Qantas takeover is still up in the air

A report in the Age over the weekend says that Qantas’ shareholders still hold the key to the bid’s ultimate success, writes Stephen Bartholomeusz.

The Qantas board bowed to pressure from the market and updated its outlook for the airline this week, but its statement hasn’t dispelled the suspicion that Australian Airline Partners and the senior Qantas executives involved in APA’s $11 billion bid know material things that the market and Qantas shareholders don’t.

In a sense, whatever Qantas had said about its prospects would, fairly or otherwise, have been discounted by a cynical market. The management, investors might argue, could hardly be expected to bid against themselves. That kind of cynicism is unavoidable when management is involved in a bid.

What Qantas said on Thursday, however, was nothing more than the market already knew. Its latest upgrading of its forecast for this financial year confirmed the market expectation that its profit was more likely to be 40% above last year’s, if not higher, rather than towards the lower end of the 30-40% range Qantas had already targeted.

The board did say that its expectation for 2008 was “in line with average consensus profit before tax estimates of approximately $1.23 billion”. Given the market’s estimates range from $975 million to $1.5 billion, that isn’t particularly useful guidance.

Moreover, the statement was studied with caveats, although those are to be expected when a board tries to provide guidance for a business as volatile as an airline.

Directors are very aware of the liability they could assume if they put their names to forecasts that subsequently turn out to be badly wrong.

The Directors said they had yet to assess the impact, or include any provision in their estimates, for the impact of Tiger Airways’ planned launch in the domestic market, or Virgin Blue’s deployment of extra capacity, or its own plans to secure more aircraft to meet the increased competition.

They referred to the uncertain outcome of the group’s involvement in “alleged price fixing” in the air cargo market and also said the 2007 and 2008 outlooks were subject to fuel costs not increasing significantly, demand growing and continued success in the group’s “sustainable future” program for reducing costs.

The statement ended with Qantas saying it was making no forecast of any specific results. While perhaps understandable in the circumstances, this places a major query over the value and usefulness of the statement. Telling the market what it already knows, using market consensus as guidance and then filling the statement with substantive qualifications and unquantified threats to the business, could hardly be said to close the information gap between the bidders and shareholders.

Given the Board’s cautiousness, its confirmation of market expectations could, however, be regarded as providing greater certainty about Qantas’ near-term performance, against which the value of the takeover offer can be reassessed. Qantas’ progressive upgrading of its guidance through the bid price — and a rerating of the sector globally as it has become apparent that the combination of lower fuel prices, strong passenger volumes and tight capacity is creating a sweet spot for the industry — have put a rising floor under the price to which the shares would retreat if the bid were to fail.

The practical importance of the statement is whether it convinces those with reservations about the adequacy of the offer that the risks of holding out are greater than the potential rewards.

UBS Global Asset Management and Balanced Equity Management between them hold almost 10% of Qantas and are in a position to stop APA from achieving acceptances for the 90% of Qantas’ capital that would enable it to acquire the remaining shares compulsorily.

It is a condition of APA’s funding that it end up with 100% of Qantas. It needs full access to Qantas’ cash flow to service the high debt levels the airline will have after the leveraged buy-out.

Of the two fund managers, Balanced Equity’s Andrew Sisson is probably the critical player, because UBS’s Paul Fiani is in an invidious position, given that UBS’ investment bank stands to receive a $45 million success fee for its role in advising the Qantas board if the bid succeeds.

Fiani is damned if he does and damned if he doesn’t accept the bid. If he accepts it, even if the decision is made without fear or favour — and Fiani’s reputation suggests that it will be — cynics will say he has been pressured from over the other side of UBS’ Chinese wall.

If he rejects it, he will be very unpopular with his colleagues and the same cynics will say he was pressured into the stance simply to protect his own reputation and that of UBS’ asset management business.

It should be noted that Fiani has already enhanced his reputation, and indeed that of UBS, by simply questioning the value of an offer that stands to generate such huge fee income for the bank.

Sisson doesn’t have any of those complications. Regarded as a very analytical and independently minded manager, either he’ll conclude that the offer is fair (albeit on the basis of information that is incomplete, relative to that available to the bidder) or decide $5.45 a share isn’t sufficient, given Qantas’ strong medium-term prospects and the self-evident fact that Qantas management believes the business is, or can be made, a lot more valuable.

If Sisson accepts, Fiani will be off the hook. UBS’ 5.5% probably wouldn’t be enough by itself to block the bid. No one will criticise him if he follows Sisson or, better still (from his perspective), holds out until his shareholding is compulsorily acquired. If Sisson remains a hold-out, the odds of the offer succeeding will diminish significantly because of the pressure on UBS and Fiani to demonstrate that the funds management business is independent.

Given the board’s cautiousness, its confirmation of market expectations could, however, be regarded as providing greater certainty about Qantas’ near-term performance, against which the value of the takeover offer can be reassessed. Qantas’ progressive upgrading of its guidance through the bid price — and a rerating of the sector globally as it has become apparent that the combination of lower fuel prices, strong passenger volumes and tight capacity is creating a sweet spot for the industry — have put a rising floor under the price to which the shares would retreat if the bid were to fail.

The practical importance of the statement is whether it convinces those with reservations about the adequacy of the offer that the risks of holding out are greater than the potential rewards.

A Report by The Mole, from The Age