Debt dependence compounded lack of due diligence

By Alan J Robb

Friday 28th September 2001

There is no mention of ebitdra or any other meaningless number. What really counts is net profit after tax

A year ago Air New Zealand tried to direct attention from its poor operating performance by creating a questionable statistic "ebitdra" (NBR, Sept 8, 2000).

Computing earnings before interest, taxation, depreciation, rentals and amortisation masked the unpalatable fact the company's results were being dragged down by its investment in Ansett Australia.

The situation worsened after Ansett became a wholly owned subsidiary. Claims Ansett would contribute integration benefits of $350 million over three years, including $175 million in the financial year 2001, have now been replaced by an acknowledgement Air New Zealand has really lost over $1 billion on the exercise.

AIR NEW ZEALAND - THE IMPACT

$m	1996	1998	2000	Year to 31 Dec 31, 2000

Debt	$1,729.9	$2,115.1	$7,399.4	$7,639.8
Equity	$1,407.3	$1,988.9	$1,590.1	$1,902.6
Debt/equity	1.23:1	1.06:1	4.65:1	4.02:1
Net interest expense	$3.7	$40.7	$72.1	$115.7
Weekly interest expense	$0.071	$0.783	$1.387	$4.450

As was pointed out at the time, ebitdra masked the fact the company was spending over $256 million a year or $5 million a week leasing aircraft. Ebitdra also masked the impact of the company's rocketing interest bill arising from its decision to finance its acquisition of Ansett largely through debt. The impact can be seen clearly in the table.

Before acquiring its 50% shareholding in Ansett, the 1996 balance sheet showed a debt-equity ratio of 1.23:1 and net interest expenses of $3.7 million a year or $71,000 a week.

Two years later the debt to equity ratio had improved to 1.06:1 but the net interest bill had risen more than 10-fold to $40.7 million a year or $783,000 a week. The increase was a consequence of increased borrowing plus the interest component of finance leases.

By June 30, 2000, the debt-equity ratio had quadrupled to 4.65:1 and the net interest expense had almost doubled to $72.1 million a year or $1,387,000 a week.

But even this was to change. While Air New Zealand held only 50% of Ansett it adopted equity accounting. When Ansett became a subsidiary on June 23, 2000, consolidation accounting was required. Consequently the balance sheet for the six months to December 31, 2000, was the first to reveal the full extent of the borrowings of the enlarged group.

Debt was shown as $7.639 billion and equity at $1.902 billion. Debt to equity was 4.02:1. The interest bill had reached $4,450,000 a week. The latest accounts show that for the full year to June 30, 2001, interest was costing just under $6 million a week.

It has been acknowledged by the acting chairman that Air New Zealand did not conduct adequate due diligence before acquiring the second shareholding in Ansett.

That mistake was compounded by a risky strategy relying heavily on debt finance. Both mistakes were aggravated by the company's flirtation with ebitdra as a measure of performance.

It comes as no surprise to see Singapore Airlines reports its performance in orthodox terms. There is no mention of ebitdra or any other meaningless number. What really counts is net profit after tax.

Alan Robb is a senior lecturer in accountancy at the University of Canterbury. He holds no shares in Air New Zealand

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