Qantas to be loaded with debt

Kenneth Davidson in The Age says that we now know that Qantas is to be loaded to the gunnels with debt if the takeover by private equity group Airline Partners Australia succeeds.

The debt to equity ratio will exceed 400%, which puts it in the category of the worst examples of crony capitalism in Asia, when the vulnerability of excessively geared corporations was exposed in the Asian financial crisis in 1997 and until Qantas can reduce its debt to reasonable levels, its borrowings will have the status of junk bonds.

Qantas unions, representing 37,000 employees, are considering using enterprise bargaining agreement negotiations to demand that the airline protect workers’ entitlements by securing them against company assets such as aircraft and terminals

This is understandable, given that the former employees of Ansett Airlines still haven’t received their full entitlement following that airline’s collapse in 2001.

Qantas won’t have the financial resources to trade its way out of any rough spots that may occur in the aviation market over the next few years, unless it has very generous bankers.

And these risks are being taken for what?

To give a bunch of financial engineers the chance to rip a fortune out of an Australian icon at the expense of the company and the community.

When the original bid was made, the public was gulled into believing that there were efficiencies that could only be extracted from the business by taking it private.

In contrast to public shareholders, Qantas would be managed by a group that was prepared to take the “tough” decisions, to postpone dividends and improvements in shareholder value in the short to medium term, but put Qantas on an even higher plane of profitability in the longer term.

The argument was tosh, designed to pacify a suspicious public sufficiently to allow the Treasurer, Peter Costello, enough political space to approve the takeover.

But people can smell a rip-off, even if they can’t quite put their finger on the mechanics of the operation.

Now this fig leaf, that tough but unpopular decisions that won’t be favourably received by a myopic market, has been blown away.

It appears that the core strategy, designed to strip Qantas of cash, load it up with debt, and avoid company tax in order to pay off the debt, can be achieved “publicly” after all, providing APA can get control of 70% of the shares.

What does this say about Australia and its regulatory authorities? The bid has been changed. What APA is really about is now out in the open.

The only real mystery is whether the $3.5 billion equity capital in the bid is being drawn from the resources of the APA partners or whether this money is also borrowed, probably from superannuation funds, based on high interest rates with the interest expense postponed until APA cashes the chips five to six years down the track, providing all is smooth sailing in the civil aviation industry.

This new bid opens the way for Costello to block the deal.

It is not often the Treasurer and heir apparent to the leadership of his party has the opportunity to take action that would appear decisive, be politically popular and be economically responsible, all in an election year where both the Government and the leadership of the Liberal Party is in the balance.

The downside for the Coalition is that if this deal goes belly-up, which means Australia could lose Qantas unless a future government is prepared to put up lots of taxpayer cash to replace the working capital that should have remained with the company, Costello (and his cabinet peers) are likely to be branded as lightweights, and the perception that the Coalition is a superior economic manager will be called into question.

And there is not much upside.

The essential ingredient in the takeover is that the $300 million-plus a year tax now paid by Qantas will be redirected to paying the interest on debt.

How many schools or hospitals could this money lost to consolidated revenue finance?

The $400-$500 million fees due for extraction from Qantas under the cloak of the original plan to delist it will be much harder to disguise if Qantas remains a public company.

This won’t be the end of it.

If this deal goes ahead, there are some $40 billion in leveraged buy-outs (LBO) in the pipeline. As the proposed $US45 billion ($A54 billion) takeover of the Canadian telco BCE shows, even Telstra will not be immune if the Qantas deal is allowed to stand.

Tax avoidance is at the heart of LBOs.

Leverage makes its leading practitioners appear to be financial geniuses in a rising market but charlatans or even crooks in a financial crisis, as occurred in 1929 and 1987.

History suggests an iron law: in a deregulated financial market, financial institutions will lend to the point of self-destruction because the only way lending institutions can compete for market share is by lowering lending standards.

As Treasurer, Costello has two fundamental responsibilities: to protect the Commonwealth revenue base, and maintain confidence in the financial system. He may earn short-term applause from those seeking to profit from the mind-boggling size of the deals, but they are only being put together to access the tax base.

Rising debt is the main factor driving the already excessive supply of liquidity. Because of trade union weakness, the flow-on is into asset price inflation, not cost inflation.

Bubbles burst. It appears the risks of this bubble are being carried by the superannuation funds rather than the banks.

It is not only the Qantas workers who should be concerned about their entitlements.

A Report by The Mole from [email protected] and The Age