The Shoeshine Column: Botched Ansett buy puts Air New Zealand's Toomey in the hot seat

Friday 16th March 2001

Singapore Airlines' profit last year was $1.6 billion so it probably isn't too worried about the paper loss on its Air New Zealand shareholding.

It picked up its 25% stake in April last year for 300c a share. With the B shares trading this week at 183c it's $226 million out of pocket.

That's probably about what its executives spend on lunch each year but even so the board must be wondering whether turfing Jim McCrea out of the Air New Zealand chief executive's seat back in July was such a great idea.

At $3.8 million, Air New Zealand's December half-year profit was slightly less than that of Reid Farmers, an Otago-based stock and station agent.

That's a staggering destruction of shareholder value. At the December 31 balance date the airline had shareholders' funds of $1.9 billion. Invested at the 90-day bank bill rate that amount would have brought in interest of $40 million after tax. So the opportunity cost to shareholders of being in Air New Zealand over just six months was $36.2 million.

The impression forming around industry circles is that the carrier has bitten off far more than it can chew.

As the brass have explained at every available opportunity much of the evaporation was due to factors outside the airline's control.

Fuel prices, as every driver knows, are still at historic highs. The Australian and New Zealand currencies are wallowing against the US dollar, in which most fuel and aircraft purchases, and lease payments, are denominated. And both Virgin Blue and Impulse have started up Australian domestic services in competition with Ansett.

Given the airline had some hedging protection against the first two perils you have to wonder what the loss would have been if it was unhedged.

But the most surprising and disappointing contributor to the profit collapse was Ansett, whose acquisition last year is beginning to look like a monumental management botch.

Firstly there have been the ructions within the ranks of management itself.

Ansett's Australian employees were shocked when Air New Zealand revealed only two had made the 21-strong senior management team for the combined airlines. Many saw this as an act of astonishing arrogance from a company used to running domestic operations far less complex than Ansett's.

Then came the sackings as Air New Zealand set about trying to produce the $300 million of annual cost savings it has promised. These fell far more harshly on the Australians than on New Zealanders and prompted a wave of defections which new boss Gary Toomey has had to make good by poaching staff from Qantas - for a suitable inducement, presumably.

The promised integration efficiencies are already well behind schedule.

And observers see some significance in Ansett's embarrassing grounding in December of six 767s when it failed to make a major check required by manufacturer Boeing. That isn't a good look for any airline, let alone one in a four-corner fight for market share. Would it have happened without the decimation of Ansett's management ranks?

Nor does the profit drop look like a one-off bout of indigestion. Sharebroker Credit Suisse First Boston last month downgraded its forecast for the June 30 year from $101 million to $14 million. For 2002 it's picking $153 million, down from a forecast $214 million.

Chairman Sir Selwyn Cushing's admission ("probably") that Air New Zealand paid too much - $A580 million - for the 50% of Ansett it didn't already own prompts another set of questions.

Ironically Singapore Airlines is partly to blame. Its attempt to buy the stake directly drove up the price by boosting News Corp's price expectation.

While Sir Selwyn contends Air New Zealand's debt-to-assets ratio is still within industry norms, the Ansett buy has stretched the balance sheet when it needs to plough vast sums into Ansett to renew and tidy up the mixed-pedigree fleet.

And if, as Sir Selwyn says, Air New Zealand paid too much it will at some point have to write down its acquisition cost, further stretching the balance sheet and handing shareholders a hefty loss to contemplate.

The lease liabilities it has taken on will give its bankers something to think about. On the profit front the Ansett buy pushed December-half operating lease costs up to $217 million from $120 million a year before.

Now the pundits reckon the only way Ansett is going to get flying again is if Singapore Airlines steps in.

A straight equity injection is out of the question. Singapore Airlines can't own any more of Air New Zealand than it already has and it would scarcely be practicable for it to take a direct Ansett stake now.

The best bet is some complex structures whereby Singapore Airlines uses its own balance sheet - geared at around 4% - to prop up those of its southern cousins.

It could, for instance, provide some form of second-tier debt such as promissory notes. It could also carry some of Ansett's lease liabilities. It would, of course, want some sort of payment for the facility but at least Air New Zealand's bankers would be more comfortable.

Shoeshine wouldn't be at all surprised if that was the arrangement behind the lease of four Boeing 767-300s announced on Monday.

Meanwhile, the upbeat Gary Toomey must be feeling the rising temperature of his seat. As one of Australia's top finance executives he's probably as good a bet as any to fix up the balance sheet but his greatest challenge will be getting two conflicting management cultures to work together.

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