Air NZ's autonomy under threat from Qantas proposal - Treasury

By NZPA

Wednesday 12th February 2003

Air New Zealand faces problematic trade-offs that could undermine its autonomy under the proposal to form a strategic alliance with Qantas, according to Treasury papers released today.

"Project Vanilla", as the proposed alliance is code-named in the papers, would result in cost saving decisions that would link Air NZ to Qantas "to a greater extent than may be considered desirable by shareholders".

"In our view, it is inevitable that the two airlines will become more interlinked over time as the alliance beds in," senior analyst Kirsty Flannagan and commercial investments manager David Taylor advised Finance Minister Michael Cullen shortly after the deal was publicly announced.

The concern about Qantas asserting control well beyond the proposed 22.5 percent holding is a continuing theme of Treasury and consultants' advice.

The Government today released the first tranche of a swag of papers on the deal, initially code-named Project K, ahead of the closing of submissions to the Commerce Commission on February 14.

Dr Cullen revealed that only on the night before the proposal was submitted to the Government and announced to the Stock Exchange on November 25 was the $550 million deal finalised between the airlines.

In a note accompanying the release of the papers, Dr Cullen acknowledged that the most important concern raised in advice was that Air NZ's ability to operate autonomously might be gradually compromised.

He said the advice suggested the best way to mitigate that was to protect Air NZ's ability to quit the alliance at minimal cost. The Government has acted on that by requiring Air NZ to get guarantees that such costs are minimised in the event of termination.

But the papers reveal that minimising the costs would not be easy.

Air NZ's brand would inevitably be devalued and its market position would be weakened. It was highly likely a discount airline would by then have established operations in opposition to an Air NZ/Qantas alliance.

Treasury said Air NZ would be in an inherently weaker position than Qantas within the alliance because a greater proportion of its business would be covered by the deal.

The papers show that initially Qantas wanted to buy a 25 percent stake. Air NZ, rather than the Government, negotiated the figure down to 22.5 percent because of the theoretical danger that Qantas could block corporate constitutional changes needing a 75 percent majority.

Many of Treasury's concerns regarding autonomy stemmed from a commissioned report by Charles River Associates, written by academics Lewis Evans and Neil Quigley.

They said that, once completed, there was likely to be on-going tension between the benefits of further integration of Air NZ into Qantas and the benefits of retaining autonomy and an exit option.

There was also a danger of Air NZ management becoming aligned with Qantas' interests.

They said Qantas's two directors on the nine-member board were likely to have more focused objectives and there was potential for administrative control to drift to Qantas to a greater extent than implied by its 22.5 percent holding.

"We consider the risks of effective control passing to Qantas, misalignment of interests and the costs of exit from the alliance to be material but potentially manageable within the framework established by the proposed alliance."

There are few insights into Air NZ's alternatives to a tie-up with Qantas. Just as Air NZ has been silent on its so-called Plan B, so the Treasury papers on the alternatives have been blanked out as commercially sensitive.

But Treasury concludes: "There are no viable alternatives that offer the same benefits as the strategic alliance with Qantas."

It said the key benefit from a shareholder perspective was that the value of Air NZ was likely to increase.

"The key risk for Air NZ is the potential for Qantas to exert significant influence over Air NZ's operations."

From a shareholder perspective, it came down to balancing Air NZ's enhanced strategic position and financial gains "against the risks from Qantas's ability to influence Air NZ and the more difficult exit options for the crown".

Without Qantas, Air NZ faced an uncertain future where its weak balance sheet made it financially vulnerable.

"The proposal is likely to be the best on offer for Air NZ for the foreseeable future", and if approved the crown would receive significant benefits from an ownership perspective.

National Party transport spokesman Roger Sowry said the papers "clearly show" a draft proposal was with Dr Cullen before the July election but had been "put on the slow burner" because it was politically unpopular.

"Not only is the deal bad, but the Government misled New Zealanders about its involvement in it and knows Qantas can commercially disadvantage Air New Zealand through it," he said.

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