MELBOURNE AUSTRALIA (Daily Reckoning): Slow and steady went the All Ordinaries last week – aside from the 2.4% drop on Monday – as the index gained a small but reassuring 0.6%. But that didn’t stop the reasonable amount of excitement that was reverberating around the market due to the approval of the takeover of Qantas (ASX: QAN).
Although, as we pointed out during the week the deal isn’t completely done. And since then there has even been talk that a couple of the institutions that hold Qantas shares may hold out for an even better deal seeing as it requires a 90% acceptance to succeed.
Can these institutions afford to hold out for a higher price either from Airline Partners Australia or from any other airline or business wishing to take control? Secondly, can the private equity group make the deal work, and why isn’t another major airline interested in buying Qantas?
From a private equity perspective it is their usual modus operandi to pay a premium to an existing share price for a listed company using debt and then finance part of it using any cash which the acquired company has, plus ruthlessly cutting expenditure where possible. Ideally for the private equity firms this shouldn’t take longer than five years. Any longer than that and the interest costs begin to erode the gains they can expect from relisting the company.
The bid by the Macquarie led consortium could either be described as the greatest deal ever struck at a time when airlines are not particularly in favour. Or it may go down in history as the biggest expression of bravado and over-confidence the Australian financial markets have ever seen.
In order for the deal to achieve success it needs several factors to run in its favour. Those include Qantas retaining its dominance as the number one Australian domestic airline, a feat it has managed to achieve whilst still having the higher fares out of it and Virgin Blue.
Allied to this is the favourable terms which Qantas and Virgin Blue have over the domestic travel market, and the exclusion of foreign carriers. One of the fears that the government has had is that if foreign airlines are able to compete on domestic travel they are most likely to stick to the high volume routes such as Melbourne to Sydney, and Sydney to Brisbane.
If Qantas’ profits and margins begin to get squeezed on these routes the story goes, it could have a detrimental impact on their ability to offer services on the less profitable regional routes.
The other major issue for airlines are their fixed costs such as maintenance and fuel and of course, staff. And it isn’t as though Qantas hasn’t slashed and burned these expenses itself over the last few years. It was almost a ritual for Qantas CEO Geoff Dixon to announce a profit at the annual or half-year meeting whilst also revealing plans to cut more costs.
So, where will the additional cost savings come from that are required if the consortium is to successfully relist the entity in a few years time?
Looking at the Bidders Statement it is difficult to tell how they are going to do it. In one paragraph they tell us that it will be the status quo, “Continue the business of Qantas in accordance with Qantas’ existing strategy; not make any major changes to the business of Qantas or to redeploy fixed assets of Qantas, other than in accordance with Qantas’ existing strategy; continue the employment of the present employees of Qantas where this is consistent with Qantas’ existing strategies for efficiency improvements.”
Hmm. Not too many savings there. Where the savings will come from is, “the continued expansion of Jetstar internationally; streamlining distribution and simplifying fares; greater use of online channels, as well as automation and self-service kiosks in airports” and “establishing the right business models for Qantas’ various markets.”
Well, that clears it up then doesn’t it?! Liberal use of “streamlining,” “online,” and “business models.” On top of this though, they are committed to renewing their fleet with the inclusion new Airbus and Boeing aircraft.
When it comes down to it we are sure that the combined bright sparks at Allco Finance Group, Allco Equity Partners, Texas Pacific Group, Onex Partners and Macquarie Bank must know what they are doing.
If not, at least they can fall back on Plan B which would be to spin Qantas off into one of Macquarie’s infrastructure funds. It would probably fit quite nicely with their UK ferry operations!
for The Daily Reckoning Australia