passenger numbers are extremely low,” Sama’s former chief executive, Andrew Cowen, told MEED at the time.

“There is no economic return on these flights so the government should subsidise them,” he said. “We are losing $4,000-5,000 a flight on these northern routes, which adds up to $1m a month.”

Both Sama and Nas Air continued to press Gaca to remove the domestic fare cap or grant them a fuel subsidy equivalent to that enjoyed by Saudia. The low-cost airlines were now paying $2.30 a litre for their fuel, while the national airline paid only $0.50 a litre.

The regulator was sympathetic and, in turn, pressed the government to resolve the issue, but continually ran into the brick wall of Saudi bureaucracy. Time and again, promises were made that the situation would be dealt with, only for no action to emerge.

By early 2008, Sama’s situation was already critical. The airline had launched with start-up capital of $80m. Within a year of launching that had been wiped out. Sama’s chairman and main shareholder, Prince Bandar ibn Khaled al-Faisal, warned that the airline could not continue to sustain these “100 per cent losses” and it would be forced to close if the situation was not resolved.

Rising fuel costs for airlines

The Saudi budget carriers were not the only ones feeling the pinch. In Europe, the low-cost market was decimated as a business model as oil prices rose from $30-40 a barrel to around $140 a barrel. More than 20 airlines worldwide went bust in the first half of 2008.

In March 2007, when Sama launched, fuel was 15 per cent of the company’s total costs. By mid-2008, this figure had leapt to 40 per cent.

While talks with the government remained stalled, Cowen expanded Sama’s international network – where the fare cap did not apply – hoping to offset losses at home. Unable to raise the cost of domestic flights, Cowen risked making the airline uncompetitive by placing a SR70 surcharge on every international ticket. The airline’s catering and maintenance were outsourced in a bid to cut costs further.

In July 2008, Nas Air and Sama won a significant victory in their negotiations with the government as both were permitted to cut the number of PSO routes they flew, with Saudia shouldering a bigger share. Sama’s PSO network was cut to six routes from 22 and Cowen expressed hope that progress on the fare cap and fuel subsidy was close.

Gaca and the government refused to be rushed, though. By September, Sama was forced to abandon flights from Riyadh and Dammam to Medina, and Cowen warned that it could abandon domestic flights altogether.

The company’s shareholders approved a SR200m injection of funds into the business, but by November, MEED revealed that Sama was no longer able to pay its staff on time. An internal email from Cowen apologised to staff for the fact that “payroll” kept coming late, but stressed that the company had to prioritise payments to its fuel suppliers to keep flying.

Unrest within the company soon became public. Internet message boards were littered with complaints from staff after the workforce went unpaid through the Eid holiday. A second email from Cowen to staff underlined the mounting sense of crisis: “We are seeing some individuals that are refusing to fly; we are seeing others that say they are ‘not fit to fly’ and are removing themselves from the schedule.”

Nas Air was also experiencing difficulties paying its workforce, but had one trump card that Sama could not match. Kingdom Holding, the investment vehicle of Saudi Arabia’s richest man, Prince Alwaleed bin Talal bin Abdulaziz al-Saud, had already invested $70m in Nas Air’s parent company, National Air Services (NAS), in February 2007.

In July 2008, with the aviation industry now in crisis, Prince Alwaleed increased his stake in NAS to 30 per cent. Despite its ongoing losses, Nas Air’s future was secured.

Cowen was removed as Sama’s chief executive in December 2008 and replaced by American Bruce Ashby, former head of Indian low-cost carrier Indigo Airlines. Cowen’s departure was followed by a further clear-out of senior management positions as the shareholders attempted to start afresh.

Ashby soon discovered, however, that without movement from the government, there was little he could do to turn the business around.

Time and again in 2009, hopes of a breakthrough were raised. In May that year, airline officials said they had received guarantees that they would be allowed to raise domestic fares by 25 per cent as an intermediary step before the fare cap was removed entirely. “This will have a significant impact on cash flow. Obviously, our target is to have the cap lifted altogether, but this will be a significant step,” said Walter Prenzler, then chief executive of commercial airlines at NAS.

Instead, the talks remained deadlocked. A source at Gaca says the two sides could not agree on a percentage increase for domestic fares. Unwilling to be seen placing air travel out of reach of the average man on the street, the government continued to drag its heels.

A deal was agreed to compensate the two budget carriers for their losses, but the SR200m settlement in August last year was, by then, inadequate to rescue Sama’s business.

Ashby continued efforts to cut costs and restructure the company in 2010, but with the fundamental flaws in the business model still unresolved, he admitted defeat in August.

Wasted potential for Saudi Arabia-based airlines

Somewhat incredibly, Riyadh appears unfazed by seeing one of its licensed airlines fall out of the marketplace and is still unwilling to level the playing field for other companies. Asked if there was any likelihood of progress soon, an official at Gaca said: “I still don’t know. It has been four years now and no solution.”

With hindsight, Sama was blighted from the start. Saudi Arabia should be ideally placed to corner a large share of the low-cost market around the region. The kingdom’s captive market in religious tourism, with millions of pilgrims travelling to the holy cities guaranteed each year, makes it a perfect hub for budget airlines. The mistake was not in granting licences to Sama and Nas Air, but in refusing to level the playing field for them to compete in a rapidly expanding marketplace.

Other regional carriers, such as Air Arabia and Flydubai, are making a success of the low-cost model. There is no reason that Sama should not have done the same, but in a crowded marketplace, Riyadh has been too slow to adapt.