Battle to keep flying in the unfriendly skies

By FRAN O'SULLIVAN

HERALD INQUIRY - Air New Zealand managing director Ralph Norris has already done a remarkable job in revamping the airline.

Six months into the job, Norris has taken the competition to the airline's traditional rival Qantas.

He's cut fares and created a budget airline, Air NZ Express, which will start flying in October.

But Norris' ability to fly an independent path is restricted by three major factors:

* The cut-throat nature of the aviation industry.

* A major shareholder reluctant to pump more cash into fuelling his flight plans.

* A board of directors been hand-picked by the Government.

As the heat grows over the future ownership of Air NZ the debate is narrowing down to one over-riding issue: Can Air NZ survive on its own?

Norris won't talk directly about Qantas' bid for a stake in Air NZ.

He says Air NZ needs to get greater regional focus.

"As a small airline, we are a price taker. We don't have the marketing clout British Airways has."

Another Air NZ source is more direct on the prospect of a Qantas shareholding; "If we do anything we are going to have to have a director on their board and that means that there is no gameplaying - I've got hold of yours and you've got hold of mine."

Yesterday, Australian Transport Minister John Anderson and Acting Transport Minister Judith Tizard formalised an "open skies" agreement between Australia and New Zealand with a signing ceremony in Auckland.

The move was largely symbolic, but has refuelled speculation that both governments may be moving towards establishing a long-term competitive Australasian aviation market.

The potential for a Qantas/Air NZ grouping to ultimately lead to a strong regional group linked by cross-shareholdings and common directors is one option at the centre of confidential negotiations between the two airlines.

A New Zealand business campaign to keep Qantas out is gathering momentum.

So too is the backlash from a Labour Party-affiliated union.

"It could be Qantas or Bust" screamed a press release from the Engineers, Printers and Manufacturing Union yesterday.

"We've heard enough from the romantic capitalists on this,"said EPMU national secretary Andrew Little.

"It's time for some economic realism."

Little accused the businessmen who have mounted a campaign to keep Qantas out of the airline of exhibiting "cultural cringe".

He says it is an economic fact that New Zealand cannot sustain two domestic airlines.

If a deal was not done with Qantas, the Australian airline could eventually destroy the New Zealand carrier.

These sentiments appear to align strongly with those of Finance Minister Michael Cullen, who is the most powerful figure in this affair.

Cullen directed Qantas chief executive Geoff Dixon to take a renewed proposal for a stake in Air NZ to the airline this year.

Any deal must first be approved by Air New Zealand's board.

But during the election campaign Cullen said: "I cannot understand this assumption that Qantas being involved is somehow worse than any other airline.

"I ask you the counter factual question: If we decide to compete head on with Qantas in full competition, why do we assume that Air NZ is going to win that competition and how deep do you think the public pocket should be to keep that competition moving along?"

Legal action could be taken against Qantas if it used blatant predatory pricing in Air NZ's domestic market.

Investment bankers also have no doubts that other mechanisms are possible to meet the estimated $400 million to $500 million that Air NZ needs.

The Government has already pledged $150 million, placements could be made to international institutions and a deeply discounted rights issue made to mop up the balance.

As custodian of the Government's $885 million investment to rescue Air NZ late last year, Cullen will weigh two factors.

The first is Air New Zealand's gutsy turnaround strategy. It has risks. Adverse movements in exchange rates and fuel prices during the airline's two-year workout period could reduce the value of the Government's 82 per cent holding.

The second is that if the Government has to pour more cash into Air NZ to pay for its growth and reduce debts, it would put pressure on his ability as Finance Minister to invest in other areas such as schools and hospitals.

But he also has fiduciary responsibilities to Air NZ as its prime shareholder.

Cullen reported to Cabinet last last year that Air NZ was a "viable business" - if a high risk one - which needed capital of $1.705 billion.

The proposed rescue gave the airline a "genuine opportunity to return to health".

A plan for Air NZ was formed. The key elements were:

* The company had to get its debt ratio down.

* Asset sales and cost cutting were to be used to free cash .

John Palmer, who was appointed Air NZ's chairman after the old board retired, had to ensure replacement directors committed themselves to the plan before taking up their board roles.

Some elements of the plan have since proved short-sighted.

But Norris, an experienced chief executive, has persuaded his board to shift ground. The engineering business which Government advisers wanted sold, is being developed.

It is also the platform for potential synergies in any Qantas and Air NZ "merger".

For a pointer to the "national interest" issues that drive any merger considerations, look no further than last year's negotiations over Air New Zealand's recapitalisation.

At that time, Qantas was battling Singapore Airlines for pole position in the Australasian aviation market.

Government advisers identified five critical national interest factors to assess the rival proposals for ownership of Air NZ and its struggling subsidiary, Ansett Australia.

* Economic benefits from tourism traffic flows.

* Consumer welfare from competition on domestic and international routes.

* Protection of Air NZ's air traffic rights.

* The presence of a viable national flag carrier for New Zealand.

* Benefits from the opportunity to transfer knowledge, skills, and new technology.

Qantas had proposed buying Singapore Airlines' 25 per cent holding in Air NZ and possibly BIL's 25 per cent holding.

Singapore would get Ansett Australia.

PA Consulting, which is involved in the current negotiations, noted then that Singapore Airlines was complementary to Air NZ while Qantas was directly competitive.

Air NZ had less chance of being marginalised under proposals for Singapore Airlines to lead the recapitalisation.

No competition problems would arise, and the deal would be more beneficial for consumers.

Advisers identified other risks, including transition costs and disruption if Air NZ quit the Star Alliance and the loss of valuable commercial relationships with Lufthansa and United Airlines which could not quickly or easily be replaced.

It is this sort of analysis which leads critics to contend that a deal with Qanta should not take place.

But buried in a raft of official documents that the Government dumped this year was this titbit: Officials believed that a closer partnership between the airlines might lead to the rationalisation of some Qantas services to let Air NZ dominate transtasman services.

However, advisers noted: "While Qantas' intention to exit the New Zealand domestic and transtasman markets would increase Air NZ's traffic feed, it might lead to an overall reduction of air services in these markets.

"Qantas as the dominant partner would have the incentive to secure the more profitable routes for itself and deliver high yield traffic."

Former Air New Zealand acting chairman Jim Farmer does not recall any proposal by Qantas to abandon the Tasman. "My understanding of the Qantas proposal was that once Singapore Airlines had acquired Ansett, that would be the competition to a combined Qantas/Air NZ.

"That would be initially in Australia, but SIA/Ansett would then operate across the Tasman and into New Zealand."

Critics say that although there is probably no other immediate potential airline buyer for Air New Zealand, it would be counter-productive to let Qantas back in.

But both airlines are vulnerable.

Standard & Poor's credit rating agency warns that although skies have cleared over Australia's and New Zealand's airlines since the Ansett collapse, the storm clouds have not completely gone.

"The return of Australia's domestic airline industry to a duopoly and, with it, the prospects for more sustainable pricing strategies are bright spots in an industry still under pressure from weak international markets, severely weakened airlines and airline collapses, and sizable or increasing debt burdens," says S&P's Jeanette Ward.

Ward notes Air NZ's high debt burden, and say that the challenges and risks the airline faces make the Government's 82 per cent holding "critical to the stability of its ratings".

And she says growing competition and weak profitability on international routes make Air NZ vulnerable.

"Despite Air NZ's recent NZ$885 million recapitalisation by the New Zealand Government stabilising its balance sheet, the airline's debt burden remains high relative to its cash flows."

Standard & Poor's outlook for Qantas is negative.

It says: "Amid depressed industry and slowing economic conditions, the industry's rising insurance and security costs, and a weak Australian dollar, Qantas' operating performance is expected to remain satisfactory given its opportunity and strategy to capitalise on the recent collapse of domestic rival Ansett."

It says that although the rationale for the company's plan to expand its fleet is compelling, Qantas relies on very strong cash flows from its domestic market and prudent management of its international business to accommodate its large capital program and rising debt burden at a time of severe weakness in the industry globally.

A rating downgrade could result.

Air NZ has some competitive advantages. It has one of the best maintenance, repair and overhaul systems in the world - way ahead of Qantas. Air NZ's fleet is also younger.

Norris is also using the negotiating period to ensure Air NZ has a better edge than Qantas - either to compete vigorously in what Qantas calls a partnership of equals or withstand any attempt by Qantas to bury Air NZ.

Air NZ's results will be out on August 28, and analysts will be able to judge how well Norris' strategy is working.

The big drop in fuel prices and the rise in the New Zealand dollar against the US pumped big benefits to its bottom line this year.

But there is a catch.

Air NZ plans to make accounting changes to bring its financial statements into line with new world standards in the post-Enron environment.

Details have yet to emerge, but they are likely to include a tougher stance on revenue recognition which will affect perceptions of Qantas, if it does not adjust its own policies when it unveils a record profit one week earlier.

When the exchange rate was at 50USc, Air NZ was in clover. Every one percentage point increase above 41USc could add up to $28 million to its bottom line.

But the dollar's subsequent drop and threat that a war on Iraq could disrupt fuel supplies have added new risks.

These are the issues which Cullen will also be considering.

Dixon said recently it was not necessary for Qantas to have a cornerstone shareholder.

Qantas could simply meet its capital needs from international markets.

A range of issues have emerged during the negotiations.

Air NZ's Star Alliance membership can not be broken without a $US25 million penalty.

But Star Alliance would welcome a Qantas breakaway from the rival OneWorld alliance.

"That message has been given to Qantas," said a source close to the negotiations.

"There is opportunity for more tourism potential - if we can promote this region together as a dual destination region.

"In world terms we're minor and they are small. With our limited resources together there is much we can do to get a better bang for our bucks."

Norris appears in no doubt that he can turn Air NZ round.

"People are talking about globalisation, but in this business we're looking to something more akin to regionalisation."

"We need to make greater use of our aircraft. We're much more of a niche player.

"Our ability to take advantage of scale through relationships and alliances is very important for us."

But there are some bottom-line issues which Air New Zealand won't back away from.

"They revolve all around the autonomy of the company - not allowing it to be marginalised and ensuring it has total autonomy and acts in its own best interests."

More:
Qantas stake would need to clear many hurdles

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