Gaynor: Naive to blame disasters on Qantas

By BRIAN GAYNOR

Air New Zealand's annual general meeting was full of personality and high drama.

An impatient and intolerant John Palmer chaired the gathering; Jim Farmer blamed everyone else for the company's problems; Roger France gave a sober view of conditions; Act MP Stephen Franks swiped at the Labour Government; Bruce Sheppard waxed lyrical about victims and villains; and Max Gunn blamed the outgoing board.

Mr Sheppard argued that Brierley Investments and Sir Selwyn Cushing were the main villains, and Mr Gunn was applauded for claiming Sir Selwyn had ruined the airline.

But the company took a totally different view. In a 51-minute address, Dr Farmer, Air New Zealand's former acting chairman, referred to Qantas more than 40 times and argued that the Australian carrier had been a major contributor to his company's problems.

Dr Farmer barely mentioned Sir Selwyn and Brierley, but he made several claims against Australia's national carrier:

* Qantas' aggressive price discounting was mainly aimed at Ansett. Dr Farmer suggested that this went "beyond the bounds of legitimate, tough competition" and "Qantas was using its financial reserves and strength to crush Ansett".

* A Qantas proposal to acquire a significant shareholding and for Singapore Airlines to buy Ansett would have "confined Air New Zealand to being a small domestic and Pacific Islands carrier" and from an international perspective the company "would have withered on the vine".

* Qantas adopted aggressive corporate tactics, helped by the Australian Government, to oppose the Air New Zealand-Singapore Airlines recapitalisation proposal.

Dr Farmer concluded: "I hope I will be forgiven for offering a warning for the future and cautioning against any future Qantas offers to buy out Government shareholding, even at prices providing the Government with a healthy profit on its investment."

It is extremely difficult to agree with Dr Farmer's interpretation of events.

In mid-1995, when Qantas was privatised, Air New Zealand was on equal terms with it.

At the end of December 1994, Air New Zealand had shareholder funds of $1.2 billion, representing 41 per cent of total, and had reported net earnings of $331 million in the previous 18 months.

At the same time, Qantas had shareholder funds of $A2.3 billion ($2.8 billion), representing just 27 per cent of total assets, and had net earnings of $A284 million ($350 million) in the 18 months to December 1994.

When Air New Zealand bought 50 per cent of Ansett in November 1996 for $A465 million ($575 million) it had a limited impact on the company's financial structure.

The acquisition was treated as an investment and not consolidated, and $252 million of new equity was raised to help finance the transaction.

Qantas was not concerned about the deal because News Corporation retained management control of Ansett and Air New Zealand was a sleeping partner.

The acquisition of the second 50 per cent in June 2000 for $A580 million ($715 million) was totally different. A highly indebted Ansett had to be consolidated, and this had a major negative impact on Air New Zealand's balance sheet.

Immediately after the Ansett acquisition, Air New Zealand changed its accounting policy on deferred tax, resulting in a writedown of $786 million.

This huge asset writedown, not mentioned when shareholders approved the Ansett acquisition just three months earlier, reduced group shareholder funds to $1.6 billion compared with total assets of $9 billion.

In addition, the company had off balance sheet debt, mainly operating leases, which Grant Samuel recently estimated at $2.2 billion. This was an incredibly weak balance sheet for a company operating in the highly volatile airline industry.

Qantas reacted aggressively because Air New Zealand now had management control of Ansett. Australia's national carrier believed a successful airline would make a much better job of running Ansett than a newspaper proprietor.

Air New Zealand's directors were being extremely naive if they expected Qantas to respond in any other fashion.

The group's problems were exacerbated by several additional factors.

* Full due diligence was not carried out on Ansett.

* Managing director Jim McCrea resigned and the board had no obvious succession policy.

* The company had an extremely weak balance sheet but continued to pay a dividend.

* Fuel costs rose.

* Ansett's fleet was old and would be very costly to replace.

Air New Zealand raised additional equity of $280 million last November, but this was too little too late. At that stage Singapore Airlines should have been asked to contribute new equity to Air New Zealand instead of buying a big hunk of the airline from Brierley.

The rest is history; the company's financial position deteriorated rapidly and shareholders approved the Government's $885 million bailout at this week's meeting.

Directors adopted an extremely high-risk strategy and had no contingency plans when several factors turned against the company.

One got the clear impression from Dr Farmer's speech that he and his fellow directors did not expect the competitive response from Qantas.

But the important issue is where Air New Zealand goes from here. Only acting chief executive Roger France addressed this, and his speech lasted just seven minutes. John Palmer gave shareholders no opportunity to ask questions after he had finished.

Mr France's message was extremely sombre: the airline industry was facing the worst trading conditions in living memory and Air New Zealand was not insulated from the situation.

The recapitalisation will give the company a platform from which to survive, but it still has far too much debt and no permanent chief executive.

Trading conditions from July to October were ahead of estimates, but November was disappointing because of fewer international passengers and more domestic competition.

The downturn in international passengers was confirmed earlier that day when Statistics New Zealand released figures showing the country's total arrivals and departures in November were 515,490 compared with 575,300 in the same month last year. Arrivals from Japan declined by 48 per cent compared with November 2000.

On the same day Geoff Dixon, Qantas' chief executive, met Finance Minister Michael Cullen and Transport Minister Mark Gosche in Wellington and said his company would substantially increase its New Zealand domestic services next year. This will be another major challenge for Air New Zealand.

Mr France concluded his brief speech with the following comments: "While the decrease in fuel costs is helping, our latest forecasts to the end of the year indicate that costs benefits may not be great enough to offset the declines in passenger revenue that we are seeing.

"In summary, the business is still facing very difficult trading conditions. Our plan targets are not soft - they will be difficult to achieve and success is not assured."

Air New Zealand now has 4.2 billion shares on issue, assuming the convertible notes convert into ordinary shares, with the New Zealand Government holding 82 per cent. At yesterday's closing prices, the company has a sharemarket value of $1.35 billion compared with shareholder funds of $1 billion.

There are several reasons why investors should continue to take a cautious attitude towards the company:

* The Government's $885 million capital injection is the absolute minimum required to place the company on a sound footing.

* The group is expected to report another loss for the current year and shareholder funds will probably fall below $1billion.

* A further capital raising may be required within the next 18 months.

The clear message from Mr France is that Air New Zealand faces a long haul before its financial position is as strong as it was in the mid-1990s.

Disclosure of interests: none

* bgaynor@xtra.co.nz