Boxing clever in the sky war

By DANIEL RIORDAN

Get ready to rumble.

In the teal corner, battered and bruised but scrapping tooth and nail for every piece of the Australasian sky - Air New Zealand's Gary "Sock It to Me" Toomey, his strategy clear:

"We'll fight them in the market, on product and price ... They've made no secret of their next step. Their strategy is to drive us to the wall. This is the start of a heavyweight bout."

In the red corner, bouncing on his toes and confident of a knockdown - Mr Toomey's old mate, Qantas' Geoff Dixon.

While Mr Toomey was making Churchillian noises on Tuesday, Mr Dixon was quipping how he would love to destroy Air NZ.

Qantas is throwing every combination it can at its closest rival - on both sides of the Tasman.

In New Zealand, the dust had barely settled on its failed local franchise when Qantas announced plans to set up in its own right, flying 737s across the Tasman from June 1 to ply the most profitable main trunk routes (Auckland-Wellington and Auckland-Christchurch), linking with regional operator Origin Pacific to cover the rest of the network.

Air NZ pre-emptively launched its no-frills transtasman subsidiary Freedom Air into the local market, while still offering a higher-priced full service under its own name.

Now Sir Richard Branson's Australian budget airline Virgin Blue wants in.

The New Zealand market may be much smaller than Australia's, but it has been highly profitable for Air NZ, especially in the past 12 to 18 months as its major rival Ansett NZ/Qantas NZ bled market share. Life at home is about to get a whole lot tougher.

In Australia, life has been a battle for as long as Air NZ has been there - first with its half-share in Ansett Australia, then, for the past 12 months, as full owner.

Ansett suffered the Easter grounding of its 767 fleet over safety concerns, losing close to $5 million, but can only wait and see what the long-term impact will be on its market share, now estimated at about 35 per cent against Qantas' 50 per cent.

Ansett's share of the key corporate market, which accounts for 60 to 80 per cent of airline profits, is even lower.

This week's good news/bad news for Ansett was the collapse of Australia's other budget airline, Impulse.

Good news because it lowers the intensity of the vicious price war on the main trunk that has hurt both Ansett's and Qantas' profitability.

Bad news because Impulse surrendered by selling out to Qantas, which intends redirecting Impulse's eight 717 jets from the Brisbane-Sydney-Melbourne golden triangle to Australia's regional routes, which are more lucrative than their New Zealand counterparts, and are where Ansett is weakest.

Taking Impulse off the Sydney-Melbourne route is also expected to open up landing slots at Sydney Airport and finally allow Virgin entry to what is one of the world's busiest city couplings.

The deal - which the parties hope to sign on May 14 - also enables Qantas to free several 737s for the New Zealand market.

Little wonder Mr Toomey wants Australia's competition watchdog to block the sale.

Peter Harbison, managing director of the Centre for Asia-Pacific Aviation, says Qantas' sights are set more firmly than ever on Air NZ. Qantas smells blood and is moving in for the kill.

Ansett is understood to have lost $144 million in the December half-year, dragging its parent down to a paltry profit of $3.8 million.

Analysts the Business Herald spoke to expect Air NZ to lose about $160 million in the year to June and about $70 million next year, although they will be marking up their 2002 forecasts since Impulse's demise.

Air NZ needs to spend $5 billion to $6 billion over the next four years renewing its fleet and rebranding Ansett (while retaining the Ansett name). Some of those plans were brought forward after the Easter groundings and Ansett will replace its six oldest 767s by October.

Air NZ's debt rating is at junk bond level, and the chances of being able to raise more equity from investors are negligible.

Last year, a $284 million rights issue was heavily undersubscribed amid plummeting profit projections for the airline. A proposed $150 million capital notes issue was postponed, then abandoned last month for lack of interest.

Thirty per cent shareholder Brierley Investments has its own problems and is unlikely to come up with more cash.

Singapore Airlines has been playing its cards close to its chest, but is unlikely to strengthen Air NZ's balance sheet unless it can raise its stake above the 25 per cent cap imposed by the Government.

Although Prime Minister Helen Clark cooed about revisiting the issue at the time of the 767 groundings, and lobbying from all sides continues, Transport Minister Mark Gosche is standing firm.

Mr Toomey, unveiling Ansett's new $38 million marketing campaign this week, said the airline was taking advice on ways to pay for the fleet upgrade. "Five or more options" would be presented to the Air NZ board in July.

These are expected to include buying aircraft on financing leases, short-term leases and mezzanine finance. Air NZ could also lean on Singapore's enviably robust balance sheet by leasing aircraft from its part-owner with Singapore taking the credit risk.

"This all plays totally into Singapore's hands," says Salomon Smith Barney's Sydney-based aviation analyst Jason Smith.

"The more Air NZ's balance sheet comes under pressure and the more competitive the environment becomes, the more Air NZ will be looking to Singapore for assistance."

And the more pressure Singapore and Air NZ can bring to bear on the New Zealand Government to raise its shareholding cap.

If Singapore Airlines' chief executive, Dr Cheong Choong Kong, is a kingmaker waiting to step in when he deems the moment ripe, Virgin's Sir Richard Branson is the joker in the pack. Is he serious about flying in New Zealand, or will bluster be all he delivers? Is he even serious about running an airline long-term in Australia?

Rumours that Virgin Blue exists largely to promote other Virgin brands will not go away.

Mr Smith believes Virgin is serious about flying here.

"It makes sense for them. They need to find further routes to fly to. They're scraping the barrel now with routes like Perth and Townsville."

Virgin, like Qantas, wants to operate in the New Zealand market while basing most of its operations in Australia.

There is nothing to stop Virgin flying within New Zealand, but because it is British-owned it needs permission from the New Zealand and Australian Governments before it can fly the Tasman.

Transport Minister Mark Gosche said after meeting chief executive Brett Godfrey this week that he was considering designating the airline as Australian or New Zealand to allow it to fly transtasman, but Virgin had yet to put a formal proposal.

Virgin says it wants to fly here before Christmas, and its entry would place Air NZ under further pressure.

Consumers may be keen, but industry experts question whether the market can sustain another airline.

While Air NZ slugs it out with Qantas - and anyone else wanting a piece of the action - it continues to be susceptible to factors largely beyond its control that make the industry something of a roulette wheel for investors - fuel costs and exchange rate movements.

"The macro drivers haven't changed," says BT Funds Management equity manager Andrew South.

"Air NZ may be in good shape with its management, but it's tough getting returns on its capital."

One analyst's model shows that Air NZ's profit takes a $10 million hit for every 1c fall in the Kiwi or Australian dollar against the US dollar, and a $US1 rise in the price of jet fuel lops $14 million off the bottom line.

Air NZ shareholders have seen the value of their investment almost halved in the past 12 months.

The turbulence is not going away. Each blow Geoff Dixon lands, and each blow Gary Toomey returns, will be felt on markets both sides of the Tasman.

The "fasten seatbelts" sign is still on.

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