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City Desk
21 August, 2007  
Will the Qantas board please explain

Geoff Dixon, the chief of the flying kangaroo, has announced he’ll hand in his pilot’s goggles in 2009 when his current contract expires. Maybe his board colleagues should consider following him

imageWhen Samuel Heyman’s US hedge fund, HIA, apparently miscalculated the timing of its acceptance and sank the $11.1 billion Qantas bid, it never imagined it would become the hero of Australian shareholders.

The Qantas chairwoman, Margaret Jackson, AC (pic), now to be replaced by former Rio Tinto CEO Leigh Clifford, had berated any shareholder who thought the post-bid share price would rise above the $5.45 offer as a “mental” case.

The rest of the board unanimously endorsed the private equity bid as the very best that could be achieved by shareholders.

And that board offered quite a pedigree: Geoff Dixon, MD, Peter Gregg (also on the Leighton board), Paul Anderson (once CEO of BHP), Mike Codd, AC (former head of the Prime Minister’s Department), General Peter Cosgrove, AC, MC, Patricia Cross (Wesfarmers and NAB boards), Garry Hounsell (Orica board), James Packer (PBL chair), James Strong, AO (chairman of Woolworths and IAG) and Dr John Schubert (chairman of the Commonwealth Bank).

imageDixon (pic) stood to make $100 million on the APA deal, which he had pledged to charity.

It has now been reported, in the context of Margaret Jackson’s insistence the bid was “unsolicited”, that management had been “stress testing” the company’s resilience to a credit crunch “going up to” a debt funded “bid”.

Contrary to all their judgments, the shares traded at around $5.70 and look set to return above the present $5.46 (Aug 21) after the current market correction, given the $1 billion profit result and other proposals.

Qantas is now proposing precisely what the privateers had planned: separate businesses and spin-offs, outsourcing and a $1 billion return of capital. The $3 billion-plus frequent flyer business has just been announced as the first to go.

So much for “mental” cases and so much for the unanimous approval by the board that the Airline Partners bid was the best thing going. If it wasn’t for HIA’s error, that massive extra value would have been lost to the majority Australian shareholders.

How did such an illustrious board unanimously get it utterly wrong?

When someone wants to buy a business, the most elementary questions for a board are: how do they reckon they will get extra value out of it above the price they want to pay and where is the extra value?

When that purchaser is a US-led private equity consortium, the raison d’etre of which is to extract value in as short a time as possible and then cash in the asset, the board is specifically on notice that there is substantial extra value to be had by restructuring the business.

Surely a key part of the board’s advice to shareholders should be to evaluate what could be expected to be done by the privateer and analyse how the company, under its present ownership, might do that for the benefit of existing shareholders.

Not a bit of it.

Fewer than three pages of the 100-plus pages in the first expert report on this examined separating the businesses. It simply rejected separation as “unrealistic”, with no comment at all in the directors’ advice.

Seven months later this is precisely what is underway.

Nowhere in the advice from the board to shareholders or in the expert reports is there any reasoned and detailed financial analysis of how a capital restructuring might unlock shareholder value and enable a return of capital.

After the privateering Airline Partners was forced to scale down from 90 per cent to to 70 per cent it had to reveal its own capital plans, which included removing a cool $4 billion from the company and then splitting up or outsourcing the businesses.

When the $4 billion capital carve-out was revealed, all the Qantas board could come up with by way of guidance to shareholders was that the privateers “have a different appetite for implications and risks of that kind”.

No explanation was attempted about how the company might do this itself without a takeover, when a mere two months later that is precisely what is under consideration at the $1 billion level.

Nowhere in the explanatory documents was it put to shareholders that one of the key reasons offshore privateers are in a more favoured position to extract excess value from Australian companies is that the Taxation Act was changed, after lobbying by foreign private equity interests, to provide for CGT exemption (Div 855) when they cash in their takeover assets.

Nor have we heard any concern from Australian institutions about this tax policy, which effectively subsidises foreigners to buy local competitive companies. Similarly, there’s been no outcry that most of the debt would have been owed to overseas institutional investors, free of withholding tax, leaving Qantas with tax deductions for the interest paid while there would be no interest income in Australia – leaving the tax man wearing a deduction with no offsetting tax.

It’s the whole board, not just Jackson, that owes shareholders and ASIC a “please explain” in relation to this sorry episode. Perhaps Leigh Clifford should be just the first new face.

From Bruce Donald