Tuesday, February 13, 2007

Qantas I'm Worried

I have been very worried by the events around the take over of Qantas. By taking the company off the share market, loading it with debt and predicating the future profits on expansion of the fleet. Larger aeroplanes at a time when we are all becoming worried by climate change and green house gases being a major contributor. The future needs to be carefully managed if we are to protect our planet. Rampant capitalism isn't the way, the era of conservative politics where the market decides what we consume must be brought under control. It is one of the most destructive forces on this planet.


A journalist who writes for The Age newspaper here in Melbourne [Kenneth Davidson] has written an article looking at this take over. I have copied it below. Or you can visit the page here.

THE Qantas Bidder's Statement released last week is pure flannel designed to reassure the public that the airline will remain Australian owned and operated in the national interest.

Remember the reasons given for the privatisation of Qantas in 1995 was that market discipline would create a leaner, more efficient, more profitable (hence higher tax-paying) entity that would generate a win-win situation for the public, the shareholders and passengers.

Now we are expected to believe that this same market is myopic, investors are so obsessed with short-term profit and the share price that management is prevented from taking the "tough" decisions needed for long-term benefits.

This is a nice argument, but it is inconsistent with the facts. The only instability in the register until the takeover offer was when British Airways sold its 18 per cent stake in 2004. Shareholders have taken up rights issues to finance expansion with alacrity.

The value of the Airline Partners Australia (APA) bid is 25 per cent higher than the pre-bid price, which adds $2 billion to the Qantas market valuation.

This suggests that either the market undervalued the company by this amount or that the bidders have overvalued the company by this amount or some mixture of the two.

The letter to shareholders states: "APA is committed to supporting Qantas' current senior management team in achieving their existing strategy. Importantly, this includes supporting a $10 billion capital investment program over the next five years. More than 70 new planes will be introduced by 2014 to increase capacity by around 40 per cent."

And yet in the trade magazine Airline Business (July 6, 2006) David Bonderman, the founder of Texas Pacific Group, the largest foreign equity holder in the takeover vehicle and the investment vehicle that helped revive or launch carriers such as Continental Airlines, American West, Ryanair and Tiger Airways told the annual meeting of the International Air Transport Association it was time to sell airline stocks because "this is as good as it gets in the airline industry and it is only going to get worse".

Airline Business quoted Bonderman as believing "the industry is probably at its peak. It has been the same phenomena every six-eight years since the Wright Brothers. The massive aircraft orders that Airbus and Boeing booked last year is the almost perfect predictor to the top of the cycle. In two years' time you are going to see everyone cancelling those airplanes," Bonderman said.

He is entitled to change his mind or lie to convince the market that he is in the market to sell airline assets when he is in the business of buying. It is the duty of Qantas board members to be informed of these matters as custodians of the company with responsibilities to inform shareholders fully.

As shareholders and the public are given to believe that Macquarie Bank put this deal together, the real (or imagined) difference in the market and the APA valuation of the company Qantas is mainly based on APA's ability to "extract" value from the enterprise that is not now available to shareholders.

Macquarie Bank is Australia's financial engineers par excellence. Anthony Munk, managing director of Canadian company Onex, which is committed to take 12.5 per cent of the equity in APA, was quoted in Toronto's The Globe and Mail on December 13 after the offer was announced, justifying the investment thus:

"This is a very good company, it is well run, its market is well protected, we think that it really has a quality service to offer on its international routes and we just feel that there is an opportunity to extract value."

Munk has to be reasonably honest because he is talking to his investors. Bob Mansfield is different. His job is to reassure politicians and the public that the takeover is temporary and in the public interest.

The question is how will value be extracted. In the absence of candour from the bidders we can only guess: apart from cutting labour costs (easy with WorkChoices) the techniques are likely to involve asset stripping, combined with splitting the airline into profit centres based on high-value, high-cost local (City Flyer and regional) and international (North America, Johannesburg, Tokyo and Jet Star taking over the less profitable) routes.

The claim in the Bidder's Statement that foreigners will be stumping up 49 per cent of the equity but will accept only 39 per cent of the voting interest is irrelevant window dressing designed to reassure the natives. The equity partners will be looking after their own interests, which may or may not coincide with the national and public interest.

The $10 billion borrowings are to to be funded by a consortium of six foreign banks led by Morgan Stanley. According to Euromoney: "Credit Suisse was one of the banks originally touted as a lead, but the bank dropped out due to the leveraged loan's lack of usual covenants." In crude terms, the bid will be financed by high-risk, high-interest, junk bonds. Security for the loans will be the company's assets.

The hinge on which the whole deal rests is Qantas directors' willingness to ditch their policy of limiting debt to 50-60 per cent of assets in favour of a policy accepting an increase in debt to about 80 per cent of assets with provision to go even higher if economic conditions are unfavourable.

Qantas profit will be wiped out by the additional debt, but so will the tax liability, which will be redirected to financing the debt. APA wants tax-free capital gains, not taxable income. With luck, taxpayers will be paying for the cost of the $10 billion addition to our international debt necessary to finance the takeover.

Don't expect to hear much about this from the ALP. Its new business adviser, Sir Rod Eddington, is a director of Allco Equity Partners, a partner in the APA bid.

The ALP voted with the Government in December to abolish capital gains tax on assets held by foreigners. This has added $200-$300 million to the value of the Qantas takeover offer to the 47 per cent of foreign shareholders who will sell their shares. And it will add hundreds of millions to the after-tax gains of the foreign equity partners when they sell out of the tax avoidance scheme in a few years, providing all goes well.

Any additional comments can be sent to mark_brickel@hotmail.com