THE DISTILLERY: QBE clean-up

Jotters say John Neal is prudent to tidy up QBE's strategy, noting a refocus away from expansion is essential in the medium term.

QBE Insurance and Virgin Australia are under the microscope of Australia’s business commentators this morning. The former because the acquisition-happy legacy of the legendary Frank O’Halloran needs to be examined for the new era of successor John Neal. The latter because chief John Borghetti is still holding the low-cost airline’s position together despite a taxing capacity war with senior rival Qantas Airways.

But first, Fairfax’s Malcolm Maiden explains how the situation at QBE is very similar to that of BHP Billiton, where a new chief executive comes in promising to get the most out of the company’s existing footprint, rather than look for expansion through acquisitions.

"John Neal took over from Frank O’Halloran at QBE last August, and he is headed down the same track. QBE has a global presence but it’s not fully integrated after years of bolt-on expansion by O’Halloran. There are for example eight different payroll systems operating in various places around the world. Neal will rationalise them as part of effort to get less complicated administrative machinery behind the group and the products it sells. He aims to lock in annual cost savings of $250 million by 2015, and his plan will involve the relocation of work from Australia, the US and Europe to lower-cost offshore centres.”

The Australian’s John Durie similarly heralds the end of the O’Halloran era, with Neal having to find a way to make his predecessor’s purchases work for Australia’s leading insurer.

"The O’Halloran years were built on acquisitions – some good, some woeful – and Neal put his stamp on the future by ruling out any major acquisitions this year while he gets the house in order. Two impairment charges in the accounts released yesterday said it all. Some $37 million came off the $203 million acquisition of the Hang Seng Bank’s insurance operations because of uncertainties over future cashflows. Given the deal closed late last year, that’s a damning indictment for the master acquirer. There was also a $16 million impairment for the Optima acquisition thrown in for good measure.

The Australian Financial Review’s Chanticleer columnist Tony Boyd notes that both Neal and his chairman, Belinda Hutchison, were careful to keep their comments to the O’Halloran polite (rightly so, the enormously respected executive simply ended on a sour note), while adding that the company’s faces a long turnaround strategy.

"There’s value in QBE but it might not emerge for years. It is still a powerful global general insurer and reinsurer but, to survive, it is making fundamental changes to its strategy, its governance, and its operational management. The growth by acquisition strategy that propelled the company into the ranks of the world’s top 20 insurers is on ice. The fact that O’Halloran’s last days were marked by poor acquisitions is evident from goodwill write-offs of about $75 million for recent transactions in Asia and Latin America. Neal says the growth by acquisition option will return some day, but not until he has been able to stabilise the balance sheet and restore growth in profitability.”

The other big corporate story out of yesterday’s news cycle was Virgin’s latest set of numbers, completing the duo of Australian aviation figures this reporting season following Qantas Airways results last week.

Like the Qantas results, much of the commentary focuses on the notion that ‘no one wins’ in a capacity war, a point picked up on by Business Spectator’s Stephen Bartholomeusz.

"Last week’s Qantas result showed that the underlying earnings of its domestic mainline business fell 34 per cent in the December half from a prior-year base that was severely affected by industrial disputes. Its Jetstar brand’s earnings were down 13 per cent. Today Virgin, which ignited the capacity war in the domestic market by moving upmarket to attack Qantas’ stranglehold on business travel, announced a 36 per cent fall in underlying profit before tax, from $96.1 million to $61 million and a decline in statutory earnings from $51.8 million to $23 million. Its domestic earnings before interest and tax fell 43 per cent, from $87 million to $49.3 million.”

Fairfax’s Adele Ferguson explains again to her readers that Qantas’s strategy is about the ‘s-curve’ theory, where market share plunges once capacity falls below a certain level. Increase it and you protect your crucial 65 per cent market share floor.

"But Virgin isn’t about to withdraw. It has committed to adding another 5 to 7 per cent capacity in the next six months. It is part of Virgin’s game plan to reposition the airline to become more resilient to market shocks by broadening its revenue base. For Virgin boss John Borghetti it isn’t about building market share for market share’s sake but adding capacity on routes that had previously been neglected.”

The Australian’s Damon Kitney reminds his readers that Borghetti isn’t so much the overlooked Qantas CEO candidate running a much smaller, less powerful competitor, but an expert Australian aviation operator that knows his competitor inside out and has the backing of some formidable international aviation investors.

"Borghetti knows that with the backing of powerful international shareholders Singapore Airlines, Etihad Airways and, to a lesser extent, Air New Zealand, he now has far deeper pockets to fight a war with Alan Joyce at Qantas than he would have had 18 months ago. In fact, if Joyce had fired the guns he has set off over the past year more than six months earlier, it’s a fair bet he would have inflicted some potentially terminal damage on Borghetti by now. Instead, Virgin’s balance sheet is still in good shape…”

But if this capacity war has been fought, then who has won, asks The Australian Financial Review’s Andrew Cleary.

"Qantas claims victory for protecting its market share. Virgin says the resurgent airline took a less severe hit in terms of declining yield – or average air fares – than its rival.”

The answer is simple. The customers have won.

In other corporate news, The Australian Financial Review’s Matthew Stevens suggests that Whitehaven Coal boss Tony Haggarty will be happy to transition into a non-executive director role after a tumultuous last half-year to his reign.

"Over just six months, Whitehaven has been diverted by a proxy challenge in the wake of a failed takeover assault by its major shareholder, a flip and back-flip by the temperamental federal environment minister, a share price denting hoax by the forces of anti-coal and income draining hiccups in the ramp-up of what was supposed to be its next stepping stone to prosperity, the Narrabri underground mine.”

In economics, Fairfax’s Malcolm Maiden argues that if the result from the Italian election is inconclusive, it’s likely that it will take the same path as Greece and hold another poll.

Speaking of the Italian elections, The Distillery would just like to take a moment to welcome News Limited economics editor Jessica Irvine to the pages of Business Spectator. The Distiller has been a big fan of her work at Fairfax and raises several whiskey glasses to her presence. Readers, watch her stuff.

Fairfax’s highly-respected columnist Ross Gittins, with whom Irvine worked, probably would admit that he shows his age a bit this morning with a piece discussing the Australian Mobile Telecommunications Association’s study on how mobile phones are fundamentally changing the way we go business.

"Old fogies like me think email and mobiles are a very mixed blessing in terms of the efficient use of our time, but the report argues valiantly that they increase the productivity of businesses.”

The Australian’s Peter Alford explains how Indonesia’s new nominee for its central bank, Finance Minister Agus Martowadojo, was a surprise choice. It was expected that President Susilo Bambang Yuhoyono (the best political name this columnist has come across… Elmer Funke Kupper takes out the corporate gong) would have nominated current Bank of Indonesia Governor Darmin Nasution for a second term.

And finally, The Australian Financial Review’s economics editor Alan Mitchell entertains the idea that the proposed free trade agreement between the United States and the European Union might be the one to break the rule that free trade agreements end up amounting to empty promises.

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