SAA Board and Executive on its future strategies and recapitalisation

Meeting report

Mr Johannes Bhekumuzi "JB" Magwaza, SAA Board Chairperson, said they had come to the Committee with a little bit of trepidation, not because they are new, but the information they have at their disposal as requested by the Committee is extremely sensitive in the market place. It is with this trepidation that they are aware of what the Committee requirements are and they find themselves trapped in a situation where they have to share information which would put their business at a disadvantage when it is in the hands of competitors. He asked the Committee to be sensitive to their limitations and problem. Inasmuch as they may have the information the Committee wants, some of it becomes extremely difficult to share in a normal commercial space because the competition is waiting for this information. It is not that they do not have the information, but the granularity or depth of that information is problematic. That kind of information would make them vulnerable in the marketplace. They are not averse to sharing the details that could satisfy the Committee. They are aware in Parliament there is no secrecy. Everything is transparent and that is where their problem starts. When they took over, they were aware about the SAA noise. When they started to scratch the surface, they realised how deep the rot was within SAA in terms of corruption and that it would take a long time to eradicate it. However, he assured the Committee the Board has the skills and savvy in business and the commitment to turn the organisation around. It is a tall order.

Mr Vuyani Jarana, CEO: SAA, said the new Board has diversity in terms of skills including aviation skills. The Board committees have been duly constituted with appropriate skills. From the governance side, everything that needs to be there is in place. In his briefing, he said SAA is a full service carrier while Mango is a low cost carrier. SAA has other capabilities in the form of maintenance repair and overhaul, catering services, cargo service, and loyalty programme. SAA has full service capability in the airline industry.

SAA has got material relevance to the economy. With its R30 billion budget, it looks after 64 aircraft, distributes 110 905 tons of cargo, delivers 10 million passengers, and consists of 10 669 employees. It has 8 domestic, 19 regional, and 8 international destinations. They want to make sure SAA is self-sustainable financially. However, they cannot ignore the other value added contribution that SAA has on the economy, that is, R10.8 billion which is 0.3% of the GDP. Total taxes are standing at R7.9 billion, creating 53 138 indirect and direct jobs, and 15% of ZA global connectivity. These benefits should be delivered when SAA is self-sustainable.

He pointed out that lack of stability undermines strategy execution. SAA has many strategies in place but there has been a lack of implementation. The organisation has not had stability for a long time. SAA is not short of strategies but the leadership should focus on one direction. Many consultancies have been approached but the only thing that has been lacking is the implementation of those strategies. The lack of stability is impacting on the business results.

He reported that SAA started making operating losses in 2012. The new Board needed to look at the nature of the problem as costs started to rise more than the revenue generated. Profit started to haemorrhage around 2014/15. When you look back into the history, you discover that it started with impairment of assets during 2014/15, including some other challenges in the market. Since 2012, the organisation has not been making profit. The funding coming through has only been sustaining the operations of SAA. This is an area they need to turn around.

There needs to be a sound capital structure to make the industry succeed. Looking at the debt to equity, SAA is negative. SAA does not have flexibility and ability to trade and support the business. On risk associated with business space capital structure, it is high because SAA borrows more and in terms of sufficient liquidity, SAA is in the negative.

Mr Jarana noted that even after the R10 billion injection, SAA would remain under-capitalised with a negative equity position of over R9 billion. The capitalisation of the business is critical for it to succeed in the market, especially in a capital intensive industry like airlines. The R10 billion injection is good but it does not take them to the desired positive equity position, but it is just there to make progress. Of the R10 billion capital injection, R7 billion would be used to repay lenders while R3 billion has been used to address short term working capital challanges. He listed the reasons for SAA's extreme reliance on debt:
• Weak capital structure: SAA is over geared and finance costs are causing additional strain on profitability.
• Over-reliance on leasing of aircraft: Only 9 of the 64 aircraft are owned by SAA. Its lack of profitability weakens its negotiating power with suppliers.
• Increased competition: domestic and international competition is driving margins down.
• Poor commercial capability: SAA services for all domestic routes and most international routes are not profitable. As a result, the company is not able to generate cash and hence the over-reliance on debt to finance operations.
• Ageing fleet and poor fleet profile.
• High cost structure: SAA has a very high operating cost structure.

On market dynamics, he indicated the aviation outlook is weakening. Overcapacity in the Middle East would lead to decrease in average fares. Cargo revenues are declining faster than passenger revenue. Turkey is building the biggest airport in the world. There is a certain economic agenda taking place in those Middle East countries where they are creating regional economic hubs. SAA needs to respond to these trends with a good commercial strategy.

The domestic market is shifting towards low cost carriers. Mango, Kulula, and Safair have registered growth. The trend in the market is moving towards low cost airlines. This trend is very important for SAA to see the shape that Mango has to take. This means coming up with good market segmentation strategies. It is a commercial challenge, but not an ideological position. This makes the whole thing doable. Flexibility and working with speed is very important.

Internationally, Emirates is leading, followed by Qatar and Turkish Airlines. It is an important trend because the Middle East hubs are growing exponentially. SAA needs a strong value proposition that is going to show them how they must play at the international level. They need to be clear on the battles they need to compete in.

Mr Jarana identified these pillars for the long-term turn-around strategy:
• Liquidity management - unlocking cash for SAA and renegotiating contracts, fixing SCM policies
• Balance sheet restructuring
• Revenue enhancement
• Cost optimisation
• Strategic direction.

The critical enablers are: revised aviation policy that is not overly liberal; good governance; best people; digital technologies; customer experience.

Programme for the implementation of the turn-around strategy:
• New Board of Directors has aviation skills
• A new CEO has been appointed
• A Chief Restructuring Officer has been appointed
• Filling of vacancies at executive level, including that of Chief Procurement Officer
• Engaging banks to extend loan maturity dates by 12 months
• CEO to engage staff and unions on the current state of SAA and the case for the turn-around.

[Tables and graphs were shown to illustrate total liabilities vs total assets; loans and long-term debt maturity profile; SAA balance sheet profile; and outstanding loans and associated finance costs]

Discussion
Mr A Shaik-Emam (NFP) asked if SAA thinks the injected R10 billion would be able to solve its problems. He asked how SAA is planning to turn around seeing that the domestic routes are not profitable. He said most government officials prefer the competitors because the problem lies in the ticket system and service offered by SAA. He asked why the Miami office that is costing SAA a lot of money is not moved to Cape Town.

Mr Jarana replied that the current equity position is not the kind of a position a CEO wants to land in. It is not enough. They would love to have a better equitable share which translates into a better bank balance sheet. On non-profitability of domestic flights, commercial delivery at SAA is lacking in market segmentation, people, and service. The airline industry has very thin margins. There is a need to focus on decision management to ensure they do the right thing. SAA would review the viability of its office and call centre in Miami. It does not make sense to him to have an office in the US while the services are offered in Africa. Call centres are moving into Africa. SAA is busy engaging on this matter.

Mr N Paulsen (EFF) asked what the CEO is going to do about corruption that happened prior to his arrival over the past five years. He asked what is going to be done with the problem of the aging fleet.

On rot that has taken place, Mr Jarana replied that investigations are taking place to ensure they run a viable business. The airline would root out corrupt employees and take action against those implicated. It would be important to focus on recent transgressions. To look back 10 years ago would sink SAA further if too much focus is spent on that. On the aging fleet, this would need a positive bank balance to be addressed. It would be addressed once SAA makes profit. It is a complex matter. Relying on the turn-around is a Catch 22 situation because competitors are moving forward with modern fleets.

Mr Bhekumuzi Magwaza, SAA Chairperson, added that SAA is going to have zero tolerance towards corruption. Investigative reports are being prepared. Information came from whistleblowers and staff members. Those implicated would be dealt with decisively. It must be clear to everyone that corruption is not the culture of SAA.

Mr A Lees (DA) asked for clarity on the ring-fenced R1.8 billion paid to SAA for Citibank and is now R1.1 billion in the SAA bank account. He asked what the negotiations are with lenders on the agreed rollovers which would ultimately reach April 2019. He asked when the 2016/17 Annual Report is going to be tabled before Parliament. He asked for clarity on the tax burden of R7.9 billion.

Mr Jarana replied that the money for Citibank was received in September 2017 and it has been ring-fenced. Citibank has been paid interest. The rollovers with lenders would continue until 2019. They are engaging with the banks to discuss the rollover of the loans and to extend the expiry dates until 2019. This would give them the going-concern status that would enable them to renegotiate longer term contracts. There have been changes in the cash-flow scenario which takes into account unforeseen or unexpected circumstances. They are engaging with the Minister on this matter. On the Annual Report, they are on track with the Auditor-General and the audit report would be done by December 2017. The AGM would be around January 2018. The tax burden refers to the passenger tax. It is not related to VAT.

Mr B Topham (DA) asked what could be done to make the domestic routes profitable and asked if SAA would consider the idea of regional hubs in order to get regional frequency. The idea of leasing planes is not a bad one, but asked if SAA is not overcharged seeing that it is a state entity.

Mr Jarana replied it is possible to find better ways of making the domestic flight routes profitable. For example, smaller planes could be sent during the day to fly tourists around certain regional routes and larger planes in the early morning and late afternoon to cater for business travellers. On the leasing of planes, all the contracts are being evaluated to see if SAA has the best deals. The focus now is on profitability, and market dynamics are important.

Ms D Senokoanyane (ANC) wanted to establish with what the 2012 year losses could be associated as SAA experienced huge losses. She asked for clarity on SAA owning nine out of 64 airplanes and why SAA is buying airplanes that are expensive and difficult to maintain. She asked if this has always been the case.

On ownership and leasing of planes, Mr Jarana replied that one needs a stronger balance sheet. There is a need to have a sub-market. SAA is busy working on an optimum fleet strategy so that people could make decisions comfortably and competently.

Ms Phumeza Nhantsi, SAA CFO, explained that the 2012 losses relate to the ten aircraft they bought from Airbus. SAA delayed in bringing the cargo to the country, and by the time the cargo came to the country its value had gone down.

Mr Peter Davies, SAA Chief Restructuring Officer, t explained that turn-arounds have got hard and soft issues. The situation at SAA is not that different from other airlines. The SAA balance sheet is not good to make an investment in acquisition of aircraft. Internal and external resources would be used to ensure SAA works. In order to turn the airline around, we need to be honest in the manner we do things, employ people we trust, and create the right environment in going forward to ensure what happened does not happen again. Fellow competitors respect SAA.

Mr Richard Seleke, Director-General: Department of Public Enterprises, reported it is good that the SAA story has come forward. His department is going to ensure that the right board and executive management members are appointed. He is happy matters have been lifted and understood. Everything is on the right track even though the right answers are not there yet, but the challenges are being addressed.

Mr A McLaughlin (DA) asked SAA to give the Committee assurance that all contracts have been negotiated and signed. He asked why SAA could not be liquidated. He then remarked that SAA is not insolvent technically. There are other things that are contributing. That is the information he got from a pilot. Competing airlines are operated by accountants while SAA is operated by pilots.

Mr Jarana reported that all the contracts have been negotiated and signed, and engagements with the CEOs of major banks have been progressing well. He pointed out that if other airlines are successful in SA, there is no reason why SAA cannot be profitable. The key thing that is needed is to inject skill and capacity in SAA. The Chief Restructuring Officer has been involved in many turn-around strategies. The brand equity of SAA is strong.

Ms S Shope-Sithole (ANC) remarked there is a tendency of mudslinging in SA. They are all responsible for the situation SAA finds itself in today. When they discussed the Public Finance Management Bill in 1998, there was this matter of timely reporting. Their task as the Committee is to follow the money. When she reads the AG reports, there are always three core items that are pointed out: lack of leadership, compliance, and consequence management. The CEO and his team must always ensure financial statements are ready. The Committee would do everything to support SAA in its efforts to turn things around. No Member of Parliament should go to the media and blame SAA.

Mr Paulsen asked if it is possible to refurbish the engines of aircraft seeing that SAA has an ageing fleet. He asked if trade unions have been engaged with regarding the new SAA strategy.

Mr Jarana replied that the management has engaged with the trade unions. Issues have been raised on pilots and over-staffing. The only thing that is needed now is to engage with employees on the issues that have been raised. The management needs to be given time to go through these issues and it would report back to the Committee.

Mr Davies replied that it possible to refurbish aircraft engines, but the costs are extremely high. It costs $4 million to refurbish an aircraft engine.

Mr Shaik-Emam asked how the equity partner is going to make the business profitable. Government is pumping money into SAA. If you are in government, it is said you do not need to make money, not unless you are in the private sector. He remarked he does not see SAA having an aggressive marketing strategy.

Mr Jarana explained that finding an equity partner would be crucial for returning the airline to profitability. Management is looking at available options. It is looking at soft assets which include landing space and traffic rights. Management is going to focus on this because it is under pressure to fly for financial stability. Decisions have to be made without being reckless.

Mr Magwaza replied that the new CEO and his team are busy developing a marketing and public relations strategy. The Board and CEO are still new and they are engaging with staff members.

Mr Lees asked what the situation is with payments to suppliers. He commented that SAA Technical has a good reputation and is servicing competitor airlines but not SA Express. He asked why the presidential jet is not serviced by SAA Technical, but by ExecuJet. He asked for the investigative reports to be made available to the Committee. The narrative goes on about corruption, but nothing happens about that.

Ms Nhantsi stated that suppliers are still paid within 30 days as per agreements. They have not engaged yet with the relevant people at SAA Technical and they have not received any request about servicing the presidential jet.

Mr Magwaza explained that there are serious issues regarding the rights of people mentioned in those on investigative reports, especially when they have not been given space to tell their side of the story. So it makes it difficult to publish them. If you give them the name of a person to speak with, they would make sure a confidentiality agreement is signed so that they could deal with that if there is leaked information.

Ms M Manana (ANC) asked for clarity on allegations that SAA is involved in unfair competitive practices.

Ms Nhantsi replied that SAA is trading recklessly. In terms of the Companies Act, when you take services from suppliers, and you know you cannot pay, then that means you are trading recklessly. SAA has never done that.

Mr N Gcwabaza (ANC) said if SAA wants to be profitable, it has to respond to the needs of its customers. This is why when government officials are going overseas, they avoid SAA. SAA is a national carrier and Parliament is supposed to support it. The new Board must not dig in the past. Its duty is to rescue SAA to move it forward. However, if it comes across transgression or misconduct while it is doing its work, the offenders should be punished. He asked what the biggest costs drivers are at SAA and if they are justifiable.

Mr Jarana assured the Committee that SAA is going to deliver a change. SAA needs support from the labour unions, Parliament, and everyone. The new SAA chapter needs to be supported to bring change within SAA and to make SAA work because the writing of the new chapter is doable.

Mr Davies pointed out that as managers their job is to keep production costs low and the revenue has to be above costs. People should not be coerced to fly the national airline or carrier. The demand for the product should be high and to ensure the revenue of SAA is justifiable.

Ms Nhantsi replied that the major cost drivers at SAA are fuel, labour, maintenance service and leasing.

The Chairperson asked for clarity on the aviation policy that SAA raised. She reminded the Committee that the Board and the CEO are still new and would not be able to answer all questions satisfactorily, especially those related to trade unions. Some issues could be discussed with the Board at the next meeting. Questions directed to the Minister and Deputy Minister should be forwarded in writing to their offices but using the right Committee channels.

Mr Davies explained there are bilaterals between countries on aviation policies. The whole thing is covered at government level and the International Civil Aviation Organization (ICAO). Once the decisions are made, the host country would determine which airlines to frequent. The parameters are determined by the governments involved.

Mr Anthony Julies, National Treasury Deputy Director-General: Assets and Liability Management, made a few remarks. On communication, the Finance Minister would not want to be the SAA spokesperson. The CEO is now going to be the face of SAA. The new Board has clear mandates and responsibilities. It is not going to interfere on the role of management. Concerning confidence boost measures, he reported there are timelines in place for the appointment of executive managers and public-private sector stakeholder engagements.

The Chairperson appreciated the words of the SAA CEO and Board Chairman about their commitment to run a transparent and profitable organisation. Their presentation was frank and they have put structures in place to ensure SAA is completely revamped so that it could be trusted and supported.

The Committee is in full support of the SAA Board’s commitment that there would be zero tolerance on corruption and that they would be decisive in dealing with it. She said it was an anomaly not to submit annual financial statements on time, and she urged the CEO and the Board to send accountability documents to Parliament in time.

The Chairperson stated the Committee welcomes the fact that there is now a multi-skilled and multi-talented executive team in place. She found comfort in the assurances from the Board and CEO that the challenges experienced in SAA are surmountable and that this situation is not uniquely SAA. She indicated the Committee is allowing the Board and the executive team to exert their efforts in the implementation of the turn-around strategy and submit quarterly updates to Parliament. The Committee expects to see SAA again in six months time when it will give Parliament a comprehensive briefing.

The meeting was adjourned.