Stumbling Air NZ faces Ansett sale

By BRIAN GAYNOR

For all the wrong reasons, Air New Zealand is expected to be one of the biggest business stories of the next few months.

The company's difficulties - which include a weak balance sheet, a substantial operating loss for the 2001 year and a plummeting share price - are due mainly to the safety problems and poor performance of Ansett, its fully owned Australian subsidiary.

New Zealand's national carrier is faced with several difficult decisions, but the more obvious solutions to its problems are the sale of Ansett or a major recapitalisation.

Air New Zealand first revealed its interest in Ansett on November 20, 1995, when chairman Bob Matthew announced that agreement had been reached to buy 25 per cent from TNT for $A200 million.

The buyer also had the option to acquire a further 25 per cent from TNT for $A225 million.

The New Zealand Commerce Commission turned down the purchase because it would have given Air New Zealand effective control over Ansett New Zealand, the country's other domestic airline.

The deal was rejigged and on September 2, 1996, agreement was reached to buy 50 per cent of Ansett Holdings from TNT for $A475 million ($540 million).

As part of the agreement, Ansett New Zealand was sold to Rupert Murdoch's News Corporation for just $75,000.

The low price reflected the poor financial performance of New Zealand's second-largest domestic carrier.

On September 27, Air New Zealand shareholders approved the transaction.

In the notice of meeting, Mr Matthew wrote that the acquisition "represents a unique opportunity to substantially enhance Air New Zealand's strategic value."

The document also claimed that Ansett had "demonstrated an ability to earn significant profits," but no historic profit figures or forecasts were provided.

Poor disclosure has been a consistent feature of reporting on the Ansett investment.

There were two other important aspects 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 rights of refusal if News Corp decided to sell its 50 per cent holding.

At the time of the acquisition, Ansett Holdings was a debt-ridden, poorly performing company that was rapidly losing market share to Qantas in Australia.

Under News Corp's management, Ansett's earnings improved.

But Air New Zealand became frustrated with its relatively slow progress because no dividends had been received on its $540 million investment.

The situation changed dramatically on March 25, 1999, when News Corp announced that it had an understanding to sell its 50 per cent Ansett stake to Singapore Airlines for $A500 million.

Chairman Sir Selwyn Cushing, who had replaced Bob Matthew and was also executive chairman of Brierley Investments at the time, adopted a tough negotiating stance.

He vetoed the sale and on June 11 News Corp announced it had terminated discussions with Singapore Airlines.

At the same time, Air New Zealand indicated that it was interested in acquiring the News Corp shareholding.

Sir Selwyn's ambition was finally realised on February 18, 2000, when he announced that agreement had been reached to acquire the remaining 50 per cent of Ansett for $A580 million ($NZ744 million).

The agreement also provided for an additional payment in cash or shares between June 2002 and June 2004 equal to 10.5 per cent of Air New Zealand's capital (30.4 million A shares and 29.2 million B shares).

The notice of the meeting to approve the transaction was extremely optimistic.

Sir Selwyn wrote that the acquisition was a positive development for Air New Zealand, adding that "the financial performance of the combined airlines can be expected to improve significantly."

Again, no profit forecasts were provided.

On April 4, shareholders approved the transaction and on June 23 Ansett became a fully owned subsidiary of Air New Zealand.

Fourteen days later, the Auckland-based airline made an amazing announcement to the stock exchange.

It read:

"Air New Zealand has been advised that Mr Jim McCrea is leaving the position of group managing director and chief executive officer. Sir Selwyn Cushing has been confirmed by the board as executive chairman pending the appointment of a new group chief executive officer. The change has immediate effect."

In other words, just two weeks into the company's biggest challenge, Air New Zealand had no chief executive.

The situation was even more drastic because Rod Eddington, Ansett's highly regarded executive chairman, had left the company in April to take the top job at British Airways and no permanent replacement had been appointed.

What was going on at the Air New Zealand board table?

If Mr McCrea was sacked, why wasn't the decision made earlier so that a new chief executive could be on deck when Air New Zealand acquired management control of Ansett?

If Mr McCrea resigned, why didn't the board ascertain this earlier and have a successor ready to take his place?

Gary Toomey, the new group chief executive, was appointed on September 13. But since he didn't take up his position until January 3, neither Air New Zealand nor Ansett had a permanent chief executive throughout the second half of 2000.

Not surprisingly, Air New Zealand shareholders have been hit with a barrage of bad news since early November.

On November 1, Sir Selwyn told the annual general meeting that the result of the June 2001 year would be substantially lower than the previous year.

Nineteen days later, Standard & Poor's reduced the group's credit rating by one level to BB+.

On February 20, Air New Zealand announced net earnings of just $3.8 million for the six months ended December 2000, compared with $127.2 million in the previous corresponding period.

Two weeks ago, shareholders were dealt another deadly blow when Sir Selwyn told the stock exchange that trading conditions continued to deteriorate in Australia and Air New Zealand was expecting a substantial operating loss for the full year to June 30, 2001.

Profits from the sale of assets will reduce these operating losses but the group will still report a large deficit for the current year.

Finally, earlier this week it was revealed that Ansett had not tested its planes for engine-mount cracks, after notification from Boeing last year, and on Thursday evening Australia's Civil Aviation Safety Authority (CASA) indefinitely grounded Ansett's fleet of Boeing 767 aircraft.

CASA blamed Ansett's inadequate safety procedures on "a pattern of ongoing structural management and personnel problems."

This is not surprising when it is considered that Ansett had no permanent chief executive for most of 2000.

The forecast deficit for the current year will further weaken a balance sheet that had total debt of $7.6 billion and equity of just $1.9 billion at the end of December.

Unless Australian trading conditions rapidly improve, Air New Zealand will have to sell Ansett or undertake a major recapitalisation.

The company would suffer a big loss, both from a financial and public relations perspective, on the sale of Ansett and a successful recapitalisation would require the Crown to change its ownership rules because overseas investors would be the most likely contributors to an equity raising.

In the past week several print publications have given a sympathetic hearing to Sir Selwyn Cushing and Air New Zealand and the chairman's positive spin on the company's performance has had wide coverage.

But the reality is different. Ansett has serious problems and there has been a destruction of share value at Air New Zealand.

An investor who bought Air New Zealand A shares before the initial Ansett announcement in November 1995 is looking at a capital loss of 67 per cent, and a B shareholder has lost 63 per cent of his or her capital, after adjusting for the two subsequent rights issues.

In the same period, Qantas shareholders have achieved a small capital profit.

Sir Selwyn and the rest of his directors must shoulder most of the blame. They should have let Singapore Airlines buy 50 per cent of Ansett or had a permanent senior executive team in place when management control of the Australian carrier was acquired.

* Disclosure of interest: none

* bgaynor@xtra.co.nz