SAA debt relief & recapitalization: public submissions

Meeting report

The Chairperson welcomed everyone to the stakeholder engagement on the South African Airways (SAA) debt relief and recapitalisation.

Lenomo Strategic Advisory Services Input

Mr Thabang Motsohi, Strategic Consultant: Lenomo Strategic Advisory Services, unpacked SAA’s operating context and made suggestions on what could be done to take the airline forward. He emphasised that clarity of purpose was the first task to undertake in rebuilding SAA. If the purpose is to run an airline on strict commercial principles that are consistent with market practices, then the implications become very clear and include the following: the governance framework and management practice must be consistent with market practice and comply with the Companies Act 71 of 2008 as well as the King Report on Governance for SA 2009 (King III); operating costs must be minimized and the business must be self-sustaining; and organizational culture of professionalism must be aligned to support the commercial purpose. However, if the purpose is to run an airline on commercial principles consistent with market practices but that must also take into account the developmental interests of the State (public interest), then the response becomes more complex and risky as public interest factor introduces a political dimension. Members had to interrogate how the political dimension affects management decision-making in an otherwise viciously competitive business operation. Also, the role of the State must be clearly articulated in the memorandum of incorporation (MOI) and shareholder compact but the independence of the board must be sacrosanct. He cautioned that under such circumstances, a mind-set and culture of P-position’ P-power and P-privilege (Triple P) would prevail. This was a dominant culture in State-Owned Entities (SOEs).

He outlined the airline’s challenges from an historical context. As the flag carrier, SAA was protected from competition for over 40 years following the promulgation of the International Air Services Act in 1949. The Air Services Licensing Act, Act No. 115 of 1990 (Air Services Licensing 1990), finally and officially deregulated the domestic market in 1991 and restrictions on market entry and exit, capacity, frequencies, and tariffs were removed. Only four airlines were active in the domestic market at that time: South African Airways (SAA) from 1934 (main routes and main airports); Comair from 1945 (secondary routes); Link Airways (later known as SA Airlink) from 1978 (secondary routes); Bop Air (later known as Sun Air) from 1979. At the time, SAA had more than 90% market of all scheduled domestic market. However, deregulation significantly lowered barriers to entry in the domestic market and increased competition led to loss of market share at the expense of SAA. The operating context for SAA changed dramatically between 1991 and 2000 and its fate was sealed during this period. The fundamental question is whether SAA did what was necessary and critical (restructure and reposition itself) for it to stay resonant to the dynamic and competitive context unleashed by the Air Services Licensing Act 1990.

Furthermore, SAA concluded a three-tiered alliance with two new entrants, SA Express and SA Airlink in late 1993 to bolster its ability to compete effectively and provide an expanded service offering. This enabled SAA to establish a hub and spoke operations pattern. However, poor management in the early 1990’s caused internal decline flagged by; heavy operating losses, deteriorating working capital, rapid increase in debt and declining market share. This was driven by: lack of strategic vision and focus; lack of depth and experience in the airline industry; poor financial control; poor strategic choices; lack of accountability; and bureaucratic culture. Mr Coleman Andrews was then brought in to stem the deterioration and turn SAA around into a sustainable profitable growth path in 1998. Key focus of his strategy included: focused cost reduction programmes; improved revenue management; sharply improved customer service; fleet upgrade and standardization; embedding a culture of business ethic; crafting and embedding a sound strategic vision. However, the very same problems of the 1990s are still evident up to today.

On the trajectory of SAA’s challenges, organisational deterioration between 2002 and now had been allowed to reach the same levels that triggered the Coleman Andrews intervention. These being lack of strategic vision and focus; lack of depth and experience in the airline industry; poor financial control and lack of consciousness for cost control; poor strategic choices; lack of accountability; bureaucratic culture. The following few examples were indicative: load factors on routes like Accra on the massive 300-seater Airbus A340 or 330s are below 50%; on the CPT JNB schedule, the A340 with 317 passengers uses more than twice the fuel per passenger than a B737 with 170 passengers. Profitability implications are clear, with foreign competitor airlines operating on lower cost per seat than SAA because of scale. Hence, Members had to interrogate SAA if it has been fit for purpose at every critical stage in the transition scanned.

A comparison with Ethiopian Airlines was essential for a deeper appreciation of the decision-making challenges confronting government. Ethiopian Airlines has a geographical advantage that lends itself to an ideal ‘’Hub and Spoke’’ route operating structure. The Ethiopian government has consistently maintained commitment to its operational independence while demanding strict adherence to the lowest possible overhead costs. There is NO subsidy from the state. Therefore, only professionally competent executive management with deep airline experience has been at the helm of the airline. Ethiopian Airlines have stuck to their business strategy that was crafted in 2004: Vision 2010, which ‘’repositioned the airline” driven by the objective of transforming turnover from $400-million in 2005 to $1-billion within five years. This was to be underpinned by the ‘’revamped network’’ as indicated above. By 2010, the airline’s turnover was $1.3-billion, exceeding initial projections, as did passenger and cargo numbers. Vision 2025: where the airline plans to have 120 aircraft flying to 90 destinations internationally and 20 within Ethiopia, turning over $10-billion. Notably, the highly capital- and skilled labour-intensive nature of the business makes taking a long view imperative. The strategy is divided into five pillars: maintain affordability and sustainability- without which Ethiopian Airlines could not be able to attract funding from the capital markets for their substantial a/c acquisition strategy; and strict maintenance of global standards at the lowest possible costs. Therefore, Ethiopian Airlines’ competitive advantage is cost; competitive infrastructure; the integration of the airline’s people, process and technology, including ICT, into a fully automated system “from cargo to payroll, finance to the manifests”; and upgrading of technology.

Mr Motsohi highlighted the state of SAA today. He observed that the Coleman Andrews intervention was a success, albeit a limited one, because the deep cuts in labour costs that were necessary to make SAA competitive were resisted by organised labour. The gains that were made have regressed substantially in the past fifteen years and the State is yet again confronted with the urgent need to intervene to settle debt obligations and inject capital in favour of SAA. Stakeholders deferred responsibility and obligations to ask difficult questions in 2002 and in subsequent years on the question of purpose for SAA. They have failed to ensure that the Boards since 2002 consisted of individuals with extensive and deep business experience and air transport competence and that it was given the oversight latitude without political interference. More critically, there has been a failure to ensure that management with both business and air transport experience is appointed to run the airline on strictly commercial basis. SAA was now faced with the same challenges that made it necessary to bring in Coleman Andrews. SAA was technically insolvent then as it is now. However what was being witnessed now is catastrophic in proportion. The level of accumulated losses and the capital injection required raises very serious questions about the level of the opportunity cost that, given the economic situation and the increasing social challenges and obligations that confront the country, has become morally impossible to defend and justify.

There were no simple answers and solutions to SAA problems. Whatever option is ultimately chosen, the State must undertake an urgent rational evaluation of the ‘’Public Interest’’ factor and finally make a decision on purpose and ownership. The Minister of Finance had stated the need for integrating the SAA operating assets. This unfortunately goes counter to conventional wisdom that separates low cost ‘’point to point’’ operations from ‘’long haul’’ operations. Success drivers in the former business model focus on low costs; in the latter on revenue optimization on the long routes. The correct statement would be to say ‘’optimize operating assets’’. Operating structures are therefore different and it is immensely difficult for an airline to be both. The real and fundamental question as discussed earlier was: what must be done to make SAA ‘’Fit for Purpose?”

He suggested the following options for SAA: put SAA into business rescue and restructure aggressively. This provides a legally unchallengeable environment to do what is necessary. Under this option, all legacy agreements (including employment) would be up for revision within the limited affordability; to pursue an aggressive drive for efficiency optimization at all levels while concurrently developing detailed answers to the question on what must exactly be done to make SAA ‘’Fit for Purpose’’. He recommended as follows: define clear purpose and marketplace for the low cost and long haul operations; define appropriate business models and organizational strategies and structures; develop aircraft fleet plan and human resources strategy; develop a funding framework and plan; draw a comprehensive and detailed execution plan and clear intended outcomes. All of the above must be completed within ten (10) weeks then decide on the level and type of capital injection required. It is critical that this process is executed under very tight independent supervision and oversight for success in order to protect the public interest.

Discussion

Mr A Shaik-Emam (NFP) commented that the presentation was comprehensive and helpful. He asked about the situation at SAA pre-1990 in terms of profitability. Clearly, there was a management problem. Did Mr Motsohi believe another Coleman Andrews type of intervention could turn things around? Can SAA be made profitable based on the interventions outlined? What was stopping SAA from developing a low cost service for the domestic market to increase its competitiveness?

Mr N Paulsen (EFF) noted that listing airlines on the stock exchange curbed mismanagement and corruption in other countries. Could that not be done with SAA so as to turn it around?

Ms S Shope-Sithole (ANC) said the presentation would assist the Committee to ask SAA the necessary and important questions during its appearance before the Committee. She urged Mr Motsohi to be in attendance during the meeting. The challenge has always been that stakeholders seem to be working in silos when dealing with SAA.

Ms D Senokoanyane (ANC) appreciated the presentation. It was an eye-opener. What was Mr Motsohi’s take about leasing or ownership of fleet by SAA?

Mr A Mcloughlin (DA) noted that government was trying to find an equity partner for SAA. He asked Mr Motsohi’s opinion on that and about the suggestion of having a pan-African airline which can be formed with fellow African states to everybody’s advantage.

The Chairperson commended the presentation as being elaborate and insightful. She indicated that some stakeholders believe SAA should focus on domestic growth of tourism by increasing domestic penetration rather than put much emphasis on foreign routes. What was Mr Motsohi’s opinion on this? Also, what should the current board at SAA do differently and focus on in the next six months?

Mr Motsohi replied that questions raised by Members were very relevant. Stakeholders should prioritise on specific focus areas to expeditiously turn SAA around. Also, the newly appointed SAA CEO had to be protected from undue meddling for him to execute his duties effectively. His protection should also be done through the implementation of the aforesaid recommendations. As it stood, lenders were not forthcoming to avail funds to SAA as there was no clear strategy to deal with challenges. What needed to be done had to be clearly defined. The diagnosis of the real challenges was what was crucial before talk about roping in an equity partner. Therefore, oversight had to be effectively strengthened to ensure the turnaround strategies are fully implemented. He expressed frustration about the lack of cost consciousness on the part of SAA executives- the aspect of cost focus seems absent. The domestic market was SAA’s endowment market that had to be exploited effectively. Also, the question of a pan-African airline was a challenge due to the prohibitive costs involved in running an airline. Overall, stakeholders should do the right things and everyone should assist SAA move forward.

Centre for Competition, Regulation and Economic Development input

Ms Anthea Paelo, Researcher: Centre for Competition, Regulation and Economic Development, University of Johannesburg, presented a study that was done on behalf of Treasury, looking into barriers to entry in the airline sector. Based on the study, there has been substantial entry and exit within the airline sector since deregulation in 1991. Of the approximately 15 private airlines that entered SA’s domestic market, only two are still in operation. Structural barriers such as high cost of entry, high operational costs and legal barriers do not seem to prevent entry. Barriers were high but not prohibitive as there has been a sizeable number of airlines entering the market. However, strategic barriers seem to prevent sustained participation. Notably, the airline industry is fraught with cases of abuses of dominance and tends to protect incumbent state carriers, allowing them to take part in anti-competitive conduct.

On SAA’s conduct within the airline sector, SAA is the dominant (56%) market share (SAA and Mango). The flag carrier has a history of anticompetitive conduct having been charged two times for abuse of dominance, and three times for price fixing. SAA has the highest number of Competition Act infringements by a single firm in SA.

The airline has been seen to engage in exclusionary conduct such as leveraging relationships with other airlines to effect its dominance in domestic routes in which it does not normally operate. The study also found that it has been the entry of new airlines that has led to real benefits for consumers, not SAA. Routes that experienced entry benefited from a drop in prices –by as much as 39% on some routes in 2014/15. The entry of new airlines also coincided with increases in passenger traffic; and more flights to less popular, smaller destinations from which tourism has benefitted

In conclusion, facilitating entry of new players into the airline sector was of importance as it would ensure lower prices, increased passenger traffic and increase in number of tourists. Subsidies to SAA have meant: exit of airlines and increased prices; reduced passenger traffic and stifled tourism industry. Therefore, policy considerations should be focused on encouraging entry and infringements of the Act should result in harsh penalties including at management level; serious re-evaluation of link to Mango, SA Express and Airlink required.

Discussion

Mr Shaik-Emam asked what the State was supposed to do to ensure the viability of the flag-carrier. He noted that anti-competitive conduct was rampant in most sectors of the economy and could not be unique to the airline sector. Pointing it out and, in the same vein, blaming SAA seemed unfair.

Mr Mcloughlin said what was crucial would be to have SAA breaking even so that it is able to cover its costs and does not come back to the State for bailouts.  

COSATU input

Mr Matthew Parks, Parliamentary Coordinator, COSATU, appreciated Members’ interest in the crisis in SAA. Alarm bells should have rang long in advance as there were about 10 000 jobs in SAA which needed to be protected. The need to save jobs at SAA in an economy with 36% unemployment was crucial. With jobs being lost on a daily basis, SAA had to be saved. COSATU was not agreeable to SAA bail outs before dealing with rampant looting and leakages. More so, attempts to raid workers' hard earned pensions at the PIC would be resisted. This was workers’ money and the unions were very wary to see government taking their money without any engagements with them. This was at the back of allegations of looting in SOEs without any meaningful efforts to bring the transgressors to book. COSATU acknowledged the departure of the SAA board chairperson but believed more had to be done to bring the entity back on its feet. SAA has an important role to play in the economy and had to be saved.

COSATU rejected any attempt to privatise or collapse SAA and called for a comprehensive forensic audit of SAA, Technical, Express and Mango to dig deeper into the looting across the board. Complaints of theft and nepotism were being reported by COSATU members and had to be investigated. Also, the airline must deal with wasteful expenditure which appeared to be money laundering schemes in some cases, and the turnaround plan had to be effectively implemented before any financial injections. There was need to prosecute those who have looted at SAA over many years, and to implement policy and cost measures to stabilise and ensure SAA's long term sustainability.

The Department of Public Enterprises has dismally failed in its mandate and something had to be done. SAA Express and Mango had to be consolidated so that they do not go the retrenchment route and the foreign debt owed to SAA by other countries such as Angola and Nigeria had to be repaid. COSATU emphasised the need for SAA to report more often to Parliament until it gets back on its feet.

Discussion

Mr Paulsen agreed with COSATU and emphasised that individuals involved in the looting of SAA had to be prosecuted to ensure SAA gets back on its feet.

Mr Shaik-Emam agreed PIC money should not be availed to SAA in its current state- workers’ money should not be used to bailout a failing entity. However, if SAA puts its house in order, then that could be an option. He noted the very high salaries being paid to executives- something had to be done about it.  COSATU’s recommendations were reasonable and should be supported. The Department of Public Enterprises was failing in its role of ensuring SAA is fully accountable. The Department does not seem to be in full control of the SOEs. COSATU recommendations were reasonable.

Ms Senokoanyane noted that wasteful expenditure at SAA indicated that there were individuals who were not serious about doing their work.

Ms Phosa asked COSATU’s take about the suggestion that SAA be put under business rescue.

Mr Parks said there was consensus among the COSATU membership that it should not be too soft with government and SOEs. It should hold government accountable in a constructive way. Consistent to this, PIC investment in SAA must be conditional as noted by Mr Shaik-Emam. Also, the huge discrepancies in salaries between the executive and lower level employees had to be dealt with. Management had to cut back on expenses as it was bleeding and at the verge of collapse. SAA was a viable business and it was only facing challenges due to mismanagement and maladministration. Government had to be proactive in dealing with workers’ concerns. COSATU was also worried about how government was handling the economy at the back of the looming downgrades.

The Chairperson appreciated the constructive engagements and thanked everyone for their inputs. The engagements would assist Members in carrying out their oversight role.

The meeting was adjourned.