O'Sullivan: By jingo - it's not over yet

By FRAN O'SULLIVAN

Airlines are a great industry but a lousy business. Investment guru Warren Buffett's aphorism should be indelibly engraved on Prime Minister Helen Clark's mind as she deliberates the extent of Government financial support to Air New Zealand's forthcoming bailout.

Each year more and more people take to the skies. But despite the glamour and the lustre of the aviation business, profits are not great, with most airlines failing to recover even their cost of capital.

The Prime Minister has now declared the Air New Zealand bailout negotiations "Commercial - In Confidence".

This is code for Government insiders to stop their spin exercises and ensure media comment is confined to the designated spokesman.

So confidential, in fact, that even Rodney Hide, the Opposition's Leaksmeister, will be hard pressed to get the usual suspects to deliver him the goods.

Government negotiator Rob Cameron will continue to pressure the key players to reach a shareholders' agreement by the end of this week to recapitalise Air New Zealand.

But those players have removed themselves from the front pages as the horse-trading enters the "down and dirty" phase where loose-lipped comments could tip the commercial balance against their own interests.

The position-taking may be muted but there are still some very crunchy issues to be determined.

Judging by the commercial track record of players such as the Government, Brierley Investments and Singapore Airlines, these issues will provide plenty of material for behind scenes dispute.

Top among them is the question of whether Air New Zealand should write down the value of its troubled subsidiary Ansett Australia when it reports its June 30 result on September 13.

Air New Zealand has in the past indicated it wants to avoid the prospect of a major writedown - if it can - and simply report an estimated $200 million loss for this year's annual result.

The airline has persistently retailed the line that the major focus for its recapitalisation is to reduce its debt/equity ratio and put it in a position where it can undertake a $4 billion to $5 billion fleet-replacement programme for its Australian fleet. But it is clear that Air New Zealand's Australian operations have also been strongly hit by savage domestic discounting and competitive pressures across the Tasman.

Stern Stewart has estimated that last year Air New Zealand destroyed $2.1 billion in value for its shareholders according to a market value added measurement.

Air New Zealand has argued that if the new capital is lined up it will not need to writedown the value of Ansett Australia. But if the airline's board opts for a major writedown, Air New Zealand's value would clearly diminish (in turn dropping the share price). This would clear the path for shareholders' funds to be restored to a realistic level through a share placement to major shareholder Singapore Airlines (SIA at present has 25 per cent of Air NZ) and the injection of further funds through a commercially priced rights issue.

But while dumping the share price would simply be standard operating procedure for some of the players at Cameron's negotiating table, it could be viewed negatively by minorities if an Ansett writedown was too aggressive.

That said, any prudent board will generally want to bring as much bad news to book as it can when a restructuring is unveiled. This positions both the board and management to report more easily a lift in performance at the next reporting date, thus ensuring the confidence of the relevant stakeholders: shareholders, bankers, and creditors.

Where the game gets interesting is if Air New Zealand is forced to sell part, or all, of Ansett Australia. If this eventuates, Air New Zealand would probably have to take the hit on its profit and loss whereas the acquirer would stand in a position to subsequently boost its earnings from inflated profits from the sale of the written down company.

In the 1980s, this type of exercise was frequently abused - but these are the sort of calculations which inevitably exercise big players when the chips are down.

Over the past month there has been plenty of public position-taking by the major players.

Each of the five has held fast to its negotiating scripts through the brinksmanship and spin war that has characterised this epic restructuring exercise: the Government portraying itself as a reluctant supporter of the recapitalisation of the national flag carrier ("Our preference is not to commit shareholder capital - but we will not let the national flag carrier fail"); Singapore Airlines portraying itself as the saviour and trying to offset claims it is the predator of the Australasian skies ("Our desire is to increase our shareholding in Air New Zealand from 25 per cent to 49 per cent"); Air New Zealand wearyingly singing its song ("This is not a bailout - if it were not for Government ownership restrictions we could go to the international markets for a recapitalisation"); Brierley Investments keeping quiet in the background ("We do not want to commit more capital"); and Qantas Airways upping the ante ("We will be marginalised if the New Zealand Government allows Singapore Airlines to create a regional behemoth by increasing its stake in Air New Zealand").

Late last week, Singapore Airlines was perceived by most observers to have the upper hand with Qantas relegated to the wings.

The Government was examining the extent of its support and the commercial "dividend" it would extract to come to the party. Judging by the Government's performance in previous financial rescues, it could be expected that the Treasury would suggest cabinet ministers extract a financial bonus for any contribution. Hence, Air New Zealand shareholders could expect Cameron to suggest that liberal underwriting fees be awarded the Government if it decided to guarantee the expected rights issue and further substantial fees if participated through a share placement or a contribution to a capital notes issue.

When DFC New Zealand collapsed the Government put muscle behind a settlement with the major creditors, but still extracted a commercial price for its assistance. With the 1990 Bank of New Zealand bailout and subsequent sale of its stake to National Australia Bank it arguably gave too much value away to the detriment of minorities - but great good fortune of Don Argus' NAB.

The other major risk is geopolitical - particularly if the Australian Government vetoes Singapore Airlines' proposal as against the Australian national interest. This theory gained ground in Australia last week but columnist Terry McCrann refreshingly poured scorn on the spin as more of the "foreign investment bogey."

The fundamental point - not lost on McCrann - is that the Singapore/Air New Zealand/Ansett behemoth, so much feared by Qantas Airways, is already in existence. The Government made its choice when it allowed the Australian Foreign Investment Review Board to approve Air New Zealand to buy 100 per cent of the Australian domestic airline.

McCrann's logic is impeccable - but not so that of the rest of the Australian media. There will be plenty more jingoism before the Air New Zealand ownership tangle is settled.

Southern Skies Properties Limited

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