Challenge to make an airline merger fly

By Brian Gaynor

Sir Selwyn Cushing faces a huge challenge. He has to integrate Ansett successfully into Air New Zealand.

The outcome will have immense influence on the carrier's prospects and share price performance.

It will also have a large impact on the group's 47.1 per cent shareholder, Brierley Investments (BIL). The Singapore-based group desperately needs a successful Air New Zealand-Ansett merger as it struggles to regain its former glory.

A satisfactory outcome will also enhance the value of Sir Selwyn's controversial 15 million BIL options, which can be exercised at 45c each.

In October 1996, when Bob Matthew was in the chair, Air New Zealand acquired a 50 per cent shareholding in Ansett Holdings for $540 million. Ansett Holdings owns 100 per cent of Ansett's Australian domestic operation and 49 per cent of Ansett International. Ansett New Zealand has no relationship with Ansett Holdings.

The acquisition was in response to the declining profitability of Air New Zealand and a much-improved performance by Qantas after its 1995 privatisation.

The agreement had two important aspects:

\EE Rupert Murdoch's News Corporation, which owns the other 50 per cent of Ansett, obtained a five-year management contract over the company.

\EE Air New Zealand was given first right of refusal should News Corp decide to sell its 50 per cent shareholding.

Sir Selwyn was appointed chairman of Air New Zealand in May 1998 and he became a director and chairman of BIL six months later.

The Ansett shareholding issue came to a head in March last year when News Corp announced it had "an understanding to sell" its 50 per cent stake to Singapore Airlines (SIA) for nearly $600 million.

This initiated a hectic round of negotiations that included discussions over Air New Zealand buying 100 per cent of Ansett and SIA taking a major stake in Air New Zealand.

SIA eventually walked away from the deal because it had no interest in Air New Zealand and Sir Selwyn used his veto to frustrate the sale of Ansett to the powerful Asian carrier.

Overseas analysts and shareholders have severely criticised Sir Selwyn's strategy. Morgan Stanley Dean Witter blamed BIL for the break down in discussions.

"We think that the rationale for this strategic move was to force Singapore Airlines to buy Air New Zealand shares at inflated prices from Brierley Investments. This manoeuvre proved unsuccessful because Singapore Airlines interests lie in Ansett shares and not in Air New Zealand."

Critics claim that the Asian carrier, which is financially strong and well-managed, could add value to Ansett and Air New Zealand would benefit from this. Overseas and domestic investors have far less confidence in Air New Zealand's management.

Large shareholders have voted with their feet. Franklin Resources, a substantial United States fund manager, has reduced its shareholding from 9.4 to 5.0 per cent and the company's "B" shares, which can be bought by foreigners, have plunged 51 per cent since early June 1999. The market value of its "A" and "B" shares has dropped from $2.1 to $1.1 billion over the same period.

Air New Zealand's association with BIL and the prospects of Richard Branson's Virgin Airlines entering the Australasian market have also adversely affected the group's share price.

The acquisition of the remaining 50 per cent of Ansett signals the effective merger between two similarly sized companies - Air New Zealand had revenue of $3.4 billion in the June 1999 year and Ansett $A3.3 billion. Air New Zealand will take over the management contract from News Corp and shareholders will be hoping for a complete reorganisation of the company's senior management.

The Lion Nathan model may be appropriate for the new Air New Zealand-Ansett company. The head office could be in Auckland with the chief executive and other senior executives based in Australia. New executives will be easier to attract if the senior management team is based across the Tasman.

Air New Zealand's interim result, which was released on Wednesday, showed that Qantas is stretching further ahead of the New Zealand carrier and Ansett. The three companies produced the following results for the six months ended 31 December 1999:

\EE Air New Zealand net earnings, excluding Ansett and non-recurring items, rose 20 per cent to $52.3 million and it had a pre-tax/revenue margin of 4.2 per cent.

\EE Ansett's net contribution to Air New Zealand fell 19 per cent to $31.1 million and its margin was 4.9 per cent.

\EE Qantas reported a 24 per cent rise in after-tax profits to $A256 million and a pre-tax/revenue margin of 9.2 per cent.

Qantas also raised its interim dividend from 8c to 11c a share and Salomon Smith Barney concluded that its result "sends a clear message to potential competitors they will be up against one of the best managed, most competitive and financially robust airlines in the world."

Air New Zealand (including 50 per cent of Ansett) had cost increases of $73.3 million associated with the rise in jet fuel prices. Although spot prices rose by 55 per cent, in Australian dollar terms, Qantas' fuel bill declined by 4.1 percent because of its superior hedging policy.

Hedging is a facility that allows an airline carrier to buy fuel at future date at an agreed price. Air New Zealand had 50 per cent of its 1999-2000 fuel purchases hedged until late December when it became fully hedged. It is 50 per cent hedged for the June 2001 year.

Air New Zealand vigorously defends its hedging policy but Qantas' strategies have been far more successful. For the full 1999-2000 year, Air New Zealand's fuel bill could be 40 per cent higher whereas Qantas' fuel costs will rise by no more than 10 per cent.

Sir Selwyn Cushing and managing director Jim McCrea have adopted a cautious approach to the remainder of the financial year because of the sharp increase in fuel prices. (Although the company is now fully hedged for the remainder of the financial year, costs will be much higher in the second half of the year compared with the same period in 1998-99).

But it is Sir Selwyn's strategy over Ansett Holdings, not the company's earnings, which has had the biggest impact on Air New Zealand's share price over the past nine months. Investors are convinced that SIA could have added significant value to Ansett whereas Air New Zealand's management is not up to the task.

One Australian airline analyst wrote this week: "We continue to believe that Singapore Airlines is still in the hunt for Ansett. It may prove wise for them to sit back from the sidelines and wait for Air New Zealand to stumble. Should this occur, SIA will probably be able to get a slice of the combined business at a price even more reasonable than currently available."

Sir Selwyn's work was only partly completed when he signed the Ansett deal yesterday. The market response to the deal was negative but the Ansett transaction has enormous potential for Air New Zealand and Sir Selwyn has a great opportunity to prove his doubters wrong.

Disclosure of interest: none.