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Taking the Sale Act out of Qantas - a one-off opportunity missed as amendment fizzles out

Qantas is expected to post a loss of between AUD700 million and AUD1 billion for the full 2013/14 financial year to 30-Jun-2014 and now faces the unsettling reality that the Qantas Sale Act (QSA) isn’t going anywhere.

Australia’s Federal Government retreated on the planned Qantas Sale Amendment Bill 2014 that would have repealed part three of the QSA, recognising it wouldn’t pass the Senate, and agreed to side with the Australian Labor Party (ALP) to remove foreign ownership limits. The largely pointless compromise revision was adopted on 18-Jul-2014.

The previous provisions prevented any single airline investor holding more than 25% of Qantas and of total foreign airline investment of 35%, capping the total foreign investment at 49%. The new provision simply caps foreign ownership at 49%, with no airline restrictions.

Australia’s progressive aviation system has kept the domestic market highly competitive

Australia is unusual in global aviation circles in that it allows 100% foreign ownership of domestic airlines. When founded in 2000, Virgin Australia, then as Virgin Blue, the new LCC was 100% foreign owned, mostly by Virgin Group/Richard Branson. That status was fine so long as the airline did not venture outside Australia, but once it went international that needed to change. At the time of Virgin’s IPO in 2004, the carrier was 45% owned by Patrick Corp (since absorbed into logistics giant Toll Holdings) and Virgin Group at 29%, with the remainder on free float.

This began to present a challenge when Air New Zealand purchased its first equity share in Dec-2010, to be followed by Etihad Airways and Singapore Airlines in 2012. Between them, these foreign airlines now hold over 60% of the equity.

To accommodate this ownership and still be able to fly internationally, the company has developed a holding structure which permits up to 100% foreign ownership, 80% of which is now held between the three airlines and founding investor, Virgin Group, all of them foreign entities. By ring-fencing the airline’s international operations using a separate (majority Australian-owned) vehicle, Virgin is able to comply with international bilateral agreements and the Air Navigation Act that requires majority local ownership of an international airline.

This structure comprises (i) the domestic (and listed) Virgin Australia Holdings (VAH) and (ii) the international division as Virgin Australia International Holdings (VAIH).

Qantas, in part, emulated this structure in 2012 when it split its domestic and international operations into separate divisions, as a way of independently running each business “according to its specific priorities and market conditions”, allocating costs and revenues more effectively between the operations. Regardless, the plan to take it further was suspended in 2013, explained as a “conservative measure to limit the amount of operational change.”

The plan could supposedly be picked up where it left off at some time in the future, and it is understood the process of obtaining a separate Air Operators Certificate (AOC) for Qantas International could have been completed in four to six months.

The Qantas Sale Act, a 22-year old piece of legislation overtaken by time

The 1992 Act – a nod to union pressures designed to ensure the newly privatised Qantas remained Australian – restricts foreign airline ownership of Qantas (and only Qantas, not Jetstar for example) to 25% or up to 35% if several foreign airlines are holding in aggregate.

The Act consists of eight parts, but part three is the most contentious and relevant to recent discussions:

  • Part 1: This is a preliminary section outlining when the Act is to become effective and including definitions applicable to the act;
  • Part 2: Outlines the order in which the airline is to be privatised;
  • Part 3: Dictates that Qantas must restrict the issue, transfer and ownership of Qantas shares to foreign parties (where the 35% limit is outlined). It also states Qantas must not change its name or operate international services under any other name, must maintain its head office in Australia, and requires that Qantas maintain operational facilities – such as maintenance, catering, flight operations, training and administration – in Australia. It also requires two thirds of company directors to be Australian nationals and prevents Qantas taking any action to incorporate outside Australia;
  • Part 4: Transitional provisions for share capital during the privatisation process;
  • Part 5: An amendment to the long service leave regulation for commonwealth employees;
  • Part 6: Repeals the Qantas Empire Airways Act 1948 and Australian National Airlines Act 1945;
  • Part 7: Details long service leave provisions relating to (ex) employees of Australian Airlines, transitional provisions relating to the CERC Act, DFRDB Act, DPP Act, Judiciary Act 1903 Long Service Leave Act, Superannuation Act 1922 and 1997 and the Commonwealth Borrowing Levy Act 1987;
  • Part 8: Other provisions relating to the airline’s sale, including removing the airline’s status as a Commonwealth or government body, including – significantly – that Qantas no longer be taken as being “established for a public purpose or for a purpose of the Commonwealth.” In other words, it is to be treated as any other listed company. The section also removes control of Qantas from the government and includes various amendments for the privatisation of the airline.

The contrasting structures of Qantas and Virgin Australia

Under the previous provisions of the QSA, any single airline investor was restricted to holding 25% of Qantas and, of any collective foreign airline investment, to 35%. Despite the 18-Jul-2014 amendment, collective foreign investment cannot amount to more than 49% of the listed Qantas. So essentially all the amendment does is take out the 25% and 35% hurdles. Whether the Sale Act is applicable to Qantas’ wholly owned subsidiaries, including Jetstar, has not been tested and would undoubtedly be controversial should any attempt be made to exercise such an option.

As of 21-Jul-2014, foreign interests hold 39.8% of Qantas, although the airline is not required to provide updates until that amount exceeds 44%. The cap on foreign investment in Qantas sits at 49%, the restriction imposed by the Air Navigation Act and Qantas is required to reduce any excess on a last in-first out basis.

VAIH is owned by existing VAH shareholders and has its own independent board of directors but operates under a long-term service and loan agreement with VAH to provide aircraft, crew, maintenance and administration services. VAIH is subsequently billed for these services; however the airline notes its loan and future capital requirements are all funded from VAH. The split has had no operational impact.

Qantas would be unable to mimic the same structure without significant legal, political and union opposition and the new amendment does nothing to help that situation. Were Qantas to make any such move, legal challenges would create uncertainty and risk significant degradation of goodwill from employees, the public and politicians. This opposition is founded mostly on a range of intangibles and misconceptions, liberally sprinkled with vague nationalistic sentiment, but it is effective nonetheless.

Qantas argues that amending the Sale Act will allow it to attract foreign capital

Qantas has long argued that, given Australia’s small investment pool, the 49% ownership restriction places it at a significant disadvantage against US airlines for example; and most analysts agree that this is the case – although they are divided on the likely impact of a change.

But Qantas’ more recent – and very publicly debated – concern was more specifically directed at Virgin Australia’s “advantage” in being able to partition its ownership. This gathered momentum when Virgin’s investors were able to inject capital, in the form of both debt and equity, supporting the smaller airline as it completed the costly transition process from domestic LCC to a full service domestic and international operator. These investments were made into VAH and therefore not restricted by the 49% foreign ownership limit.

Qantas’ concern gained poignancy as Virgin mounted an aggressive attack in the domestic market – the jewel in Qantas’ crown and a market which has a historical profit value of as much as AUD1billion. As a result of the tough battle for market share in 2013 and 2014, most of this profit has been stripped from this year’s financial results.

Qantas argues, directly and indirectly, that Virgin is therefore being subsidised by foreign (government-owned) airlines, giving the smaller airline an advantage that Qantas is unable to leverage.

So there are essentially two limbs to Qantas' argument for removing the ownership caps – to encourage more foreign investment in general and more specifically to place Qantas in a position where it could emulate the structure of its main competitor.

Meanwhile, Qantas' more predictable investors have mostly dismissed speculation about their interest, but that is only to be expected. So long as the legislation remains in place interested parties are unlikely to come knocking. If a similar structure to VAH were possible, that would almost certainly change.

Qantas is relatively well cashed up, retains a powerful brand, owns the best airline frequent flyer programme in the world, still has two thirds of what remains one of the world’s most lucrative domestic markets, in a country whose population is highly peripatetic. These are features that attracted Emirates as a partner and there are numerous other airlines that would see value in anchoring a stake in the airline.

CEO Alan Joyce said, “given the amount of partners that we have around the globe, the interest that there is in the Australian market and the attractiveness of this brand name there is not going to be a shortage of people interested in the company,” but remained silent on possible parties: “It is just speculation until we understand what happens with the Qantas Sale Act.”

So the recent amendment adds only marginally, if at all, to the attractiveness of Qantas as an investment for a foreign airline. And probably more importantly, the unsavoury political halo that has been locked around Qantas' ankles would create disincentives to investment, in contrast to Virgin Australia, which is typically treated as a normal listed or private company. Despite the explicit provisions of Part 8 of the Qantas Sale Act, there are many who, for various reasons still expect Qantas to be preserved for some unspecified “purpose of the Commonwealth”.

There would certainly be interested airline investors, were Qantas to be available

An obvious first call is Emirates. Qantas and Emirates have maintained close ties since the inauguration of their partnership in Mar-2013, but Emirates has repeatedly and vocally affirmed it has no interest in taking a stake in Qantas. Australia's Minister for Trade and Investment Andrew Robb met with Emirates chairman Sheikh Ahmed bin Saeed Al Maktoum in early 2014 to raise the possibility of an Emirati investment, noting his belief that “it’s the only solution to make sure that the Qantas brand and its viability remains very strong.”

Sheikh Saeed Al Maktoum responded in May-2014 by stating neither Emirates nor Qantas is looking to take an equity stake in the other “as we stated when the partnership began.” During a Senate inquiry, Mr Joyce refused to comment on whether an investment provision was included in the pair’s partnership agreement.

Given the close and deepening tie with Emirates, it is becoming highly unlikely that the Gulf carrier would not join Qantas’ share register should there be a substantial shift in the government’s position. Equally, that partnership would help define any future equity relationships that Qantas might undertake.

Then there are the fast growing Chinese airlines; they will undoubtedly become major forces in international aviation by the end of this decade and will be investing in foreign airlines as part of their global spread. Privately owned Hainan Airlines has already made some strategic foreign airline investments. Privately owned Spring Airlines has established an offshore subsidiary in Japan and the “big three” will inevitably follow suit as they get their houses in order.

China Southern for example took tentative steps toward a 10% to 15% stake in Qantas during 2013, even engaging lawyers to advise on the purchase; however the process ultimately went into abeyance. Qantas has consistently moved closer to China Eastern, expanding their codeshare reach and examining additional areas of cooperation such as pilot training and freight. No formal announcements have since been made, however China Southern reaffirmed its investment position during Jun-2014, announcing it is not currently considering an equity stake and instead prefers closer codeshare ties.

Shanghai based China Eastern and Qantas are partners in the delayed Jetstar Hong Kong venture alongside ShunTak Holdings, each holding a 33.3% stake. The pair has developed a strong codeshare agreement and the relationship has the foundations for expansion; however there has been no public indication China Eastern is interested in or is evaluating Qantas as an investment on its own.

The third of the big three, Air China, is not a prime candidate at this stage, but it is still Beijing’s preferred instrument and, despite its position in the Star Alliance, has a joint cross shareholding with oneworld airline Cathay Pacific Airways. Even the least expected allegiances become possible as new market opportunities arise.

Otherwise, Qantas has previously held discussions with British Airways, Singapore Airlines and Malaysia Airlines over potential equity deals, none of which has progressed beyond preliminary talks. British Airways was a shareholder in the airline from privatisation until 2004 when it sold its stake, but the carrier returned to the table in 2008 proposing an AUD8 billion merger brokered by ex-CEO Geoff Dixon. The deal didn’t proceed and is unlikely to reemerge after Qantas and British Airways terminated their joint venture in 2012 and British Airways went its separate way with Qatar Airways.

But the level of turbulence and disruption in the global airline industry – and particularly in Asia – is such that this year’s unthinkable can quickly become next year’s given, so ruling out any prospective purchaser would be imprudent.

Then there is the potential too for a “privatisation” of Qantas – taking it off the register, with private investors acquiring the entire shareholding. This can occur without the need for changes to the Sale Act. A proposed bid came within a hair of succeeding just before the global financial crisis and was narrowly defeated by shareholders. Privatisation would implies dramatic changes for the airline and, with Qantas’ share price where it currently stands, remains an option that many in the financial services industry will again be eyeing, although it would be more difficult this time around.

The fallacy in helping Qantas to survive by handicapping it

Most of those responsible for maintaining the heat and opposing change clearly see little relevance in the immense changes the airline industry is undergoing.

They are in no position to prevent those changes occurring, but seemingly would prefer to focus on maintaining a pretence of supporting the status quo. Qantas does seem now at least to have convinced Canberra that its international operations are a victim of these external changes, rather than the fault lying at the feet of management; but it took a massive shock to the system – shutting down the airline in 2011 – to bring that point home.

But meanwhile the ownership debate has remained mostly coloured with catchy rhetoric and often sheer erroneous assumptions.

The federal opposition (ALP) has said its watered-down amendment will make “sure that Qantas still calls Australia home” and maintains the QSA is required to protect skilled jobs – especially in the area of aircraft maintenance.

While Virgin Australia performs no heavy maintenance in the country, Qantas’ de facto status as the “national carrier” seems to require it be held to a different standard. There is an ideological attachment to Qantas that it is ‘our’ airline and it must be kept nationally pure. This is an argument which Qantas has selectively fuelled on many occasions, so it is unsurprising in many ways that it should be used against it now. Statements like “no other airline in the world can be relied upon to always put Australia first,” and a heavy reliance on being Australia’s own in its marketing efforts only weaken the case for Qantas.

Maintaining the status quo while all else changes

Nonetheless the status quo argument has little support in fact. “Propped up by foreign governments” (so it is argued), Virgin Australia has expanded its Australian workforce by more than 41% between 2010 and 2013 while Qantas grew by only 2.39% – and that is before the planned reduction of several thousand more positions. Including those, by Jun-2015, Qantas will have downsized by almost 10% since 2010. Granted, Qantas has a significantly larger workforce than Virgin at 33,265 vs 9,200 (during FY2013), but the point remains that if “protecting jobs” is the goal, the QSA has clearly not been any sort of guarantee.

Opponents however remain adamant that a 49% limit on foreign investment remain, as should part three of the QSA. ALP Transport spokesperson and former Transport Minister Anthony Albanese announced: “We have stated from the very beginning that majority Australian ownership of Qantas is not negotiable… It's very clear the Government was on its own here when it comes to abandoning Qantas as an Australian-based airline.” The ALP has never articulated why Virgin Australia is not held to the same standard (other than having not existed as long) or how maintaining the status quo will be encouraging Qantas’ future stability, by placing Qantas at a disadvantage to Virgin.

Australia’s de facto Transport Minister Warren Truss said the government continued to support a full repeal of part three of the Qantas Sale Act but that it was clear the original proposal would not pass the Senate. Mr Truss optimistically noted the compromise would “go some way to easing restrictive ownership provisions” and “give them [Qantas] some greater capacity to raise additional capital.”

Qantas is not endangered yet, but it would be unwise to wait until it is

When, during the heat of the popular debate it became apparent that a comprehensive amendment to the QSA was unlikely, Qantas changed tack, requesting a government-backed debt guarantee, or failing that, an AUD3 billion unsecured loan facility. While appearing briefly to consider it, the Australian government rejected any consideration after a report from PricewaterhouseCoopers noted “no immediate financial concerns” or any cause for urgent government intervention.

Qantas responded by claiming a debt guarantee would “take the distortions out the playing field” in the short term with QSA amendments remaining a medium to long-term issue. This was always a most unlikely outcome leading only to a reinforcement of the Qantas-as-a-limb-of-government arguments and turning back the clock on government subsidy. It is one thing for foreign governments to underwrite Australia's domestic airline system, but quite another for the Australian government to do so.

Qantas is at no immediate risk of collapse, but the question of financing is a pertinent one. Despite Qantas’ aspirations to improve access to big foreign capital markets, the airline has recently had little difficulty raising funds at home. Qantas ended 2HFY2014 with “a strong liquidity position of AUD3.0 billion” consisting of AUD2.4 billion of cash and AUD630 million in undrawn debt facilities. Availability of domestic capital sources has not recently been articulated as a problem by Qantas.

There has been an unquantifiable cost however: the airline has had to back away hastily from as many longer term capital commitments as possible to reassure analysts and investors that its debt remains manageable. That is, new aircraft orders have been either delayed or cancelled and other capital investments will be sidelined, for example in IT innovation. These are matters that directly affect the future size and competitiveness of Qantas, but they will never be quantified or recognised as negatives because they will be invisible omissions.

Another negative that is missing from the debate is the competitive and strategic advantages that could be afforded to Qantas through an equity tie-up with a larger partner, as Virgin has been able to access and leverage successfully. There should be no uncertainty that the most recent legislative changes are unlikely to yield any benefits in that regard.

Australia’s political maelstrom is not conducive to reasoned debate and Qantas is mere collateral damage

In recent times Australian federal politics has been reduced to little more than Tweedledum and Tweedledee "ya-boo" style debate on major issues and so it is unsurprising that Qantas’ predicament has been treated in a similarly shallow context.

After a high profile public debate Prime Minister Tony Abbott said Qantas needs to “settle on what it wants” and argues it has had difficulty explaining what it’s trying to achieve. When looking at the timeline, that appears to have some merit: Qantas seemed to forget about its liquidity ‘challenge’ shortly after debt guarantee and loan requests fell flat. Next on the agenda appeared to be blaming the QSA for restricting investment in the carrier, while it quietly raised domestic capital. Qantas then stated it is facing no liquidity challenge before decrying a cashed up competitor, all the while sitting pretty on a not insubstantial amount of its own cash.

The more subtle reality is though that Qantas has never argued it was facing an immediate risk of insolvency; but it has consistently argued it needs help to open the doors to foreign investment. In the washing machine of Canberra, Qantas may not have emerged shiny clean, but then few who enter there ever do.

Qantas has competed effectively in the past, and an appetite for change may be placated by almost 90 years of history behind it. But it is 25 years since a competitor with the backing of significant funding has presented itself. Throughout the latter part of the 1990s Qantas had the benefit of competing at only jogging speed against an overweight Ansett. After Ansett collapsed in 2001 there was a brief challenge as Virgin Blue quickly chewed away at its now-cumbersome operation, but that was headed off eventually by the inspired introduction of Jetstar to defend the leisure market. It has only been in the past couple of years that a spirited reincarnation of Virgin Australia has shocked Qantas by attacking it across the board, domestically and internationally.

Just as the international market became untenable through combination of the GFC and the Gulf carriers (and Virgin on the Pacific route), suddenly the domestic market has become severely threatened. Qantas’ momentum has so far carried it through, albeit losing its investment rating in the process. But that is not the future; it is history.

Loving the airline to death is hardly a good recipe for long term survival

Opposition voices may be right to fear job losses, although the arguments have studiedly avoided spelling out numbers and specific reasons. The fact of an actual 5,000 imminent skilled job reduction has somehow been ignored in that discussion as Qantas struggles to bring down its cost base. It is easy to argue that Qantas is interested in the repeal of the Sale Act as a means to outsource key functions. But it can already do that to some extent and, as a commercial operation, where its competitors are able to make management judgments that reflect financial realities, there is little point in forcing it to adopt less than optimal strategies.

As the world environment quickly changes, that can only lead to weaker outcomes and progressive decline.

Qantas is no longer government owned, it’s not the national carrier and any sense of nationalistic ownership is misguided when discussing a commercial enterprise. If there is a real sentiment to re-nationalise Qantas, that is the course that should be taken. But there is no credible suggestion that that is in any way likely, let alone good policy.

In a competitive dual-carrier market like Australia’s, restricting one publicly listed competitor under an ideological guise has to be inappropriate – and as such presumably contrary to the national interest.

Repeal of the Qantas Sale Act would not immediately change the competitive dynamic. Virgin will remain majority foreign owned and a transformation process for Qantas would possibly only unfold over a period of possibly years – but it would allow Qantas to begin to plan towards a more meaningful restructuring and partnership strategy.

Qantas would then be in a better position to develop a more competitive cost base for future expansion and growth, rather than continuing to shrink. So the alternative is the promise of a Qantas that struggles and shrinks; but at least everyone can sleep easy knowing it’s Australian.

Australia’s aviation system will need to adapt in a changing world

Many things have changed since 1992, when the original Sale Act was formulated and Qantas was privatised. In a lot of ways the Act’s restrictions conformed with the norms of the time (although at home Ansett was about to become 100% foreign, as then-owner News Ltd became an American citizen, along with Rupert Murdoch, renouncing Australian citizenship in the process).

Today Australia is no longer a closed market place and airline partnerships, increasingly cemented by equity ownership, are becoming the norm as global markets overlap.

CAPA has identified at least 10 airlines in Asia that have plans to operate international service to Australia, many of them low cost operators. Several airlines have also assessed the option of establishing domestic operations in Australia.

China is fast becoming a major force in the region and its airlines will be investors in future. The list of impending change is a long one. There can be nothing more certain than that the market place will be drastically different by the end of this decade.

Virgin Australia has shown the way with one of the more creative and forward-looking models in the industry. Qantas has already also taken a major step by sealing an essential partnership with Emirates.

But much more is needed – especially if Australia’s airlines are to become a force in the potentially vast Asian market. Negligently hobbling one airline in the cause of rhetoric is merely handicapping it in the race to survive and prosper.

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