PAR Capital’s Ed Shapiro looks to position key IFE and connectivity holdings for market dominance

Ed Shapiro of Boston-based PAR Investment Partners, which is managed by PAR Capital Management, is no stranger to the world of commercial aviation. PAR played an instrumental role in facilitating the merger of US Airways and America West in 2005, and thereafter Shapiro served on the US Airways board for three years.

In the last few years, however, PAR – guided by Shapiro – has been gradually making its mark in the world of inflight entertainment and connectivity by acquiring sizeable stakes in fibre optics-based IFE hardware company Lumexis, satellite-supported inflight high-speed Internet provider Row 44, and Advanced Inflight Alliance (AIA), which acts as a holding company for more than 20 international subsidiaries including major IFE content service provider Inflight Productions and inflight gaming leader DTI Software.

A series of recent transactions will put AIA on track to become an even stronger force in the passenger experience industry. At the end of May, AIA announced plans to acquire a minority stake in Row 44. The transaction is financed by a capital increase in kind at AIA by issuing over 5.2 million new shares that will be subscribed by PAR. In return for the new shares of AIA, PAR will contribute nearly 85 million shares of Row 44 to AIA, representing approximately 12.5% of Row 44 (and valued at $25 million).

The deal will effectively increase PAR’s holdings in AIA from presently below 30% to over 45%, according to AIA, and trigger the obligation for PAR to launch a public tender offer, which is currently under review by German regulators. “The synergy of the Row 44 acquisition will enable Advanced Inflight Alliance AG to provide a much more powerful and global offering of a total solution that will include truly end to end service. I look forward to growing our business and to pursuing our course to provide a complete inflight service offering to our airline clients, and a global experience to passengers around the world,” AIA CEO Louis Bélanger-Martin said in a recent letter to shareholders.

So why is Shapiro so keen to invest in inflight entertainment and connectivity companies? “As a shareholder, my goal is to create substantial long-term value by providing capital and guidance to the companies we invest in. There are an enormous number of simultaneous changes occurring right now – in technology (inflight connectivity and fibre-based VOD), with airline economics (product unbundling and maximization of ancillary revenue), and passenger behaviour (iPads and on-demand content) – and as a result, I believe there are a number of very interesting investment opportunities in this space,” says Shapiro, who serves as chairman of AIA’s supervisory board.

Among the drivers impacting his decision-making is that airlines now have a strong desire to generate ancillary revenue through inflight entertainment and connectivity, and passengers crave content. “It’s not just about product differentiation and market share, it’s about ‘How do I deliver something that the customers will value, and monetize an asset I’ve always had, which is a very targeted and captive customer base’. In today’s 500 channel, web-connected world, the airline industry can deliver something truly unique: a large number of customers, literally strapped in their seats for hours at a time, looking for ways to be entertained, informed and connected, increasingly using the new device they just invested in. And with airlines operating in a highly competitive environment, I see IFE as the next frontier in generating ancillary revenue opportunities. So it is these two trends – passengers seeking onboard content and airlines generating new revenue sources – which has created these new IFE investment opportunities,” he tells the APEX editor’s blog in an exclusive interview.

Helping to underscore Shapiro’s point, US low-cost Southwest Airlines –  which is in the midst of equipping its Boeing 737 fleet with Row 44’s Ku-band satellite-supported inflight Internet – has now fitted almost 250 aircraft with the Row 44 system, or about half of its 737-700s, and that new installations occurring at a rate of approximately 20 per month.

“All of the 700s are expected to be equipped by early next year. Additionally, as the AirTran -700s transfer into the Southwest fleet, Gogo is being replaced by Row 44.  Finally, all 737-800s [that] SWA is receiving (at a rate of three to four per month) are being equipped with Row 44 before entering service. The net result of this is that we expect to have approximately 400 Southwest planes installed by year-end and approximately 450 by the end of 2013,” he reveals.

Row 44 has also fitted Norwegian Air Shuttle’s Boeing 737s with Row 44. And it has announced three new customers – Mango, Transaero, and Icelandair – which will expand the company’s footprint into South America, East Asia and the North Atlantic, respectively. Row 44 says Icelandair’s entire fleet of 12 Boeing 757-200s will be equipped with the system; activation is scheduled to begin in the fourth quarter of this year, and to be completed in the fall of 2013. Icelandair will ultimately determine its own pricing mechanism, and whether it wants to adopt Row 44’s television over IP service in addition to the Internet, adds Row 44.

In terms of securing line-offerability, Row 44 is working closely with Boeing, Southwest and Norwegian to be able to offer “some type of a line-fit option for both existing and future orders of narrow and wide-body aircraft”, says Shapiro. “We don’t know when this will occur but we are hopeful that with the strong support of our current customers and the increasing global interest in connectivity, both Boeing and Airbus will add Row 44 line-offerability in the near future.”

Shapiro personally believes there are two critical aspects of the Row 44 Ku system which will differentiate it from the predominant Gogo air-to-ground system being used today in the United States – coverage and bandwidth.

“The airline industry is global and 2/3 of the world is covered with water. So in order to reach airline passengers across their journeys, you need a system that isn’t limited by both national spectrum licenses and terrain. Further, it is very clear that in 2012 people want bandwidth, and the more you give them, the more they want.  What we’ve seen, first in homes and offices and then in hotels and cars, is that there is an insatiable demand for content and while the initial reaction to inflight connectivity might have been ‘OMG, I’m connected in the sky!’, we are already hearing from passengers that they expect an experience which is not too dissimilar from what they are used to on the ground,” he says.

“So while bandwidth clearly has a cost, the fact is that Ku satellite-based systems are (theoretically infinitely) scalable given the available global capacity, vs. a ground-based system which is limited by the amount of capacity being dedicated and sold for ATG uses by each country.  And while we haven’t yet seen this bandwidth advantage in terms of a differentiated product, stay tuned for some very exciting product launches in the next couple of months.”

Row 44 does not own any of its own satellites but instead today leases Ku capacity from multiple satellite owners (with its partner Hughes Communications) in various regions and delivers the data to an antenna (from its partner Tecom) installed on commercial aircraft.

“Today, we believe that Ku is the only system which can deliver high-bandwidth, global inflight connectivity.  However, if at some point in the future a superior (lower cost/higher speed) system is available in geographic regions where our customers operate, then it will clearly be in our interests to be able to offer this system to both our existing and future customers,” says Shapiro.

“I do believe at some point a Ka-band inflight system will be available (at least in some parts of the world) and Row 44 and its partners are well positioned to leverage our Ku satellite experience to maintain our leading position.  Timing is the biggest question and I happen to believe that Ka will take longer to develop and not become ubiquitous for quite some time.  One additional factor to consider is that as Ka is deployed and ground-based systems (residential and commercial) migrate from Ku to Ka, Ku transponder costs are likely to fall, further decreasing any apparent cost advantage Ka may have today.”

Row 44’s main competitor in the Ku connectivity space is Panasonic Avionics (Gogo also recently announced plans for Ku, but it is not as far along in the development process as the other two).

Interestingly, Transaero has a mix of Panasonic and Lumexis IFE and now will have both Panasonic and Row 44 connectivity. Shapiro says he has tried to encourage all the IFE and inflight connectivity companies in the PAR portfolio to work together “and this is definitely happening”.

For instance, Lumexis and Row 44 “are working together at Transaero and other airlines interested in a combined in-seat and wireless product. AIA has been working with Lumexis and flydubai to add new content to the [fibre-to-the-screen] system and some of these applications (such as e-reader) are on the current flydubai-Lumexis platform. And as a result of AIA’s recent investment in Row 44, those two companies are working together to leverage AIA’s substantial inflight content experience with Row 44 and its airline customers’ rapidly expanding platform.”

He adds: “Stay tuned for additional partnership announcements among all three companies (and possibly some other PAR investments). In some cases, the products being developed will logically be made available to other platforms and benefit from scale while in other cases the products will remain proprietary for the companies and/or our airline customers.”