What Kind of Business Is Airline Food, and Why Is One Company Worth 9.4 Billion Yuan?

Scale, market reach, and a high barrier to entry. And for HNA, which has been buying aggressively all over the world, this is an international asset worth owning.

Over the May Day holiday that just ended, plenty of people went through another round of agonizing over "chicken with rice, or beef with noodles?"

According to figures released by VariFlight, domestic routes flew 27,030 flights over the three-day holiday, and domestic-international routes (including Hong Kong, Macau and Taiwan) flew 6,470.

You may have complained again about how bad the food was while quietly eating all of it. Or, on a full-service carrier that served no meal at all, felt slightly cheated.

None of this is new. But a recent acquisition offer from HNA Group raises a question worth chasing: why is a company that makes airline meals worth close to 10 billion yuan, and what kind of business is it?

On April 11, HNA Group announced plans to buy the Swiss airline caterer Gategroup Holding AG for US$1.5 billion (about 9.4 billion yuan). Gategroup is the world's second-largest airline caterer; its clients include Delta Air Lines, American Airlines, easyJet, Emirates, United Airlines and Virgin Atlantic.

In 2015 Gategroup took in 3 billion Swiss francs (about 20.3 billion yuan) and lost about 63.4 million francs (about 430 million yuan) net. Last September it announced 300 job cuts, and the stock fell 15% — its worst drop in three years.

The deal is not done. Gategroup's board unanimously recommended that shareholders accept the offer, but an activist shareholder holding 11.3% of the stock turned it down, saying the price "does not adequately reflect the company's value." The deal needs 67% shareholder approval plus clearance from regulators, and other bidders may yet appear.

Still, once HNA's offer became public, Gategroup's stock jumped 18%, its biggest intraday gain since May 2009.

"If you have enough scale, catering is a good business," said Um Kyung-A, an analyst at Shinyoung Securities in Seoul.

According to a report by the U.S. research firm Global Industry Analysts, the global airline catering market will reach $17.6 billion by 2020. Asia-Pacific is the fastest-growing region, at a compound annual rate of 5.6%. A separate IATA study says China will pass the United States by 2032 to become the world's largest air passenger market.

9.4 Billion Yuan for an Airline Caterer: What Does That Actually Buy?

It supplies easyJet alone with 3.5 million cups of coffee a year — one for every resident of Berlin. In the United States it supplies 135 million grapes a year, roughly the weight of 500 hippos.

Now multiply those numbers by the more than 270 airlines Gategroup serves.

Gategroup is the world's second-largest airline caterer. The largest is LSG Sky Chefs, owned by Germany's Lufthansa — which is why Gategroup likes to call itself the largest "independent" airline caterer.

In 2015 Gategroup's revenue reached 3 billion Swiss francs (about 20.3 billion yuan), of which airline catering accounted for 1.66 billion francs (about 11.3 billion yuan).

For a point of comparison, that is the same order of magnitude as Domino's, the world's second-largest pizza chain, whose 2015 global revenue was $2.216 billion (about 14.4 billion yuan).

Many people think of airline catering as "making boxed lunches." Gategroup feeds 960,000 people a day around the world. Lihua Fast Food, currently China's largest Chinese-style fast food company, peaks at close to a million meals delivered a day.

So Gategroup is really a fast-food chain at enormous scale — and that leaves out the other half of its business, which includes in-flight retail and logistics support. It runs 165 sites in 33 countries on six continents and employs nearly 28,000 people. Most of its central kitchens and offices sit in the United States and Europe, but it is also pushing harder into Latin America, the Middle East, India and Southeast Asia.

What Kind of Business Is Airline Catering?

First of all, a hard one. We talk constantly about food safety these days, and no food faces tougher safety requirements than an airline meal.

A tray of airline food may look like an ordinary boxed lunch, but an airline caterer's processes and requirements differ sharply from a regular fast-food company's. Someone at an airline catering company told QDaily the differences come down to three things: temperature, timing and aviation security.

Conditions in the air are more constrained, so safety demands are higher than on the ground. Quality is inspected strictly from the moment ingredients are bought and received at the warehouse. Chilled and frozen goods are also checked against standards and aviation security rules before they can go into storage.

To keep foreign objects out, every ingredient's outer packaging is stripped off and the contents moved into containers used only in the kitchen. Workers may not wear jewelry or watches, and must put on a cap covering all their hair to enter or leave the production area.

Apart from the hot kitchen, every production room must stay below 20°C. The whole process runs on the cold chain: half-finished and finished dishes are held in cold storage below 8°C, long-term freezers below -20°C, and refrigerated trucks kept below 20°C carry the food straight to the aircraft.

Ordinary fast food goes like this: half-finished dishes are refrigerated, heated, and eaten. Airline food adds a blast-chilling step — after heat processing, half-finished dishes must come down from above 70°C to below 10°C within four hours before going into storage, because that is the path least hospitable to bacteria.

Half-finished dishes keep for 48 hours, finished ones for 24. In other words, a meal must be loaded onto a plane within 24 hours of being made; if a delay or anything else pushes it past that, it has to be thrown out. According to Civil Aviation Administration of China figures published in 2015, the share of flights getting off the ground within 15 minutes of schedule has been under 80% since 2010, and in 2014 it fell below 70% for the first time.

These extra demands are why airline food costs so much. Ingredients are the biggest single expense: as the chart below shows, raw materials account for 41.6% of Gategroup's operating costs, and 66% at Yishi Co., currently the only listed airline caterer in China.

Yet the margins are thin. Yuan Yaohui, secretary-general of the airline food committee of the China Air Transport Association, has said that on a main meal bought at 22 yuan, the caterer clears only 1 to 2 yuan — a net margin of roughly 5% to 10%.

The business is also harder now than it used to be. Between 2008 and 2013, eight big U.S. airlines merged into four; American, Delta, United and Southwest now control more than 80% of the U.S. market. That consolidation gave the airlines far more bargaining power and left caterers, as suppliers, in the weaker seat.

Short-haul routes have also been shifting toward low-cost operations in recent years, which has actually cut the number of passengers eating on board.

Over the past decade or so, some U.S. airlines have started charging for meals, or swapping full meals for snacks. The savings are not trivial: in 2005, dropping pretzels from domestic-route service alone saved Southwest Airlines $2 million a year.

Airline Food Tastes Bad, but Airlines Don't Pay Little for It

To keep things moving, central kitchens use industrial equipment — big skillets, steamers, dishwashers, even machines that press rice into shape. Take the familiar chicken-and-rice tray: one pot can braise 40 to 50 kilograms of chicken at once, and since an airline meal usually holds less than 200 grams of meat, that is enough for about 250 trays in a single batch.

All of that applies to economy class. For the sake of efficiency and cost, economy meals are mostly braised or stewed dishes in sauce. Cooked in bulk, reheated a second time, and eaten by taste buds that go about 30% duller at altitude — no wonder they taste bad. First and business class add pan-frying, stir-frying and deep-frying, which is part of why they taste better.

But airlines are not paying little for a tray like this. Assume an airline fed every passenger it carried, and you find that in 2015 each of them spent more than 20 yuan per passenger on food alone. Look at how freely Emirates spends here, though, and you see that in the end this is a trade-off between cost and return.

And the bad meal and the well-liked one may well come out of the same kitchen. Guangzhou Nanlian Airline Food, owned by China Southern Airlines, handles all meal delivery at Guangzhou Baiyun Airport, while Beijing Air Catering, owned by Air China, holds about 75% of the market at Beijing Capital Airport. What mainly creates the difference in quality is each airline's meal standard — in plain terms, how much it pays per tray. International routes, for instance, usually carry a higher standard than domestic ones.

China has more than 100 airline catering companies, and nearly all of them are controlled or part-owned by airlines, or belong to airport groups. That thin exposure to market competition is itself one reason airline food tastes bad. Markets abroad are more competitive, and third-party caterers like Gategroup are more common there. To some extent, that is why so many people find the food on international flights noticeably better than on domestic ones.

The big airlines that hold the leverage also have little reason to fix the "tastes bad" problem. You may complain about the food, but think back to when you actually bought the ticket: it almost never entered the decision.

What you looked at first was which airline flies the route, what time it leaves, the price, the on-time record. Whether the food is good sits at about the level of whether the flight attendants are attractive or the uniforms look nice — a bonus, nothing more. Mid-sized regional airlines, by contrast, are more likely to sell good food as a way to stand out. Xiamen Airlines and Shenzhen Airlines did, though they now belong to China Southern and Air China.

What HNA Stands to Gain

The 9.4 billion yuan price for Gategroup sounds steep, but analysts still call it a good buy.

HNA said the purchase is meant to "accelerate HNA's international development, strengthen HNA's capabilities in the airline food industry, and create synergies." Its international ambitions were already plain in last year's run of acquisitions, and in its 2015 annual report HNA said it would speed up that push in 2016.

"For an Asian company, buying an already-mature European company means a chance to expand its scale and get into overseas markets," said Zhang Qi, an analyst at Haitong Securities in Shanghai.

HNA now flies more than 40 international routes, mostly to Asia, Europe and the Americas. In 2015 alone it added eight: Chongqing–Rome, Beijing–San Jose/Birmingham/Prague, Shanghai–Seattle/Boston, and Xi'an–Rome/Sydney.

Europe and North America happen to be Gategroup's two most important markets. By Gategroup's own count, the EMEA market (Europe, the Middle East and Africa) brings in 48% of group revenue, and North America 35%.

Through the history of aviation, catering companies have always grown up attached to an airline or an airport — even Gategroup, now independent, began as a Swissair subsidiary. By buying a caterer spread widely across Europe and North America, HNA has stationed a supply corps along its future international routes in advance.

That is only part of the reason, though. Hainan Airlines' 2015 annual report puts its food costs at 816 million yuan, or 3.17% of total costs. HNA is buying Gategroup more as an investment.

Gategroup's assets and standing in the global airline catering market, plus its current squeeze, are what made it a target.

Over the past year HNA has bought across aviation and its suppliers and customers, hotels and real estate — nearly one deal a month.

HNA's acquisitions over the past year

2015.5

Bought 6.2% of South African Business Aviation

2015.6

Bought 2.99 million common shares of Red Lion Hotels

2015.7

Bought the Irish aircraft lessor Avolon for $2.5 billion

Bought 100% of Swissport, the world's largest airport ground-handling and cargo services provider, for $2.8 billion

2015.8

Bought Reuters' London headquarters building

2016.1

Bought the U.S. information technology company Ingram Micro for $6 billion

2016.4

Bought the Swiss airline caterer Gategroup for $1.5 billion

Bought the British currency exchange operator International Currency Exchange (ICE)

Bought an office building at Canary Wharf in London

Bought the U.S. hotel group Carlson Hotels

"[HNA] has said it will speed up its internationalization in 2016, and given how aggressive the company has been in past capital moves, that strategy may not stop at putting more capacity on international routes," said Zheng Wu, an analyst at Guotai Junan Securities.

More than one person who has dealt with HNA Group chairman Chen Feng says that he and his acquisition team hold their negotiations tightly to one goal: building a global travel and transportation company. HNA's strategy, they say, is to take controlling stakes in airports, airlines and aircraft lessors, adding value to its ever-growing portfolio of hotel and travel assets.

Word that emerged recently suggests HNA Group plans to merge two of its six divisions, HNA Aviation and HNA Tourism. If that is true, the intent behind the string of overseas purchases is not hard to read.

"For now the thinking behind the integration seems to be connecting the aviation and tourism chains — building a complete industry chain out of air transport, travel agencies, hotels, tourism finance and OTAs, and pulling together the regional airlines and the overseas airlines HNA holds stakes in, all in the service of tourism as a whole," the article quoted a person close to HNA as saying.

After this run of deals, HNA Group has become an investment-driven company.

Once the transaction closes, HNA Group plans to take Gategroup off the Swiss stock exchange and run it as a separate business under the group. Gategroup's headquarters will stay in Switzerland, managed by its current leadership team.

Either way, HNA will have acquired a valuable international asset — if the deal goes through.

Charts by Yuyao Lin

Cover image: johnmariani, VCG