Thursday, December 14, 2006

Qantas, Macquarie Bank & open skies

Qantas looks likely to pass into the hands of Macquarie Bank and its backers for about $11 billion or about 25 times current earnings. On the face of it the price looks very good and I am curious about the source of value – which I am fairly sure will be there – for the scrounging, superhero debt creators at Macquarie and its backers – and of course, tidbits for senior executives in Qantas who cooperate and who continue to have a role in the 'new' Qantas.

It’s the usual sort of financial engineering deal – if control shifts to Macquarie debt levels of Qantas will more than double – unhelpful longer-term if Qantas seeks to expand or if things turn out to be difficult in the industry. You can’t help thinking that the long-discussed possible partnership with Singapore Airlines or one of the quality, efficient Asian carriers might have made better sense both for Australia and for Qantas’ long-suffering shareholders.

As I discussed the other day a consequence of Qantas’ privileged position in the Australian aviation industry is the opportunity to earn monopoly rents visa restrictive Air Service Agreements on key routes such as the Australia-Japan and Australia-US routes. The difficulty for Macquarie and its US backers in this deal is that there will be little incentive for Australian governments to continue to protect Qantas from competition if Macquarie and the US-owned Texas Pacific and Onex end up owning something like half of Qantas. Its hard to see the national interest in protection even without an ownership change, as I argued earlier, but if ownership does change the protected environment that Qantas has operated in will end.

Moreover, it is difficult to see how Macquarie et al can protect themselves from such deregulatory risks and consequent deregulatory costs. Perhaps they could scream with financial pain if their debt servicing costs became too onerous - 'need to protect the national carrier' etc. But I doubt it.

As with any takeover however implicit contracts within the target firm are certainly likely to change. Unprofitable regional routes are likely to be closed, offshoring of aircraft maintenance is likely and the budget operation JetStar expanded. The intractable problems CEO Geoff Dixon has had in reducing staffing costs on Qantas flights might be more easily dealt with by the new owners. I would refer to all of these gains to Qantas as x-inefficiency cost reductions where I use the term x-inefficiency to describe the managerial losses stemming from managerial or organisational inefficiencies associated with having monopoly power.

My guess is that to Macquarie and its backers the deregulatory costs from placing Qantas in a more competitive environment must be much smaller than the x-inefficiency cost reductions that can be secured with a change of ownership – hence the sense of this deal to the non-financial cowboys. But x-inefficiency losses can be addressed by a revitalized management team - a takeover which leaves Qantas highly geared seems unnecessary. However this deal will almost certainly go through on the basis of a myopic assessment of short-term gains to current shareholders.

It’s a pity that a key national asset can only have its value enhanced through the intervention of the financial engineering cowboys at Macquarie. The management and Qantas Board should have been able to do a better deal for their shareholders.


rabee said...

"It’s the usual sort of financial engineering deal – if control shifts to Macquarie debt levels of Qantas will more than double"

Harry, do you know how this is happening?

hc said...

Rabee, Its a stated attention of the purchasers - they claim Qantas' gearing levels are too low.

FXH said...

Macquarie does it's voodoo by gaming tax laws and part of this is pushing the debt / equity levels. Not talked about much is that a big bit of Macquarie's work (or insurance) is lobbying govt and treasuries, even in the states, for favourable laws for such things as PPPs.

Macquarie's business is not about the business - their business is the rules and regulations.

hc said...

fxh, I think your comments are accurate. The Commonwealth will lose $200 million annually from this piece of nonsense.

derrida derider said...

Still, the deregulatory risk has to be very large. Not to mention the tremendous cyclical risks inherent in this industry which an overgeared company won't withstand easily.

Perhaps they are using a 'Chainsaw Al Dunlap' strategy - slim the company down radically for a large temporary boost in earnings and use that to sell it on before either of these risks have time to work. Or perhaps it's a roundabout way to extract more monopoly rents from the airports they own. But it looks an awfully high-risk play - it could easily end in tears for the debt holders (though of course the millionaire factory will have handed out its bonuses for the deal long before then).

From my POV as a consumer it's all good anyway - I doubt the level of service can get much worse, and it may lead to a more open skies policy by the government.

hc said...

I agree DD that the burden will fall primarily on the shareholders of the banks when this mania for private equity unravels.

I find the service from Qantas poor to ordinary. They have the unobliging tone of the bully monopolist and charge like hell.

The upside could be greater competition and a renewed bout of care on the part of the crazy banks that are funding these high risk ventures.

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