Compass Collapse Analysis

A major problem ironically was the airline’s name.

Southern Cross thought that it was getting a PR bargain with taking on the image of what for a brief time had almost become anational icon Compass I. However, financiers both here and abroad were reluctant to advance money to the new carrier which meant that Compass II had to purchase many assets that ordinarily would have been leased. On top of that, with the international finance community generally wary (and not before time) of the long term fiscal viability of airlines, Compass had to lodge considerable deposits on equipment that it originally had hoped to acquire on a full value lease basis.

Consequently capital was quickly eroded to the point where it became essential that the airline actually achieved a positive cashflow on its day to day operations literally from the commencement of the first service. This of course is impossible in any business and led to Compass reporting a $10. 9m loss for the half year ending Dec 31 1992. At that date it was also revealed to the Australian Stock Exchange (ASX) that the company had assets of just $4. 3m rather than reserves of around $30m as indicated in the original prospectus.

Obviously a gutsy battle plan had to be put into place and consequently the airline moved to access $9. 2m worth of loans from deputy chairman Doug Reid’s family company Decer Investments. The additional capital would have enabled Compass to pay its debts through the March quarter and to see the introduction of aircraft six and seven to increase Compass’ capacity by around 40% and thus achieve the ability to reduce overall debits per seat kilometre by as much as 10%. Increased non stop flights between Melbourne and Queensland would also increase the airline’s share of the premium fare business market whilst boosting services to Coolangatta, an essential leisure market destination (refer p18 April 93 AA formore data on the Compass recovery plan).

However, as most readers would now be well aware, this was not to be.

The loans did not eventuate and the ASX, backed up by the Australian Securities Commission (which is still investigating the demise of Compass I) asked for more information following the release of Compass’ half yearly report on February 23. Without the extra funding, and wisely not wishing to operate whilst knowingly insolvent, Southern Cross Airlines Holdings Ltd suspended trading in its shares on the stock exchange while additional avenues of funding were pursued.

However, to both the general public and the investment community this was the kiss of death for an airline that had done pretty well at keeping its operating performance a state secret. From the start the airline had forbade the Department of Transport & Communications (DoTC) to publish its specific traffic figures in the DoTC’s quarterly domestic airline performance report. This effectively eliminated a whole raft of previously available data on RPKs, pax uplift and load factor for each airline that now was no longer available.

Not surprisingly, industry observers were quick to smell a rat and feared the worst as to why Compass didn’t want its performance data released. The airline defended its position by stating that it didn’t wish to reveal its performance to its major competitors, a claim that in our opinion couldn’t be taken seriously as both Ansett and particularly Australian knew exactly what the new entrant’s weekly uplift was.

Not surprisingly, this secrecy was reflected to some extent in the declining share price, which never achieved anything like its 50c opening, falling to the mid to high forties before declining to a low of 32c prior to the cessation of trading on February 24. In retrospect, those who had thought the worst about the reasons why Compass II did not wish to divulge its uplift and load factor performance were sadly proven to be correct.

Thus in a state of virtual insolvency Compass was placed into the hands of a receiver manager on the night of March 4. Mr Richard Barber of Price Waterhouse thus had the difficult and time constricted job of seeking a solution to Compass’s monetary problems in less than one week. Round the clock negotiations took place with a number of financiers in addition to several overseas airlines, the CAA and FAC (who claim they were unable to extend credit to the airline due to inadequate financial guarantees) though as history now sadly recounts these efforts came to nil as the travelling public naturally did not wish to risk its money with an airline that appeared to be heading for the same destination as its forebear.

This was not helped in the final days of the airline when general confusion reigned regarding the extent of coverage given by the insurance scheme on ticket sales after the airline was placed in the hands of the receiver manager. (For updated news on the Compass situation please refer to Stop Press on p5 of this issue. ) The nail in the airline’s coffin though was struck when Compass’ driving force and co chairman, Mr Doug Reid was arrested on March 9 for allegedly providing misleading information to the board. A cruel twist of fate as Reid had always been recognised as the one person, more than any other, who was responsible for getting Compass II into the air.

Consequently with all financial recovery avenues exhausted and its management credibility shot to pieces, Richard Barber sadly announced to the Queensland Supreme Court on the evening of March 11 that there was no alternative but to file for voluntary liquidation. The Compass dream was well and truly over.

So what went wrong? Readers of this magazine will certainly be aware that we have been very strong supporters of the rejuvenated airline. Our September issue Recce even went as far as stating that the airline would succeed, though with the proviso that it’s capital base was definitely on the tight side.

We countered this by saying that hopefully the fairly conservative estimations of load factor in the prospectus (62%) would be comfortably exceeded with the result that cashflow would be sufficient to see the airline over the crucial first year start up hump that any new business experiences.

We were wrong, and wrong because that simply did not happen.

Ironically, whilst the nation was madly enthusiastic for backing the original Compass during the early weeks of 1992, by Compass II launch time in late August the national euphoria had largely dissipated. This of course was exacerbated by a worsening recession where consumers looked for bottom line. value more than ever and often moved across to the deep discount holiday packages on offer by Australian and Ansett that were actually cheaper than those of Compass II.

The new airline was of course also fighting against Australia’s travel agency environment where the majority of agents are little more than direct sales outlets for the airlines which own them. Compass CEO, Sam Coats had asked the Trade Practices Commission (TPC) last December to investigate this perceived agency bias (refer p90 April 93 AA) after finding that 80% of the airline’s non direct bookings came from just 6% of travel agents.

Many large corporate accounts and those of government departments are also the province of one or the other airlines. A classic example of this is where Mount Isa Mines are contracted to Ansett, thus no other airline can gain enough uplift into Queensland’s Mt Isa to warrant serving the route with jet equipment. Disappointing though was the attitude of govern- ment, particularly that of the Queensland State Government, which despite being a major shareholder (and thus losing $7. 3m of taxpayers’ money in the process) gave almost no real world support to the new airline despite its declarations during the emotive failure of its predecessor that all Queensland state public servants would travel on Compass if the airline should be resurrected. Unfortunately, like all politicians, Premier Goss’s words sounded great at the time but obviously meant little in the longer term as few State government employees flew with what was supposed to be ‘their’ airline. It was obvious also that many consumers were afraid of the possibility of the new airline failing with their hard earned cash going the way of thousands of travellers who lost money following the collapse of Compass 1. An innovative ticket insurance scheme had been set up to protect travellers via CE Heath and National Mutual (a major Compass shareholder) though at presstime there appeared to be some confusion about this as Compass had reportedly downgraded its risk from the original $7. 5m to just $2m in December. At the time of liquidation, it was believed that around $3. 5m was outstanding in unused tickets.

Consequently most leisure travellers opted not to book months in advance (as they often do and did with Compass I) but to exercise the airline’s excellent no restrictions seven and 14 day advance purchase fares. Consequently Compass was never able to build upon the war chest of advance purchase fares that is so important to any airline.

The other factor was yield. The airline had anticipated, in its revised prospectus of mid 1992 that 50% of travellers would fly on a discount fare. Obviously this was closer to 70-80% whilst the important business class section of the aircraft generally achieved load factors substantially lower than in the main O cabin. Prospectus load factor was a conservative 62%, around 15 points below the industry average though unfortunately Compass never achieved anything like the support of its rivals. In essence it suffered from the same dilemma that has always afflicted Ansett’s Eastwest-lower than required load factors coupled with lower than required yield per available seat kilometre, equalling a loss on operations that would not turn around till both these crucial issues were addressed.

This would have been overcome in time if the extra capital had been forthcoming (or the airline had been adequately financed from the beginning) and a new marketing plan had been put in place aimed squarely at the full fare business market.

Compass did not have a cost problem, it had a revenue problem and not in reality a great one at that. It would not have had to achieve much to break into profit on a week to week basis. Certainly less than was required to get either Ansett or Australian into the black following their dismal performances through 1991 and ’92 despite record growth and load factors the envy of the world.

That of course is now history but can’t pass without comment from this magazine. It is indeed a tragedy that the business community did not support Compass more. The first Compass offered business travellers little-large aircraft with minimal service standards, minimal frequency of service, crowded terminals and little thought (from our experience) to placing full fare ‘suits’ amongst screaming kids, somebody else’s grandmother reciting her life story and football teams in party mode. This was amply covered in our analysis of the demise of Compass I in our March edition last year and reflects starkly in direct comparison with the vastly superior product offered by its successor.

Compass II offered a standard of business class travel that was certainly as good as its rivals. Additionally, travellers flying business class were allowed free access to the comfortable lounges at major airports without needing to pay hun- dreds of dollars annually to be a member of either Golden Wing or Flight Deck, etc. So for less than the standard economy fare on Ansett or Australian (few business people can afford to endure the many restrictions placed on discount fares so are forced to opt for the full economy fare whether they like it or not) you could fly Compass business class, enjoy first class seating and catering in addition to the use of a well appointed airport lounge.

A fare comparison showed that a standard Sydney/Melbourne return economy with the big two was $468. The Com pass business fare was by comparison just $340 at peak time and $300 off peak. Business travellers could also benefit by taking the economy cabin and paying just $300 peak and $260 off peak in what was a limited service but exceptionally comfortable economy cabin thanks to the five abreast seating of the MD-80 twinjets and the exceptional quietness of these aircraft.

If you are a frequent business traveller and deliberately ignored what Compass had to offer then don’t ever have the audacity to complain about the fares that you are now and will be paying with either Ansett or Australian. Your lack of support for the new airline was a fundamental reason for the need for this article to be written.

Another reason for the lack of business support though was the almost invisible marketing programme that the airline undertook to promote its product. Apart from the launch flurry, little more was done to actually sell the airline to the business traveller. Research also indicated that the majority of business travellers also equated Compass II standards with that of its forebear so in effect the hero image of the original Compass that Southern Cross had judged as a winner in early 1992 proved its achilles heel, as in reality it had undeservedly inherited an image as a low standard service, minimal frequency carrier.

Also strongly entrenched by the time Compass II was operational were the greatly expanded frequent flyer programmes from Australian and Ansett. These plans do make people think before choosing a carrier just as a travel agent will naturally tend to sell its owners product before the competition. This is to be expected and coupled with the vastly more comprehensive route structure of the majors, enabled them to lose nothing to the new entrant, with or without its excellent business product and enhanced frequency of service. Roy Morgan Research indicated that by year end Compass had scored barely 3% of the business market.

Compass II only needed one thing to survive, and that was simply a proper cash base at time of launch. We and other analysts have gone on record as stating that an operation with something in the order of five 150 seat jets really needs at least $100m at day one. Any less and it won’t make it through the first year as start up costs alone will absorb halfthat bank within the first few months of operations in a hundred unexpected ways. Hopefully, investors and aviation minded dreamers alike will remember these words so that next time another band of investors don’t lose their money through an insufficiently capitalised airline.

Losers were many, again, and it is tragic to think of the hundreds of loyal staff who deliberately kept out of long term alternative employment following the collapse of Compass I just to work with its successor. In all, around 700 people suddenly became redundant on the evening of March 11 whilst probably two to three hundred more now face a tenuous future as their companies were major suppliers to the fledgling airline. And that is not taking into account the several hundred jobs that would have been created with the introduction of the additional two aircraft, due to have been in service as these unfortunate words are read.

For Australia the untimely demise of Compass is a tragedy that far transcends the immediate short term impact upon the tourism and transport community. That this nation will now be the domain of the Ansett Group and Qantas/Australian is a fait accompli. Perhaps Air New Zealand will operate here eventually though the massive investment it will have to raise to make it on its own will pretty well place it in the same no win situation as Ansett finds itself in the Kiwi carrier’s homeland.

Compass II had the right operational plan. It certainly had the right equipment, class structure and overall product quality. What it didn’t have was enough capital to overcome the natural inhibitors of restricted terminal access, chronic congestion at Australia’s key airport, a biased travel agent environment and ironically a commercially dubious image via its predecessor.

Compass is dead, and with it died the hope that this nation will ever host an independent third carrier. Sadly, third time lucky is not a phrase that rings well in aviation.