KEY POINTS:
The proposed offer for Qantas suggests that the Australasian airline industry may be in for a shock dose of Ryanair-itis. This is where an airline charges nothing or virtually nothing for its seats but travellers pay for everything else including luggage, food and drinks.
Ryanair now gives approximately 25 per cent of its seats away - or charges a nominal one penny a trip - and attempts to sell rental cars, hotels and packaged holidays to customers. It also sells advertising space to outside organisations and subjects travellers to inflight ads. There are plans to introduce online gambling and pay mobile phone facilities.
The high price being touted for Qantas suggests that new owners of Australia's national carrier may have to revolutionise the Australian and New Zealand airline sector to obtain a satisfactory return on their investment.
Irish-based Ryanair was founded in 1985 and is now the world's 14th largest airline according to Flight International. It carried 33.4 million passengers last year compared with 32.7 million for Qantas, which is in 15th place, and 11.7 million for Air New Zealand, which ranked 46th.
Ryanair's low-cost, low-fare strategy has been extremely successful and it had an operating profit margin of 32.3 per cent for the March 2006 year. This is substantially higher than the other four airlines included in the accompanying table.
But Ryanair doesn't always get its way. Aer Lingus, the Irish national carrier, was listed on the Dublin Stock Exchange on October 2 after the sale of shares by the Government at €2.20 each. Three days later Ryanair made an offer for the newly privatised company at €2.80 a share.
The offer is unlikely to succeed because of fierce opposition from the Irish Government, which retained a 25.4 per cent stake, and employee groups controlling 17.1 per cent.
As the table shows, labour costs represent between 24 and 31 per cent of the operating costs of Air New Zealand, Qantas, Virgin Blue in Australia and Aer Lingus but only 15 per cent of Ryanair's costs. The latter has only 30 staff per aircraft whereas Aer Lingus has 100 employees per aircraft and the employee groups, which obtained a material shareholding through the IPO process, are totally opposed to the Ryanair bid because they fear heavy job losses.
One of Ryanair's primary objectives is to contain employee costs. As a result, it now charges for luggage, to encourage passengers to travel baggage-free and reduce handling costs. The group is looking to outsource back-office operations to India and plans to raise the percentage of contracted pilots from 20 to 40 per cent as these are 10-15 per cent cheaper than Ryanair employees.
Ryanair's low-cost, low-fare strategy has been very successful as far as shareholders are concerned as it now has a sharemarket value of €7.38 billion ($14.2 billion) compared with A$10.32 billion ($11.8 billion) for Qantas.
The Irish company is worth more than Qantas although its revenue and operating profit are much lower.
This is because investors believe that Ryanair still has considerable growth potential, both in terms of passenger numbers and non-traditional revenue growth, and continues to have an aggressive approach towards containing costs.
The proposed offer for Qantas, by a Macquarie Bank and Texas Pacific Group-led consortium, has created considerable interest across the Tasman. The proposal is based on the bidders' ability to reduce costs and sell assets as Qantas' growth prospects are far less exciting than Ryanair's.
This is because the Australian carrier dominates its domestic market and its international operations are governed by Government-negotiated bilateral agreements.
Qantas already has a cost-cutting programme, particularly in information technology and maintenance. The group's ability to cut costs is severely restricted by a heavily unionised labour force of 37,000. A strong union movement was a contributing factor to the 2001 demise of Ansett under Air New Zealand's stewardship.
The Australian carrier is trying to get around its high labour cost structure by launching Jetstar International, a long-haul, value-based airline flying to a number of destinations in Southeast Asia.
Qantas also has the ability to sell assets including Qantas Holidays, the long-term leases on its Sydney and Melbourne terminals and its catering and freight operations.
No matter which way you look at it, Qantas will offer even stiffer competition to Air New Zealand under private equity ownership, particularly as the proposed merger and code-sharing agreements between the two companies have been abandoned.
Air New Zealand reported an operating profit (earnings before interest, tax, depreciation, amortisation and rental and lease expenses) of $689 million for the June 2006 year, a margin of 18.1 per cent. The group's operating profit has been remarkably consistent, having been between $689 million and $735 million in each of the past five years.
This has been achieved even though fuel costs have surged from $570 million to $949 million and labour costs have risen from $709 million to $863 million. All other major costs - maintenance, aircraft operations, passenger services and sales and marketing - have fallen in the same five-year period.
Fuel costs are a major issue for Air New Zealand and other airlines.
At the October 25 annual meeting, chairman John Palmer told shareholders, "Given recent jet fuel price movements, and if current trading conditions persist, then the current year's profit before unusuals and tax would exceed last year's."
The group also gave an update on its fuel hedging position showing that it is 68 per cent covered through to the end of its June 2007 financial year.
This has been the catalyst for a strong share price rally, but Air New Zealand remains hostage to oil prices over the longer term and is likely to face stronger competition from a private-equity-owned Qantas.
It also faces fierce competition from a number of other carriers, including Emirates, and operates in an industry that is undergoing substantial change.
What are the odds that in five to 10 years all the Australasian airline groups will be private equity owned? Transtasman fares will be available for no more than $50 return, seat allocations will be made online before passengers leave for the airport and travellers will have to check in only if they have luggage, which will be charged on a per kilo basis.
The cockpit and cabin crew will be contracted from Allied Work Force and aircraft interiors will be covered with advertising. Passengers will pay for all meals and drinks and be able to watch pay-per-view movies and live sporting events from around the world and access online gambling from their individual inflight entertainment facility. They will also have access to a mobile phone signal, for a payment to the airline, and be able to use their phones on board.
Airlines will also attempt to sell rental cars, accommodation and destination packaged tours inflight.
Last but not least, the airlines may also have introduced a new fare system that will transfer the fuel cost risk to passengers. Carriers will establish a benchmark fuel price and passengers' credit cards will be credited or debited depending on whether fuel prices are above or below this benchmark on the day they travel.
These predictions are not unrealistic based on the plans and forecasts of Ryanair, the clear industry leader in Europe.
