Thursday, February 15, 2007

More on QANTAS

Here is a follow up piece from Kenneth Davidson in The Age Newspaper re. the sale of Qantas. It is worth a read cause it will most definitely relate to a company in your neck of the woods too.
PS I have been told by one of my readers that she prefers my more personal tales. I will endeavour to find one around here soon.

THERE are five reasons why Treasurer Peter Costello should block the sale of Qantas to private equity consortium Airline Partners Australia (APA).

The sale is at the expense of Australians both as taxpayers and superannuants. It increases the risk that Qantas will go bankrupt.

And even if APA achieves its objectives, the takeover will not generate wealth and will add to Australia's already onerous

net foreign debt of about $550 billion.

But more importantly, if this deal goes ahead, it will be the forerunner to a flood of similarly financially structured takeovers that will load Australian corporations with debt levels not seen since the '80s, which led to the "recession (Australia had) to have".

If this deal goes ahead, any company, no matter how large and well managed with a prudent debt-to-equity ratio, will be vulnerable to takeover by privateers who will finance their takeover by loading the target company with debt.

In the '80s the main actors were the paper entrepreneurs — the Bonds, the Holmes a Courts, the Spalvins and the Abe Goldbergs.

The immediate victims were the banks, which lived in a world of unlimited financial liquidity thanks to financial deregulation, were desperate to lend to anybody, and ended up with $28 billion of what were laughingly called non-performing loans.

Compared with today — with trillions of dollars sloshing around desperately looking for profit — the '80s was a period of financial drought.

Today the paper entrepreneurs have been replaced by a new breed of financial engineers who specialise in private equity.

The banks still play a major role in putting the deals together, but instead of risking their depositors' funds, the deals (and the risks) are passed on to superannuation funds.

It helps to understand what is going on by knowing why APA can pay a 25 per cent premium on the value of the pre-bid shares, which adds

$2 billion to the Qantas market valuation.

APA would like you to believe that by going private, the entity will have more freedom to restructure and take a longer-term view than that available to management of a publicly listed company subject to the discipline of investors and regulations designed to protect investors. Maybe.

The name of the game is leverage — the same game that was played out in the '80s. APA will finance its highly leveraged bid by accessing the $330 million-a-year corporate taxes paid by the company now to finance the extra interest on borrowings and use the assets (mainly planes) as surety for the loans.

The takeover proposal reduces equity in Qantas from $6 billion to $3.6 billion. Debt is increased from $5 billion to $8-9 billion.

For a given revenue, the smaller the equity, the higher the return to equity holders; but the higher the debt, the higher the fixed costs and the greater the risks.

The transaction and success fees that will be extracted from Qantas if the takeover goes ahead are staggering — in the order of $400-500 million — for what amounts to low-grade activity that adds nothing to Qantas' value.

The participants expect another similar round of transaction fees when Qantas is sold back to the public in five years, provided the company's value rises sufficiently.

Whether the value rises during this period depends far more on the economic environment continuing to be favourable to civil aviation in general (low interest rates and global growth) and Qantas in particular (the regulatory regime that continues to exclude Singapore Airlines from profitable routes) rather than the superior management skills of the new, temporary owners, who have said they intend to keep the present management and corporate strategy in place.

According to a report in The Age last December of a speech by Reserve Bank governor Glenn Stevens, private equity companies claim they have more room to restructure, "but mainly their strategy is one of leverage", adding that, if the process continued, corporate debt could be a bigger risk to the economic and financial system than it has been for 20 years.

According to the Reserve Bank statement on monetary policy, issued this week, leveraged buy-outs (LBOs) rose from an average of $1.5 billion a year over the previous five years to $7 billion last year. In the last December quarter alone, the value of completed or pending LBOs was $19 billion.

The RBA commented: "If the current surge in LBO activity continues for some time, the increase in corporate leverage could become a long-term risk to economic management."

In the absence of a reversal in the scandalous decision to abolish capital gains tax on capital gains realised by foreigners, and the absence of changes to the corporations regulations to make private companies subject to the same rules of disclosure as public company, the only way to prevent the surge of LBOs becoming a flood is for the Treasurer to stop the Qantas takeover and any others of the same ilk in the pipeline.

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