October 21, 2001

Don't pay twice for Aer Lingus

Posted in Sunday Business Post ·
Share 

Clifden, founded in 1812 by Hyacinth D’Arcy, was a relatively quiet place until 1919 when John Alcock and Arthur Whitten Browne completed the first successful crossing from North America to Europe by crash-landing their aircraft in Roundstone bog outside the town.

Fuelled by fascination about the possibilities of air travel, the world’s press descended on the capital of Connemara. For weeks the place was bedlam with guesthouses fully booked, pubs teeming and the road from Galway jammed with foreign hacks.

Eventually Clifden returned to normality, but the financial markets remained transfixed with airlines and airline stocks. During the bull market of the 1920s, airlines, along with electricity and automobile stocks, played the same role as telecoms and dotcoms in the last leg of the 1990s bull-run.

Financial history reveals that the airline business always had the characteristics of binge/purge cycles. In good times, captains of industry accumulate enormous debts and buy planes as if there was no tomorrow. In bad times, US airlines appeal for anti-trust relief to protect their monopoly at hub airports, while the state owned carriers in Europe stick out their hands for state aid.

Even during good times the business can be very difficult. For example, in the extraordinarily prosperous late 1990s, airlines continued to make very ordinary return on capital. According to Fortune magazine, in the period 1995-2000, despite making total earnings of $23 billion, US airlines only managed to generate an 8 per cent return on capital.

Two factors seem to dog the industry both in Europe and the US: huge loans and poor industrial relations. Modest rises in the interest burden relative to sales can affect the bottom line adversely. And because margins are low, strikes — even short ones — can mean the difference between a profitable or a loss-making year.

That said, these industries have been run well and there is no reason to believe that Aer Lingus will not navigate its way through these tough times and generate handsome profits in the years ahead. The government must have shared this relatively sanguine view as it was prepared to sell the asset to the public this time last year.

If privatisation was an option this time last year, why is it not an option now? One of the most amazing things about the present Aer Lingus debacle is that only two solutions are being entertained: the government bails it out following a restructuring plan or the company goes bankrupt. What about the glaringly obvious third option, the company is sold to private investors, not through an initial public offering (IPO) but through a leveraged buyout (LBO)?

The situation at Aer Lingus is analogous to the Eircom story without the messy little privatisation piece in the middle. With Eircom, the state wanted rid of an asset. It sold it to the people with much fanfare, backslapping and guff about a “shareholding democracy”.

When the management could not get the share price to rise, due in significant part to world market conditions, the punters became disgruntled and a consortium of private investors picked the asset up for a much lower price two years later.

With Aer Lingus, the situation is similar, but instead of offering us shares as a way to part with our money, the state this time will just ask us to cough up via the bailout.

In the next cyclical upswing when the company is showing decent figures, the state will try again to sell us shares in Aer Lingus via a much-heralded privatisation. So we will have paid for Aer Lingus twice — once in today’s restructuring and once again in a privatisation in a few years time.

Then, lo and behold, the share price will fall in the next global recession, punters will get restless and a savvy group of investors will pick it up for a song.

Why not avoid all this malarky and sell it now to a consortium? A quick look at the annual report of 2000 and some back of the envelope calculations make for interesting reading.

Last year, the company made e80 million profit after all charges. This is a lot of money. With this sort of profit, the fact that the management is talking about bankruptcy now only reinforces how badly the company has been run in the past six months. How much of a loss are they projecting? e80 million? e90 million?

Even if last year was a particularly exceptional year, Aer Lingus made e60 million the year before. So let’s say that on average with its present cost structure, Aer Lingus could make e45 million per year.

The annual report also tells us that the wage bill for the company was e280 million last year. If this were to be slashed by 30 per cent as envisaged in the restructuring, the company would save e90 million.

These savings added to average profitability would make this a very attractive operation without starting to talk about the value of the brand, goodwill etc.

Such a takeover would be meat and drink to leveraged buyout merchants like Valentia or e-Island consortia. Last year the pre-privatisation value of Aer Lingus being bandied about was e500 million.

Let us say that this has now fallen to almost zero if we believe the latest spin which forecasts that the company will be bankrupt by the first quarter of 2002. Apparently it needs around e100 million to survive until then so it can put the restructuring plan in place.

This should be perfect terrain for a takeover. In fact, it is amazing that someone has not put a bid in now. A bid of a nominal �1 plus the restructuring costs and an arrangement with creditors to be paid back at say 70p in the pound would do it. �1 may sound ridiculous but the company’s own management has said it is bankrupt.

A new management could be put in place. There will certainly be many unemployed senior managers from the airline industry knocking around next year. Customers would get to fly Aer Lingus at decent prices. The government would be rid of it. Taxpayers would avoid having to fork out any more cash for it. So why not go for it?

The reason appears to be the unions. Because margins are tight in this business, management is afraid to take on the unions.

Even in the US this is the case where pilots are among the best-paid professionals in America. We are back to the Eircom problem: shareholders and customers are losing out to the unions. Arguably, the only reason the Valentia consortium won was due to a sweetheart deal with the trade unions.

So who owns state or former state assets — the government and taxpayers or the unions? In the case of Aer Lingus, the unions do. It is the unions that would prevent a leveraged buyout from saving Aer Lingus and it is the unions that will force us, the taxpayers, to pay for Aer Lingus yet again.

It is the unions who prevent customers from having the freedom of the skies. For a capitalist, island nation with a bankrupt national airline this is a ludicrous position to find itself in.

Alcock and Browne, who believed passionately in the free spirits governing air travel, would never have believed we could have got into this situation.

But then again, the telegraph system that guided them straight into Roundstone bog was made by Marconi and look what happen to that outfit! Ach sin sceal eile.