A private venture

The reality and the dilemma is that the public and thus the government of Australia, like elsewhere in the world, believe that the “national airline” ought to be viewed as a public utility with a duty to provide services when, where and at what price the utterly unforgiving and largely ill informed public demand.

Regardless of whether the deal goes ahead, it exposes once again the federal government’s “policy on the run” approach to the airline industry as was the case with the events during the Ansett demise in 2001.

Add to that the lack of understanding of the airline industry by most analysts and part time airline commentators and the public and it is certain that it is only going to lead to more tears. But the deal also focuses attention on whether or not Qantas deserves the government’s and the public’s support.

The buyout deal has been in the offing for years, fuelled by a combination of the Australian stock market’s lukewarm approach to Qantas and the federal government’s hard line on relaxing foreign ownership caps, which restricted Qantas’s capital raising ability.

The players are well documented but their potential roles and influence is not so well understood and could have a major impact on the outcome for Qantas going forward.

After several weeks of intense speculation, the Qantas board unanimously accepted a revised and higher offer from Airline Partners Australia (APA), the consortium led by Australia’s Macquarie Bank and Texas Pacific Group of the US, on December 13.

APA comprises Australia’s Allco Equity Partners (34 per cent), Macquarie (less than 15 per cent) and Allco Finance Group (11 per cent), along with foreign investors TPG, Onex Group of Canada and other foreign funds that will hold no more than a combined 40 per cent, with no one group holding more than 15 per cent, to comply with Australian competition laws that cap total foreign investment in the airline at 49 per cent.

In a filing with the ASX (Australian Securities Exchange), Qantas chairman Margaret Jackson said APA’s $5. 60 per share cash offer “allows

The reality and the dilemma is that the public and thus the government of Australia, like elsewhere in the world, believe that the “national airline” ought to be viewed as a public utility.

Qantas shareholders to realise significant value for their shares that has not been fully recognised in the public market. ” The revised offer, worth $11. 1 billion, replaced APA’s earlier offer of $5. 50 that included a $100 million break fee that Qantas would owe the consortium if the deal was scuttled by shareholders or regulators. The new deal eliminated that fee and also included a $0. 05 dividend per share.

The $5. 60 price was 33 per cent higher than the closing price on November 6, the day before “the first speculation about the offer”, Qantas said at the time, adding that the transaction will be implemented by way of an off-market takeover bid and will be subject to 90 per cent minimum acceptance.

The carrier told the market it would de-list from the ASX if the bid was successful and retain its current management team. Jackson also said APA “expressed its support for core Qantas strategies”, including its two brand operation of Qantas and Jetstar.

Putting the best possible perspective on the deal, Jackson insisted that Qantas would remain majority Australian owned and Australian based. She told media: “The foreign based consortium members are experienced airline investors with a long standing association with the industry. The consortium members have made it clear to us that they recognise the immense value of the Qantas brand and intend to improve it and grow the business. If this bid succeeds, Qantas will continue to play a vital role as Australia’s national carrier. ” Certainly, Texas Pacific has extensive airline experience but none with a full service brand like Qantas in what is a virtual monopoly position as the ‘national carrier’. One of the big successes touted by Texas Pacific was its involvement with Continental Airlines.

That airline has indeed been a great success but the reality is that success had less to do with Texas Pacific and more to do with CEO Gordon Bethune. (See breakout box. ) The other claim to airline fame is the Allco group. For the Allco group, Qantas is a perfect fit with a substantial number of the Qantas fleet leased from Allco Finance and former airline heavyweights Sir Rod Eddington and David Turnbull are on the board.

But the deal was met with howls of protest and warnings from the union movement including the pilots. Australian Manufacturing Workers Union (AMWU) national secretary Doug Cameron told The Australian that the union does not want the airline “treated as a plaything by merchant bankers and cashed-up equity consortiums. ” He told ABC News that AMWU is “calling on [Prime Minister] John Howard to say quite clearly that the jobs should stay in Australia because we depend on Qantas for our transport, for our defence and in case of emergency when Australians are in trouble overseas. ” Australasia’s leading aviation think tank CAPA (the Centre for Asia Pacific Aviation) told this writer that Qantas was a “plum target” and Texas Pacific “a powerful and experienced stalker of companies” with private equity funds nearing $20 billion. It said the carrier “could benefit from a strong, extremely well funded backer” that would help it “access fresh pools of foreign capital to fund its future aircraft acquisition and development programs. ” Media commentators and analysts were wary of the deal fuelled by the belief that the bidders were planning to sell bonds backed by the carrier’s fleet of 217 aircraft to raise half the required funds.

Some focused on Qantas management – who would remain – getting “a plum” one per cent of the deal. CEO Geoff Dixon did his part to mollify public concern by committing the entirety of his performance and time based Long Term Incentive Scheme worth up to $60 million (if Qantas achieves a 25 per cent annual return for five years), to a charitable trust “for the benefit of the community, particularly in the areas of medical research and indigenous health and education. ” Dixon’s generosity notwithstanding, public and market disquiet continued into the Christmas break. New federal Labor leader Kevin Rudd – and part time Channel Seven celebrity – put the concerns of the wider community into perspective when he told Channel Seven’s Sunrise program: “It’s a very competitive business worldwide and subject to huge external shocks. Take for example things like national security shocks, terrorist

Costello cautioned the APA consortia that it was essential that Qantas continue to offer a full slate of domestic services, “particularly on the domestic routes where we don’t have another full service airline. ”

attacks, outbreaks of communicable diseases around the world. How does a company cope when those big things are happening if they’re loaded up with a lot of debt?” Labor’s treasury spokesman Wayne Swan also raised concerns about the level of foreign ownership proposed in the Qantas takeover with regards to voting rights and economic ownership and also took issue with the level of foreign ownership in some of the “Australian” listed partners of the consortium.

These concerns sparked a vocal round of calls for various guarantees relating to employment of Australians and work remaining in Australia, levels of regulations few, if any, other Australian companies are shackled by. Qantas CEO Dixon said there was no guarantee on his own job and that Qantas “reserves the right to run the company in the best interests of everybody. ” However, former Cathay Pacific Airways CEO David Turnbull, executive director of APA member Allco Finance Group, contributed to the debate, telling Bloomberg News in Sydney that there is no reason for the government to change policy. “Qantas is equally Australian owned after this event as it was before, therefore why should there be a fundamental change?” he asked.

APA has stated that it supported core Qantas strategies, including maintenance of an extensive domestic and international network and the use of both the Qantas and Jetstar brands.

But the latter is also a catalyst for significant industrial strife, as many Qantas staff believe the company will move significantly more business to the low cost Jetstar operation, a prospect that will gain even more momentum with the huge debt level accompanying APA’s bid, some market analysts suggest.

Looking back to the demise of Ansett and hinting at conditions on the sale, Federal Treasurer Peter Costello told ABC Radio: “They [APA] are on their own. Any suggestion that you could takeover an airline, get yourself in trouble and then ask the taxpayer to bail you out is not on. No way,” Costello warned listeners.

He also cautioned the APA consortia that it was essential that Qantas continue to offer a full slate of domestic services, “particularly on the domestic routes where we don’t have another full service airline. ” Adding to the speculation on conditions of the sale and yet inadvertently pointing to the reality of such conditions, Deputy Prime Minister and Transport Minister Mark Vaile told ABC TV on January 8 that foreign ownership and other regulatory approval conditions have not been decided. “On the commercial side of things, that’s a matter for the market,” he said. “It’s a bit difficult to put overly restrictive requirements on there, but certainly it would be in the national interest to maintain a high level of skill in the aviation industry in Australia. ” Vaile hinted that conditions might be similar to those imposed when Air New Zealand acquired Ansett Australia in 2000 – that Ansett remained based in Australia, kept regional routes and did not reduce skilled employment.

As it turned out, those conditions were utterly meaningless when the airline went into bankruptcy – prior to 9/11.

Not well known was an Ansett /Air New Zealand plan – similar to the infamous WW2 Adelaide-Brisbane line – drawn up in May 2000 to abandon all intrastate and regional routes in Western Australia to stem savage losses. But putting a serious perspective on the deal in mid January was CAPA, which warned that the Qantas buyout “must succeed if only because of the dire consequences of failure. ” According to Peter Harbison, founder and executive chairman of CAPA, “the consequences of failure are too grotesque to imagine. If the deal is knocked back, there would be a massive loss of confidence and the share market would bail out of the stock sending the share price below last year’s lows. ” Harbison added that Qantas is a child of regulation and as that protection is slowly removed through liberalisation so Qantas would progressively wither on the vine. “This is an international trend and beyond the control of the Australian government, even if it wanted to prevent change. In the face of this evolutionary process, Qantas would be lucky to survive another 10 years in its current form,” he warned.

“It would contract into a domestic airline and eventually be taken over by one of the post-2010 multinational airlines. ” Many airline analysts, including Harbison, believe that the ASX, conditioned to quarterly reporting, does not understand the long term nature of the airline market and Qantas’s high standing in the global airline market.

That lack of understanding was also reflected in a Roy Morgan research poll quoted in The Australian which found that a small majority of Australians did not want the buyout to proceed, but that sentiment was based on the false premise that Qantas is either government controlled or 100 per cent Australian owned.

Australian Aviation also informally surveyed 50 Qantas staff and general airline employees and found that most did not know that the airline was already 49 per cent foreign owned.

Harbison also added that greater airline liberalisation is coming – particularly in Asia, and “Qantas needs to be able to access capital to implement its strategic push into Asia. ” “The Airline Partners Australia investors may be money hungry, but stupid they are not; they see the international emerging opportunities in much the same light as Qantas CEO Geoff Dixon does,” he explained.

“Their ‘patient equity’ (as APA’s chairman, Bob Mansfield, describes it), unconstrained by quarterly analyst scrutiny and therefore able to take long term strategic positions, allows APA to make more aggressive financial plays, where such moves would see slumps in a listed Qantas’s share price. ” While leading analysts, such as Harbison, are backing the deal, there is enormous heat being applied to Qantas from around Australia by federal and state politicians and tourism bodies clamouring for greater services from Qantas.

Leading the charge have been politicians in Victoria and Queensland with Tasmanian politicians pitching for services to be increased or at least protected.

Not well understood is that the Qantas of today and its ability to serve Australia is in many cases a legacy of decisions taken – or more to the point, not taken – in the 1990s, such as aircraft types and inflight service levels.

Analysts point to the fact that the airline has withdrawn from European cities, such as Rome, Athens and Paris because it does not have aircraft like the 300-seat 777-200ER, which is perfectly matched for the passenger demand for those routes.

Qantas, in fact, is the only major long haul airline that does not have a 300- seat long range jet in its fleet.

The airline’s management in the 1990s was also slow to install seatback videos for all passengers, which is thought to have cost business. Others complain that the airline does not offer a more spacious premium economy product to the western world’s second tallest people who fly the longest routes.

Current CEO Geoff Dixon took over in 2000 and, with current CFO Peter Gregg and Qantas GM John Borghetti, has moved aggressively to reposition the airline to the forefront in innovation, both operationally and in market positioning, with the launch of low cost Jetstar.

Qantas has the second largest order of 20 of the giant 500-seat A380 and is the second largest customer for the 270-seat 787, with both aircraft slated for delivery in mid 2008. The delay in the delivery of the A380 has derailed new “more spacious” product offerings, insiders suggest.

The Australian Consumer and Competition Commission (ACCC) and the Foreign Investment Review Board (FIRB) were examining the deal on a range of complex issues, including the cross ownership of Sydney Airport by bid leader Macquarie Bank and examination of how the bid parties have acted. The reports from both bodies to the government were expected late in February.

Treasurer Peter Costello will consider the case on national interest grounds but that review may take some time as it did when, in 2001, Costello took six months to reject the bid by Anglo- Dutch oil giant Shell for Australia’s Woodside Petroleum.

Possibly the greatest problem for Qantas is that the public – and thus the government – take it for granted and do not appreciate that Australians enjoy the world’s best domestic airline service and one of the finest international services.

While union and tourism bodies are up in arms over the deal suggesting there will be an increased focus on Jetstar at the expense of Qantas, the reality is that more and more Australians are voting with their wallets and changing to another airline for a $50 reduction in a $2000 fare. Like it or not, Qantas’s backyard is home to some of the world’s lowest labour costs and airlines such as AirAsia have an ASK of just 2. 75 cents compared to Jetstar and Virgin Blue which have costs around 6. 5 cents and Qantas around 10 cents.

And going are the days – thanks to a dramatic improvement in airline safety – where Qantas and its pilots could demand a premium in fares and salary for their safety record.

Aircraft such as the 777 have a perfect safety record so crash headlines are becoming a rarity, and thus the influence of Dustin Hoffman proclaiming that he would only fly Qantas in Rain Man – that underpinned higher margin fares – is wearing off and fast.

Dixon’s well worn assertion that “Qantas’s future is not assured” still stands and is now supported by Harbison.

But the thing is the government wants Qantas to be all things to all people, including carrying the national flag, helping out stranded Australians after natural disasters or terrorist bombings, providing a good service to the bush and maintaining full service operations – particularly out of Canberra.

At the same time, it is facing massive pressure from its own ranks and the rejuvenated opposition under Rudd, to open the flood gates to foreign airlines both for access to Australian cities and fifth freedom access to Qantas’s lucrative routes.

It is ludicrous for the government to put any sort of service level or route conditions on Qantas, either in its present form or in the hands of APA, if it is going to open the skies to all comers.

Qantas’s management has piloted the airline into a solid financial position by being hardnosed on what works and what does not. Sure, they have rubbed some noses the wrong way and even delivered some biffs – where needed – but the reality is that Qantas is in as good a shape as the best and way, way better than most.

Mark Vaile summed up the situation well on the ABC’s 7. 30 Report in January when responding to Ali Moore’s question on guarantees on jobs, maintenance and regional routes.

He said: “The strength of that business [Qantas] is its brand, its network internationally, its network domestically and its network regionally. I would not think that they would be likely to disaggregate that or to weaken that brand or weaken the network that they have.

That is part of the important position that Qantas occupies in the Australian economy. It is vital to the Australian economy. But also that structure’s vital to the success of the business, I would have thought. ” The Australian newspaper, in a well thought out editorial, summed up the government’s dilemma thus: “As The Australian has said previously, in the volatile international airline industry dominated by government carriers, there is little that resembles open and transparent market forces. The issue is whether Australia has a strategic and public policy interest in preserving a national flag carrier. While it is easy to argue for open-slather access to Australia’s international air routes in the complex world of aviation, the case has still to be made that an open-skies policy would result in a better deal for Australian consumers overall. ” The paper added: “The fundamental national interest concern with the Qantas takeover arises not because it is being sold from one private owner to another but because of the way in which it is taking place. If the national interest dictates that having a national flag carrier is a strategic necessity, taxpayers have every right to question the proposed takeover deal. They are, after all, indirectly footing much of bill because of the sophisticated and opaque accounting techniques which leverage debt to minimise tax. ” However, Qantas and its new owners- in-waiting would argue, and rightly so, that while the public may foot the bill through tax breaks for leveraging of debt, it also reaps the rewards with lower airfares.

Perhaps Vaile had the last word or words on the sale prospects when he rounded up the 7. 30 Report interview by saying: “I can’t comment whether most Australians are for or against it [the Qantas sale]. What has been expressed by some people to me is a concern that Australia be able to maintain its national carrier. I believe that this proposal will see that happen.

You’re not going to have an entity investing the sort of money that is involved here, in the vicinity of $11 billion, to lose a brand, to breakdown a network that is its intrinsic value of an international network, a domestic network, a regional network. ” And perhaps a portent of what is to come was given by Kell Ryan, the co-founder of Irish based discount airline Ryanair, which TPG has a stake in and Bonderman is the chairman of, when he told ABC Radio that unions had ruined such airlines such as Sabena, Alitalia, United. “If you look at the examples, particularly in the States and then maybe even in Europe as well.

They [unions] won’t accept change.

Unions have to realise that companies have to be flexible, that there is competition and they have to be able to adapt to a changing world. ” Ryan told ABC’s Emma Alberici. To the question “Is there a future with the style of airline that Qantas and British Airways have traditionally run?” Ryan told listeners, “I don’t think so.

You have to have a flexible work force, I believe, and you have to have people that can adapt to change. ”Interestingly Allco’s Eddington told this writer in 2005 that “achieving a culture change at an airline was equivalent to performing an engine change in flight”.

But there is one thing for certain. If the deal does go through, while Dixon may not have to deal with quarterly reporting, he will have to deal with the barrage of “blame the deal” every time the airline does something that the public or unions don’t like – which is far more often than every quarter.

Bonderman v Bethune at Continental

The saying goes “The first casualty of war is truth” and so it is with some analysts claiming that Texas Pacific’s (TPG) greatest success was the turnaround at Continental Airlines in the USA.

Certainly TPG has made a handsome profit from Continental’s turnaround but it was Gordon Bethune the CEO that TPG brought in to run the airline who is soley responsible for the Continental success story.

And while some may suggest that TPG should take the credit for hiring Bethune, in an extraordinary move Bethune was forced out of the position in late 2004 because of a power struggle over an alleged conflict of interest of TPG’s chairman David Bonderman.

When Bethune arrived at Continental from Boeing in 1994 it was a basketcase and the laughing stock of the industry. It had gone through two bankruptcies through the 1980s and early ’90s and was staring at a third.

According to Fortune magazine the airline’s employees were so ashamed to be associated with Continental that consultants suggested changing the company’s name. Bethune thought not. “We don’t need to change our name, we need to change us,” he told Fortune.

Over 10 years Bethune transformed the airline from laughing stock to industry leader.

When he took over, Continental had the worst ontime record and not surprisingly the worst lost baggage record and was spending a fortune booking its premium passengers who had missed connections on the opposition’s aircraft.

Bethune inspired the staff with a host of initiatives such as on-time and lost luggage bonuses, ripping doors off management offices and having open office drinks late on Fridays to meet and talk to management.

Bethune could walk with kings but never lost the common touch and never forgot his roots as a mechanic in the US Navy.

According to Fortune Continental lost on average US$1. 2 billion in the four years pre-Bethune, but in 1995 Continental made US$287 million and soared to nearly US$600 million in 1999.

Continental’s stock leapt from US$3. 80 to US$87 and it was that success that led to the fallout betweenBonderman and Bethune, with the latter claiming “airlines aren’t deals. ” But Bonderman did a deal to sell Continental to Delta in 1998 and Bethune was incensed with the “raw deal” that was being dealt to Continental employees that would see the employees sacrificing their seniority.

According to Fortune Bethune went before the board, saying: “I always told the employees, ‘I’ll never sell [the company] and you get screwed. ’ I have to honour that. ” Bethune sought out Northwest Airlines for a competing bid and won out but later in 2000 sought to buy the stock back as Continental was not allowed to run autonomously as agreed.

The buyback deal was finally struck in early 2001.

At the time Bethune declared it Independence Day because for the first time since 1982 when Frank Lorenzo took over the airline it wasn’t under the thumb of a controlling investor.

But the battles were not over yet for Bethune.

Bonderman and partner William Price were still on the Continental board, while TPG was actively trying to buy intoother airlines such as US Air and controlled American West – both Continental rivals.

Bethune saw this as an intolerable conflict of interest that could impact the Continental staff, who worshipped him as a god.

Finally in 2004 the two men reached an odd armistice with Bethune agreeing to leave Continental if Bonderman would leave the board.

Bethune’s view, suggests Fortune, was that “he took one for the team [Continental staff]”, believing that Bonderman’s departure would help ensure Continental’s future.

Tom Barrack, Continental’s chairman of the board’s governance committee told Fortune at the time; “This was probably the right time for them to move on and to allow the company to move on to the next place. My personal regret is that David Bonderman and Gordon Bethune are two of the smartest people in their respective spheres. I wish the focus was celebratory: Look what’s been done here. ” As Qantas management consider their potential new owners and what is about to be done perhaps they should gain some insight by Googling: Bethune and Bonderman.

Interesting reading!