Wednesday 6th September 2000
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What on earth's the matter with investors these days?
You go out and make a hefty acquisition at a favourable price, yell "synergies" and "global scale" all over the place, cement in a trade shareholder with huge financial muscle and operational nous - and the market slashes your share price. Well, golly me.
That could easily be the refrain coming from the Air New Zealand boardroom right now. And it is really most vexing. I mean, the carrier has spent a not insignificant $858 million swallowing the half of Australia's Ansett that it didn't already own. The deal has also attracted the prestigious attention of Singapore International Airlines, which has bought a 25% stake in Air New Zealand. Now the directors want to raise $280 million through a rights issue to bring the balance sheet back into shape. And yet the share price is languishing at a 40% discount to last year's peak.
Of course, Air New Zealand's shares have always had their ups and downs, in keeping with the classic airline pattern. Six times in the past six years its lucky stars - low jet fuel costs, high tourist arrivals and a generally perky share market - have come into alignment and the B shares have traded above $3.80.
In between are the bad times when they've struggled to stay above $3.00 (they were under $2.50 as Unlimited went to press). In other words, they've provided a pretty lousy investment over that time. A dollar invested at the beginning of 1994 would still have been $1.00 at the end of 1998. It's now worth about 78 cents. What's wrong with Air New Zealand?
It's not as if the airline hasn't brought home the bacon. When it was floated in 1989 it had total assets of $1.6 billion and a net profit of $66 million. Last year assets were $4.2 billion and profit had more than tripled, to $214 million.
But is the market grateful? No way. In the past 18 months the market's mood swings have become more violent. Last year's arm-wrestle over Ansett between SIA and Air New Zealand saw the Kiwi company's stock peak at $4.15 on the expectation SIA would buy into Ansett. But when SIA walked away from an Ansett buy in, the share price slid all the way to $1.40. Lately the stock has been dragging along sideways at a depressed $2.50 as investors contemplate the uncertainties created by six months of rapid change. What change? This year alone:
Meantime, Air New Zealand itself is resolutely upbeat. The Ansett acquisition, it points out, creates one of the world's 20 largest airlines by revenue and passenger-carrying capacity. Management has estimated annual savings of $256 million by 2003 through merging the two airlines' operations - that's as much as Air New Zealand's total earnings before interest and tax last year. And the full benefits of membership of the global Star Alliance have yet to flow.
"Yes, the share price is undervalued. The annual result will be accepted as very satisfactory given the fuel price escalation this year. And looking forward it appears the fuel price is reducing," says Air New Zealand chairman Selwyn Cushing.
So what's the market's problem? Analysts say investors have plenty to worry about, not least finding a new boss.
The fact is, says Centre for Asian Pacific Aviation's Peter Harb-i-son, the outcome for Air New Zealand is anyone's guess. "Having Singapore in the picture makes it very complex to determine where Air New Zealand's going to go. It could be positive, it could be negative."
The uncertainty lies partly in the fact SIA wanted a direct Ansett stake, not a holding in Air New Zealand. It ended up on the register after Air New Zealand effectively exercised pre-emptive rights to News Corp's 50% Ansett stake.
SIA has strong reasons for wanting to control Ansett (see "Do 'super carriers' doom SIA?") but with only 25% of Air New Zealand its ability to call the shots is limited.
Jet fuel prices are also a wild card, says Harbison. There's a feeling they've peaked, but the industry thought so last year and was proved wrong. Fuel prices account for around 12% of Air New Zealand's costs.
Harbison thinks the airline's $256 million in synergy gains is realistic but, unlike the departed McCrae, he thinks it won't be easily come by.
"Ansett's not a simple, straightforward merger proposal. There are plenty of issues like harmonising the workforce, industrial relations and the Australian government conditions," (such as keeping the workforce at current levels and maintaining a substantial Australian head office).
The upside in the merger includes the two airlines being able to save costs and get higher revenues from rationalising suppliers, catering and maintenance, sharing lounge and check-in facilities and routing Air New Zealand traffic onto the Ansett domestic network. Another big opportunity lies in rationalising Ansett's fleet. Eric Betts, an analyst at investment banker Nomura Australia, says big savings could be made from retiring Ansett's ageing Airbus planes and replacing them with Boeings - some of which might come from Air New Zealand's youthful fleet.
All those internal worries say nothing about the fresh competition the incumbent airlines face from new entrants like Virgin and Australian-based "chips and cola" carrier Impulse.
"As far as we're concerned we're competing quite satisfactorily but we've only owned all of Ansett since June. We haven't had a lot of chance to respond," says Cushing. Air New Zealand and Qantas both say that the newcomers' low prices will expand the market, introducing a new breed of inter-city leisure traveller who previously hadn't been able to afford it.
Merrill Lynch's Simon Gresham agrees, to a point. He says growth in airline traffic is held back by the number of aircraft, not the demand for seats - a "lack of capacity" in aviation-speak.
But the argument will hold only if the entrants - and the incumbents - don't bring on too many extra aircraft. JB Were's Peter Sigley is more cautious. "The line is that the new business will equal the new capacity but I don't quite buy that one." The way he sees it, the key will be what impact the upstarts have in the high-margin corporate travel market. "To be successful long term in the corporate market you have to have the right [flight] frequency. So that's the area to watch."
Another key to the airline's future - one much under-recognised, according to the analysts - is its membership of the Star Alliance, which is still being built up. The multicarrier frequent-flyer programmes such alliances offer, explains Harbison, exert a heavy influence on travellers' carrier choice both domestically and internationally.
Alliance code-sharing and the routing of passengers through fellow members' networks mean everyone gets to fly with more seats full, says Nomura's Betts.
Cushing forecasts further benefits. "We're seeing enormous upside already and SIA has only just become a full member. That will bring further dimensions for Air New Zealand and Ansett to and from the Asia regions. It's helped immeasurably with the load factors [that is, how full an aircraft is]. If you can add 3% or 4% it assists the bottom line very much because your fixed cost component is so high."
Whoever replaces McCrae is going to have to roll their sleeves up quick, getting Ansett bedded down and refocusing on the competition, both old and new - a process analysts reckon could take up to 18 months.
An indication McCrae's successor is succeeding, says Harbison, will come from the level of interest from the international investment houses. These are more or less obliged to have an Asia-Pacific region carrier in their portfolios. In the past their focus has been on Cathay Pacific, Singapore Airlines and Qantas.
If Air New Zealand can find its way onto their "buy" lists it will have made the big league, at last.
A potential threat to Singapore International Airlines (SIA) comes from the super carriers being built by the likes of Europe's Airbus, which will be able to fly from the US or Pacific Rim to Europe without stopping to refuel. That could devastate Singapore's tourist stopover industry, a major export earner.
Part of the SIA remedy is to go global. It's a member of the Star Alliance but is also keeping its options open through moves like the tie-up with Richard Branson's Virgin Atlantic.
Another part is to look for domestic carriers that can deliver passengers to SIA's international network. Australia fits the bill, generating respectable quantities of outward traffic and attracting several million visitors a year along the "Kangaroo Routes" from Europe and America.
Hence SIA's interest in Ansett. But with only 25% of Air New Zealand, SIA will have no direct influence on Ansett and only limited influence on Air New Zealand, which has its own international ambitions and might be reluctant to traffic-share with its Singaporean shareholder.
Market watchers were quick to blame SIA machinations for the surprise resignation in July of managing director Jim McCrae, at a crucial point for the airline as it struggles to absorb Ansett.
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