Talking tough on a Qantas takeover

There's nothing new in the speculation of another private equity tilt at Qantas or the rumours that former chief executive Geoff Dixon and other ex-Qantas executives are involved. The talk has been swirling around Qantas all year as its financial performance and its share price have deteriorated.

Qantas itself hasn't been approached but appears to have taken the view that where there's smoke there might be a fire.

Last week's $100 million buyback and announcement of a $650 million debt-reduction program could be justified in the context of the ailing share price and dividend-starved shareholders but could also be interpreted as a sign that Qantas' board and management are very aware of the speculation and of their group's vulnerability during a period of radical, complicated and, in terms of its labour relations, sometimes controversial change.

With its shares trading at levels roughly half the book value of its assets and three potential magnets for private equity – Qantas domestic, its frequent flyer program and Jetstar – Alan Joyce and his board would be derelict in their duty to shareholders, and the airline, not to take the threat seriously.

It was instructive that last week Emirates' Tim Clark strongly endorsed Joyce's strategy for turning around Qantas' international business (which has as a centrepiece an alliance with Emirates) while taking a not-so-thinly-veiled shot at the former Qantas management supposedly at the centre of the plot to storm Qantas for the legacies they'd left.

It has to be said that while there has been a lot of smoke, and while there may have been some exploratory discussions about the prospects of another private equity offer for Qantas, there are no signs of anything much more than that.

It is also worth noting that conditions for private equity, and for a private equity bid today, are nothing like they were in 2006 when the Airline Partners Australia bid was unveiled or in that part of 2007 when it was actually launched.

To mount a takeover offer for Qantas today might not require quite as much funding as it did then but neither the funding markets nor Qantas are in the same shape today as they were pre-crisis.

Qantas first. In 2006 the global economy appeared in a reasonably solid state, the international industry generated more than $US10 billion in profits (an unusual event in the aviation industry) and Qantas itself was in the middle of a year in which it posted a $1 billion pre-tax profit. Etihad Airways was less than three years old and Virgin Blue, as it was then, was a discount airline targeted mainly at leisure routes.

In 2006/07 Qantas looked like a strong player in a weak industry with an extremely valuable loyalty program which wasn't reflected in its share price and a discount brand in Jetstar that would also be more valuable if spun off. It also had some non-core transport and catering assets that could be flogged off.

Global aviation has since been ravaged by the financial crisis and rocketing fuel costs and Qantas' international business, which had occasionally made profits but rarely its cost of capital, has been badly undermined by the continuing emergence of newer hub-based carriers with more modern and efficient fleets, particularly from the Middle East.

Qantas is now going through a major and quite difficult restructure with, after last year's confrontations, a core of unsettled and disaffected employees.

While Qantas would be a lot cheaper today than it was then – the APA bid valued Qantas at $11 billion whereas today its market capitalisation is just under $3 billion – large-scale funding is far harder to raise today, particularly for sputtering businesses, than it was in 2006.

With $7.5 billion of net debt if its off-balance sheet funding is included to re-finance, plus perhaps $4 billion-plus to acquire the equity, a Qantas bid wouldn't be easy to finance.

There's also the issue of the Qantas Sales Act and the necessity for any bidder to have a majority of Australian equity given the need to protect its bilateral arrangements (and to head off the protests about the sale of a national icon).

In 2006 David Coe's Allco group – Allco Finance and more particularly its cashed up cash box Allco Equity Partners – provided the core of the local equity. They would have held a combined 35 per cent of a privatised Qantas, with Macquarie Group providing 15 per cent. The other partners in that Airline Partners Australia consortium were TPG (25 per cent), Onex of Canada (12.5 per cent) and foreign institutions (11.5 per cent).

All up there was $3.5 billion of equity, half of it local. The volatile nature of aviation meant APA had to commit to keeping $2 billion of cash within Qantas plus a $1 billion revolving credit facility it could draw on and it had also struck a deal with providers of that facility that Qantas could pay its interest in "payments in kind" notes – i.e. it could pay the interest on its borrowings by issuing IOUs.

Debt, of course, was freely available in 2006 and was extraordinarily cheap given that the world was working towards the tail end of that particular credit bubble. It is neither as available nor, for leveraged transactions, as cheap today.

The political environment has also changed from an established conservative government to today's hung parliament and charged atmosphere. A Qantas takeover offer put forward by private equity and contemplating a break-up of the national carrier would ignite a political storm. The bidder couldn't expect any support in parliament but would face inevitable opposition, potentially from all corners of the House.

More prosaically, it would be difficult to make a break-up work because there would be no future for Qantas' international business if it weren't supported by the domestic business and the frequent flyer program. Jetstar is important in protecting Qantas' domestic business and, increasingly, creating a regional low-cost presence with regional partners.

The Emirates alliance, the ACCC permitting, is vital to both strengthening Qantas international offer and enabling it to reposition and reschedule its full service presence within Asia.

Trying to finance and manage a value-extracting break-up while Qantas is in the midst of such a delicate and complex reorganisation and while the international business is still bleeding torrents of red ink would have been difficult in 2006/07. The degree of difficulty today would be far more extreme.

With private equity one should never say "never," and no doubt the backs of a lot of envelopes have been scrawled on idly by the former Qantas leadership that got so close to being part of a successful APA takeover, but only a bidder with very thick skin, enormous faith in their ability to manage the actual businesses within Qantas and access to lots of Australian equity could even contemplate reprising that attempt.

Even then the concept would probably be better left on the backs of those envelopes.