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Qantas, Macquarie Bank & open skies

Qantas looks likely to pass into the hands of Macquarie Bank and its backers for about $11 billion or about 25 times current earnings. On the face of it the price looks very good and I am curious about the source of value – which I am fairly sure will be there – for the scrounging, superhero debt creators at Macquarie and its backers – and of course, tidbits for senior executives in Qantas who cooperate and who continue to have a role in the ‘new’ Qantas.

It’s the usual sort of financial engineering deal – if control shifts to Macquarie debt levels of Qantas will more than double – unhelpful longer-term if Qantas seeks to expand or if things turn out to be difficult in the industry. You can’t help thinking that the long-discussed possible partnership with Singapore Airlines or one of the quality, efficient Asian carriers might have made better sense both for Australia and for Qantas’ long-suffering shareholders.

As I discussed the other day a consequence of Qantas’ privileged position in the Australian aviation industry is the opportunity to earn monopoly rents visa restrictive Air Service Agreements on key routes such as the Australia-Japan and Australia-US routes. The difficulty for Macquarie and its US backers in this deal is that there will be little incentive for Australian governments to continue to protect Qantas from competition if Macquarie and the US-owned Texas Pacific and Onex end up owning something like half of Qantas. Its hard to see the national interest in protection even without an ownership change, as I argued earlier, but if ownership does change the protected environment that Qantas has operated in will end.

Moreover, it is difficult to see how Macquarie et al can protect themselves from such deregulatory risks and consequent deregulatory costs. Perhaps they could scream with financial pain if their debt servicing costs became too onerous – ‘need to protect the national carrier’ etc. But I doubt it.

As with any takeover however implicit contracts within the target firm are certainly likely to change. Unprofitable regional routes are likely to be closed, offshoring of aircraft maintenance is likely and the budget operation JetStar expanded. The intractable problems CEO Geoff Dixon has had in reducing staffing costs on Qantas flights might be more easily dealt with by the new owners. I would refer to all of these gains to Qantas as x-inefficiency cost reductions where I use the term x-inefficiency to describe the managerial losses stemming from managerial or organisational inefficiencies associated with having monopoly power.

My guess is that to Macquarie and its backers the deregulatory costs from placing Qantas in a more competitive environment must be much smaller than the x-inefficiency cost reductions that can be secured with a change of ownership – hence the sense of this deal to the non-financial cowboys. But x-inefficiency losses can be addressed by a revitalized management team – a takeover which leaves Qantas highly geared seems unnecessary. However this deal will almost certainly go through on the basis of a myopic assessment of short-term gains to current shareholders.

It’s a pity that a key national asset can only have its value enhanced through the intervention of the financial engineering cowboys at Macquarie. The management and Qantas Board should have been able to do a better deal for their shareholders.

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