Friday, March 09, 2007

Saturday Forum: The Qantas protection racket gets set in stone.

All that was missing from this week's orgy of self-congratulation and the sea of red and white on the newspapers and TV were the rousing strains of I still call Australia home.

The Treasurer had pulled off a deal that he said would ensure Qantas remained “Australian owned, Australian controlled and in Australia”.

The foreign-financed consortium bidding for Australia’s national airline is delighted – the Foreign Investment Review Board and the Treasurer will allow its bid to proceed. The overwhelming mass of Qantas shareholders are delighted – they can now get $5.60 a share for an investment whose price has typically ranged between $3 and $4.

And the Treasurer Peter Costello has defused a political time bomb – how to appease those members of his backbench concerned about what will happen to jobs under the new owners and also those concerned about the implications of blocking the world’s biggest airline takeover.

What’s not to like about a political fix designed to deliver the airline’s shareholders $11 billion and to ensure that it remains one of Australia’s biggest employers?

When the dust settles, I fear that there will be a lot not to like...

Indeed: for airline customers, for the Australian economy, for the Australian taxation system and for the Australian government itself the outcome looks to be about the worst possible.

In order to understand why it is essential to recognise that Qantas is far more than just another Australian company. The Treasurer himself acknowledged this in announcing his agreement with the biding consortium on Wednesday. He said one of its clauses requires the new owner to continue to provide “practical assistance to Australians in times of emergency”.

Qantas has long been and will remain an agent of the Australian government for some purposes. Australia needs a national airline and would be unlikely to let it collapse. When the privately-run Air New Zealand faced bankruptcy a few years ago the New Zealand government injected money and bought it back.

In addition the Australian government has long been and is set to remain an agent of Qantas. Our government negotiates access to foreign air routes on behalf of Qantas, and from time to time blocks foreign airlines from competing with Qantas on routes to Australia.

Right now there is hardly any price competition on the most lucrative of Qantas’s routes – Sydney to Los Angeles. Our government continues to block Singapore Airlines from competing with Qantas and United ensuring that travelers to and from the US pay an estimated 38 per cent more than they need to.

According to work done for Singapore Airlines by the Canberra consultancy Econtech an extra airline on the route could boost the number of travelers moving between Australia and the US by as much as 8 per cent, and boost spending by visitors to Australia by more than $100 million.

The Australian government has blocked requests for access the Australia-US and Australia-Japan routes not because it was acting in the interests of Australian travelers or the Australian economy, but because it was acting in the commercial interest of Qantas. (And also in the potential interest of Virgin Blue in the case of Los Angeles, should it start flying on the route.)

Until now an unwritten deal has seen our government has protect Qantas from competition in return for Qantas acting as a good corporate citizen – among other things paying around $200 million a year in tax, employing Australians, and being on call in times of need.

But the takeover bid approved by the Treasurer this week could reduce the Qantas tax bill to something close to zero. Most of the $11 billion that the consortium is spending to buy Qantas will be borrowed. The interest payments, potentially $700 million a year are likely to obliterate the airline’s reported profit and its annual tax bill. (As is the case with all negatively geared transactions, the new owner will in theory be liable for capital gains tax when it eventually sells Qantas for an expected profit, but it is likely to structure the deal in such a way as to avoid as much of the tax as it can.)

And notwithstanding the employment and other guarantees in the deed of undertaking it signed this week, its mammoth interest bill will put it under immense pressure to cut costs.

The five partners in the bidding consortium are the US-based Texas Pacific equity group, Canada’s Onex group, Australia’s Macquarie Bank and Australia’s Allco Finance Group and Allco Equity Partners. Texas Pacific has form when it comes to running airlines. It has taken over
Continental, America West, and the Irish airline Ryanair. Its cost-control at Ryanair is said to be so severe that the airline’s pilots are not allowed to charge their mobile phones at work.

After the Qantas bid became public a number of commentators including myself applauded it as a welcome development. I wrote that “a takeover of Qantas led by money-hungry over-indebted American spivs could be the best thing that ever happened to the Australian traveling public”.

My thinking then was that if the new owner behaved in a totally commercial fashion our government would abandon its implicit contract with Qantas and instead start serving the interests of the traveling public.

Bruce Baird, one the Coalition backbenchers deeply concerned about the takeover encouraged me in this view.

Previously a big supporter of shielding Qantas from competition he told me then: “If it becomes just another company, and for instance starts moving jobs offshore, all bets are off”.

But it turns out that Bruce Baird was a key player in this week’s accord.

He has told me that he had a number of discussions with the consortium and the Qantas chief Geoff Dixon and told them: “if you want to settle people down these are the areas you need to give assurances in”.

He says they listened and replied: “Well that’s what we are planning to do anyway”. He suggested a guarantee.

On the face of it the bidders have got what they want – approval for their takeover – and backbenchers such as Bruce Baird have got what they need – a guarantee on jobs and the like.

But the guarantees in the consortium’s deed of undertaking are full of holes. For example it notes that the consortium has “no intention” of breaking up the airline and “no intention” of reducing regional routes.

That’s why backbenchers such as Bruce Baird are keeping something in reserve. He says for the moment talk of open skies is off the agenda: “We will allow the deal to proceed and then see 12 months into it how they are performing, whether they are living up to their assurances or not,” he says. Only if the consortium misbehaves they will it be threatened with real competition.

The implication is that Qantas will remain protected - perhaps indefinitely - in order to ensure that it continues to act pretty much as it has been.

For travelers, and for the Australian economy, it looks like the worst possible outcome.

But it gets worse.

Baird and his fellow backbenchers believe that if the new owner does abandon its stated intention and indicate that it needs to cut back its Australian workforce they can threaten it with competition.

They may not be paying sufficient attention to the likely financial state of Qantas at the time and the government’s need for it to survive.

After the takeover Qantas will be some $11 billion in debt, with only $3.5 billion in equity. On an operating basis it will be financially precarious. Any unexpected development such as a terrorist scare or an oil price hike could push it to the edge of survival. If in those circumstances it announced that it had to cut staff or move jobs offshore it would be plain that it would not be able to survive an injection of competition.

The threat that Baird and colleagues believe that they are holding in reserve would become worthless. If the new owner does abandon some of the guarantees it has given this week, any punishment to make it comply might run the risk of pushing it under.

Qantas is too important to the Australian government to be allowed to fail. If the consortium does get into trouble there will be a political imperative to help it further rather than harm it by opening Australia’s skies.

The consortium’s financial weakness will become its political strength. That’s part of the genius of the consortium’s takeover plan. It is likely to never have to face real competition and the government is likely to do whatever is needed to ensure that Qantas survives. The fortunes of the government and a group of ruthless foreign-backed takeover merchants will become tied together. If you would like not to be ripped off when you travel overseas, you are now likely to have to wait a very long time.