Lifting foreign investment caps won't unshackle Qantas

The imminent lifting of the sub-caps on foreign investment in Qantas is an apparently significant but, at a practical level, probably meaningless gesture towards levelling the domestic aviation playing field.

Removing the 25 per cent ceiling on individual foreign shareholdings and the 35 per cent limitation on foreign airline shareholdings – while retaining a 49 per cent limit on foreign ownership generally – removes the Qantas-specific restrictions on foreign investors and notionally aligns its position with Virgin Australia’s.

Virgin, of course, has been able to devise a way around its own limitations by putting its international operations into a separate vehicle, technically 51 per cent Australian-owned, even though all of its operations are carried out by the listed holding company which is now more than 79 per cent foreign-owned.

The retention of the 49 per cent foreign ownership cap is necessary to protect the bi-lateral rights (negotiated on a government-to-government basis) both carriers need to fly to international destinations.

Theoretically Qantas might be able to emulate Virgin and restructure itself so that foreign investors and airlines could own more than 49 per cent of the group and receive the economic benefits of majority ownership while technically maintaining Australian majority ownership of its international business. Virgin hasn’t encountered any difficulties with its bi-laterals since its restructure.

The government had wanted to do away with the 49 per cent limit and other Qantas-specific measures in the Qantas Sales Act as well, but was never going to get that through the Senate.

Labor has supported the lesser changes to the Act but opposed removing the provisions that dictate the composition of its board, the location of its headquarters and the Act’s direction that a majority of its maintenance and other operations has to be retained within Australian. Those provisions are unique to Qantas.

The practical question raised by the amendments that now have the backing of both the major parties, however, is who would want to buy into Qantas in its current condition?

Most of its main competitors are already significant shareholders in Virgin. Air New Zealand owns 25.99 per cent, Singapore Airlines 22.2 per cent, Etihad Airways 21.2 per cent and Virgin Group about 10 per cent. Air NZ, Singapore and Etihad have very recently been granted board representation, albeit with a raft of protocols to protect against any conflicts of interest.

Qantas does have an alliance with Emirates on the routes to and from Europe but Emirates has made it clear that it has no plans to support that alliance with a shareholding. The cynics would say that it has got everything it wanted from Qantas already.

The existence of that alliance would be a deterrent to other airlines taking up equity in Qantas and so the only obvious near-term source of interest in the group might be from private equity, which came so close to gaining control of it in the lead-up to the financial crisis.

In its current condition Qantas might make for an interesting break-up play – but the intensity of the politics that still surrounds Qantas probably means that any private equity tilt would be blocked, particularly if it involved carving the group up.

The other deterrent to foreign investors, whether strategic or portfolio, is the reality that Qantas is haemorrhaging and in the midst of a massive restructuring program aimed at reducing its cost base by $2 billion a year by 2017.

It lost $252 million in the first half of this financial year and the market is anticipating it will lose at least twice that much in the second half, taking its losses to at least $750 million. There may also be some large non-cash adjustment to asset values as Qantas tries to get all of its bad news out at once.

Qantas isn’t alone. Virgin lost $84 million in the first half ($188 million pre-tax) and is expected to report full-year losses of between $200 million and $250 million.

There is some relief in sight. Virgin stopped adding capacity to its main brand in the domestic market earlier this year, although it continues to ramp up the capacity in the Tiger Australia brand that it now controls, albeit off a very small base.

Qantas has responded by saying it will freeze its own capacity – there will be no capacity growth – for the first quarter of next financial year.

There will still be excess capacity in the domestic market as a result of the capacity war over the past 18 months or so but at least the two players won’t be adding even more. It will take some time – probably until the 2015-16 financial year – before growth in demand absorbs that excess capacity, assuming Qantas and Virgin behave rationally.

With a domestic market that is a sea of red ink and an international business which is also losing heavily it is difficult to see why there would be foreign interest in its shares.

Changes to the Qantas Sales Act to ease the restrictions on foreign shareholders might have helped lower Qantas’ cost of capital in the days when it used to be one of the world’s most profitable airlines, before the flood of post-crisis capacity from hub carriers undermined its international business and Virgin attacked its core business franchise and ignited the capacity war.

When Qantas was (unsuccessfully) lobbying the Abbott government for help late last year, however, the foreign shareholding restrictions weren’t the main game, or even close to it. It wanted a government-guaranteed line of credit, not to draw down, but to demonstrate the government’s support and to protect its investment grade credit rating, which it subsequently lost.