How will Hockey handle Qantas' baggage?

The Qantas-Virgin debate highlights Joe Hockey's policy dilemma. Lifting restrictions on Qantas' foreign ownership or providing subsidies will do little to disarm the threat of a destabilising capacity war.

Would relaxing the restrictions on foreign ownership within the Qantas Sales Act address Alan Joyce’s concerns about the $350 million recapitalisation of Virgin Australia by its three foreign strategic shareholders? Probably not.

Surprisingly, Joyce’s lobbying efforts over the past couple of weeks have borne some fruit. Joe Hockey has accepted that Qantas is now competing on a playing field that isn’t level and may not be commercially sustainable.

As Hockey sees it, the government’s options are either to change the Act, which restricts foreign ownership of Qantas to 49 per cent and limits any foreign carrier to a 25 per cent shareholding, or provide some form of taxpayer support.

While Qantas has tried to get the limitations on foreign ownership relaxed to lower the cost of its capital and make it easier to merge with other carriers, the joint venture it has with Emirates means changes to the Act would have little impact.

Emirates doesn’t need (nor does it appear to want) a shareholding in Qantas given the strength of the operational alliance already in place. That alliance would probably deter any other foreign carrier from seeking a strategic shareholding.

Qantas wouldn’t say no to government subsidies or a monopoly on government business. But these options fail to address Joyce’s core concerns.

The real issue for Qantas – and it is a fear rather than a current reality – is that the dominance of Virgin by Air New Zealand, Etihad Airways and Singapore Airlines could see Virgin acting strategically rather than commercially. Air New Zealand owns 22.9 per cent of Virgin, with approval to lift that to 25.9 per cent, and Singapore and Etihad each have 19.9 per cent shareholdings.

Virgin’s John Borghetti has vehemently and angrily rejected any suggestion that Virgin would allow itself to be used in that fashion. However, there is a common interest shared by Virgin and its strategic shareholders in weakening and destabilising Qantas.

From Qantas’ perspective, it gained what it fears could be a glimpse into the future last financial year when Virgin ignited a capacity war. About 8 per cent was added to domestic market capacity, which saw both airlines lose money in the second half. Virgin lost $100 million for the year and Qantas, while reporting a full-year profit, lost $31 million on an underlying pre-tax basis in the second half.

With more capacity still being added to a soft domestic market and its international competitors continuing to add seats on its international routes (Etihad today announced an increase in the capacity on its Melbourne to Abu Dhabi route), there are analysts forecasting that Qantas will lose as much as $500 million this year.

The conspiracy theory that underpins the aggression of Qantas’ response to Virgin’s capital raising is that its key competitors will encourage Virgin to use the capital to add domestic capacity. This would undermine the core of Qantas’ profitability while also putting pressure on its loss-making international business.

Borghetti refuted any suggestion that Virgin could be used as a vehicle for his major shareholders’ larger ambitions. He said the airline was being run rationally and commercially with the aim of creating a sustainably profitable business in the long term. While Virgin plans to give the strategic shareholders board representation, it has said there will be governance protocols to ensure the group acts in the best interests of all shareholders.

Qantas’ fears that Virgin’s shareholders could encourage it (and fund it) to compete without regard to profitability in order to undermine Qantas’ domestic dominance are understandable.

The other dimension to the presence of the foreign airlines on the Virgin register relates to last year’s very clever restructuring of the group. The restructure quarantined Virgin’s international business within a technically separate entity while remaining legally majority-Australian owned.

This gave Virgin access to bilateral rights and the ability to compete directly with Qantas as an Australian carrier on routes that the three strategic shareholders might not have access to themselves, even though the airline is more than 70-per-cent owned by foreign shareholders.

In terms of the level of foreign ownership of Virgin, the genie is out of the bottle. It is quite improbable that the government would contemplate action to stuff it back in. However, given the significant increase in the level of foreign shareholdings since the Virgin restructuring, the government might review that structure and its implications for bilateral agreements.

Given that all the shareholders have gained foreign investment approval for their holdings (and Air New Zealand for an increase in its stake), the only obvious option for Hockey would be to make it clear that no further increases will be approved. He might also have a view on board representation.

There is a very real policy dilemma at the heart of the debate about Qantas and Virgin.

The domestic market needs Virgin to be a strong competitor to Qantas to protect the interests of consumers and the wider economy. Virgin also needed to be recapitalised.

Qantas is, however, the national carrier. It is competing on its own as a fully privatised entity with purely commercial motivations against an ever-increasing range of mainly state-owned or supported airlines. It is carrying legacy baggage that its competitors generally don’t have.

Now the core group of those competitors have a dominant position on the register of its only significant domestic competitor, and have demonstrated their willingness to fund its attack on Qantas’ domestic dominance.

There may not be any ulterior or common motive in their support for Virgin. But even a remote suggestion that there could be will concern Hockey and his colleagues, as well as Qantas.

Allowing Qantas to replicate the Virgin structure and have the capacity to attract more foreign investment wouldn’t appear to do much to address the core of Qantas’ fears. That, or direct or indirect financial support from the government, would appear to be the only actions available.

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