By BRIAN GAYNOR
How could Air New Zealand lose $1.43 billion in the June 2001 year? This was its second disastrous result in a row and the group has now reported losses of $2 billion and wiped out 75.6 per cent of shareholder funds in the past two years.
And what about the company's prospects? Does the abandonment of Ansett and the proposed recapitalisation place it on a sound footing for the future?
Air New Zealand's problems are clearly related to its involvement with Ansett Australia. This began with the purchase of 50 per cent of the Australian carrier from TNT in 1996. The purchase price was $A325 million and Air New Zealand injected a further $140 million of equity, bringing its total cost to $A465 million.
At the time Brierley Investments had a very strong influence over Air New Zealand with four board representatives, including chairman Bob Matthew and deputy chairman Sir Selwyn Cushing.
There were two important features of the purchase agreement:
* News Corporation, which owned the other 50 per cent of Ansett Holdings, obtained a five-year management contract over the company.
* Air New Zealand was given first right of refusal if News Corp decided to sell its 50 per cent holding.
Although Air New Zealand had no management influence it had several representatives on the Ansett board. These included Bob Matthew (until he was replaced by Sir Selwyn Cushing as Air New Zealand chairman in May 1998), managing director Jim McCrea and John Curtis, an experienced Australian director.
In March 1999 News Corp announced it had an understanding to sell its 50 per cent Ansett stake to Singapore Airlines for $A500 million.
Sir Selwyn Cushing took a firm stand on the issue and vetoed the sale to Singapore Airlines. After protracted negotiations, which included Singapore Airlines' acquiring 25 per cent of Air New Zealand, Sir Selwyn finally realised his ambition and the remaining 50 per cent of Ansett was purchased for $A580 million in June 2000.
The acquisition of the second 50 per cent is the primary cause of Air New Zealand's problems. Ansett had major engineering, financial reporting and operational reporting problems that were not identified by Air New Zealand. )
Directors argue that they did not have the opportunity to undertake full due diligence because News Corp had two potential buyers and Air New Zealand had to act quickly to veto the proposed Singapore Airlines sale.
But why didn't the Air New Zealand representatives on the Ansett board recognise these problems? Why didn't Mr McCrea, who has a strong engineering background and had been deputy chairman of Ansett since 1996, identify the shortcomings and communicate these to his fellow Air New Zealand directors?
On July 7 last year, 14 days after Air New Zealand took full management control of Ansett, Mr McCrea resigned as group managing director and Sir Selwyn Cushing replaced him as executive chairman. By the time Gary Toomey, the new chief executive, took up his position six months later Ansett was already in serious trouble.
The Australian operation was facing increased domestic competition and experienced maintenance problems over the Christmas holiday period. During the Easter holiday period Australia's Civil Aviation Safety Authority grounded the company and since then market conditions have remained very competitive.
The company's domestic and international activities reported an operating loss of $188 million for the June 2001 year. In addition, Air New Zealand wrote down its Ansett investment by $1.32 billion.
No figures have been supplied for the previous year but in the June 1999 year , Ansett reported operating earnings of $A231 million ($280 million).
Throughout Ansett's problems Air New Zealand has strongly maintained the Australian acquisition was its only viable option. A few weeks ago, Jim Farmer, who replaced Sir Selwyn Cushing as chairman on May 29, wrote: "Without Ansett, Air New Zealand would become unprofitable and commercially impotent ... and ... Australian-focused competition would crush the New Zealand national carrier."
These comments are important in the context of this week's developments.
The second leg to Air New Zealand's problems has been the failure to complete a satisfactory recapitalisation that would have enabled it to hold on to Ansett.
On June 19 Dr Farmer announced that, subject to Government approval, Singapore Airlines would significantly increase its stake in Air New Zealand through a placement of new shares at $1.31 each.
The highly successful Asian airline had also agreed to support subsequent capital raisings.
Air New Zealand then presented three different plans to the Government over the next 10 weeks:
* A capital injection of $850 million, to include $640 million from Singapore Airlines.
* Then a proposal to purchase Virgin Blue and have a capital injection of $1350 million.
* Finally, after the Virgin Blue purchase fell over, it said a capital injection of between $1600 million and $1900 million would be required.
Last week Singapore Airlines withdrew its offer to purchase shares at $1.31 each and Air New Zealand tried to sell Ansett to Qantas. These negotiations broke down on Wednesday. Ansett was placed in voluntary administration later that day and stopped flying yesterday.
Control of Ansett had switched from Air New Zealand to PricewaterhouseCoopers and our national carrier's ambition to become a major regional airline had come to an end.
Air New Zealand claims that if the Government had allowed Singapore Airlines to increase its shareholding at an earlier stage Ansett could have been retained and the $1.32 billion write-off avoided.
These accusations are difficult to justify. Based on Air New Zealand's last plan and the June 2001 accounts, the group needed an equity injection of at least $1.6 billion if it was to retain Ansett. Singapore Airlines agreed to contribute $640 million, but where would the remaining $1 billion plus have come from?
Air New Zealand has been stripped down to its pre-Ansett size but its financial position is much weaker than it was five years ago. Before its Ansett investment the national carrier had total assets of $3.1 billion and shareholder funds of $1.4 billion.
According to the June 2001 accounts Air New Zealand has shareholder funds of $500 million and New Zealand assets of $4.5 billion. Singapore Airlines and Brierley Investments have agreed to contribute equity of $150 million each and the Government will provide up to $550 million of loan facilities on commercial terms.
The $300 million equity injection, which will bring shareholder funds to $800 million, appears to be totally inadequate because Air New Zealand could be subject to claims from Ansett's voluntary administrators. These could relate to employee entitlements, aircraft lease agreements, director indemnities and financial liabilities.
Air New Zealand has a highly geared balance sheet, is facing difficult international trading conditions and still has to account for Ansett's operating losses for the July 1 to September 12 period. These are estimated to be in excess of $100 million.
The national carrier will have to raise at least $500 million additional capital or sell assets before it is in a strong position to face the future.
The disastrous performance of Air New Zealand is due to the decision to move to full ownership of the Australian group last year. The company would be in a much stronger position today if Sir Selwyn Cushing and his fellow directors had allowed Singapore Airlines to purchase 50 per cent of Ansett in 1999.
But the board and management wanted Air New Zealand to become a major Australasian airline and didn't allow the reality of Ansett's situation get in the way of this ambition.
* Disclosure of interest: none.
By BRIAN GAYNOR