Will the fourth restructuring in 10 years fix SAA?

South African Airways seems to be in a constant state of restructuring. The government-owned flag carrier was only a few months removed from what it had called a turnaround when in February 2007 it called in outside consultants to help it restructure to avoid running out of cash. SAA has spent the last 22 months in restructuring, a mode it was also in from 2005-06, from 2001-02 and from 1998-99. As the carrier prepares to finally emerge from its current restructuring effort in March 2009, chief executive Khaya Ngqula says this time SAA is really transformed.

"Our restructuring is the first fundamental restructuring in the history of the airline. We are addressing the way we do business, through simplifying and rightsizing the business, re-looking at our value chains and the way we deliver our services," Ngqula says. "In 2005 the only thing that was done was cost-cutting, which proved inadequate."

The consultants that were brought in to fix SAA this time and served as the carrier's surrogate executives from February 2007 to April 2008, Seabury managing directors Michael Cox and Scott Gibson, also believe this restructuring is different. "Historically in their restructurings they lay off a few people. That's not a restructuring that's a budget change," Gibson says. "We went after permanent and contractual changes. This is very different than the garden variety restructuring."

But after so many failed restructuring attempts, it is not surprising the latest SAA transformation plan has its share of sceptics. Chief among them are SAA's main competitors - low-cost operator 1Time Airlines and Comair, which operates a British Airways franchise in southern Africa as well as low-cost unit Kulula.

"They are calling it restructuring which is just ridiculous," says Comair joint chief executive Gidon Novick. "They try to put on a show and say they've turned around but there's no substance behind it." Adds 1Time chief executive Glenn Orsmond: "It's not the first restructuring - they've had consultants in three times in the last six to seven years. It's a constant cycle: perform a restructuring, write off one-time costs and recapitalise. As long it's owned by the government and the government continues to write them a blank cheque they'll never fix the business."

Orsmond, Novick and several South African airline industry observers say the public has become tired of SAA's constant financial woes, which have become a drain on taxpayers as the government has been forced several times to recapitalise the carrier. But Gibson says this time the government told Seabury from the beginning that it would only fund one-time restructuring costs and not write another blank cheque or recapitalise the carrier, like it had done in previous restructurings. "They were very emphatic with us," adds Cox. "They were not funding more ­operating losses."

But after going the first 20 months of the restructuring without an infusion of capital from the government, SAA recently decided to ask the government for a recapitalisation. "In order to be properly capitalised as an entity functioning in a highly competitive environment it would be prudent for the shareholder to look into recapitalisation," Ngqula says. "Until this is done SAA will channel a substantial portion of its profits and operational improvements to service debt."

Novick says it is unfair for SAA to again be recapitalised because it will further distort a playing field which is already not level. Publicly-traded Comair and 1Time now compete against SAA and its low-cost subsidiary Mango, which Novick and Orsmond claim is being unfairly subsidised by the taxpayer, on all major domestic routes.

"The reality is the bailouts are happening at a greater rate than ever before. They call it recapitalisation but effectively it's recuperating losses," Novick says. "The bottom line is it is sucking billions of rand from the South African taxpayer. I'm frustrated because it's such a drain on our industry and it's bloody hard to compete against." Orsmond adds: "I think [the recapitalisation] has been approved already on the basis that it will be the last one. We've all heard that a few times."

But Airlines Association of Southern Africa president John Morrison says recapitalisation is a natural part of the restructuring process and other carriers should understand that as long as the government owns SAA it is responsible for making sure it has sufficient funds. AASA represents SAA as well as most of the country's private carriers. "I think few people doubt that the restructuring was necessary and that it was an expensive process," Morrison says.

He adds that the private carriers also need to recognise SAA was not fully compensated for the restructuring costs. Ngqula says that "SAA funded most of the restructuring itself" with the exception of 650 million rand ($65 million) for labour-related costs. He says the government also "gave guarantees of 1.5 billion rand for the grounding of the Boeing 747s, which SAA used to raise capital in the open market". He adds that the grounding was one of the most important steps in the restructuring, explaining that the aircraft had become "uncompetitive to run" due to ballooning lease payments and the fact that the size of the fleet was small. Back in July, SAA said the grounding would generate 600 million rand in savings in the current fiscal year, accounting for about 60% of the roughly 1 billion rand in annual savings so far identified in the restructuring, with labour accounting for most of the other 40%.

But in a U-turn, SAA recently reactivated part of its 747-400 fleet, putting one 747 back into its network and wet-leasing another to an Angolan carrier. SAA head of business development Jason Krause explains the carrier has had trouble finding new homes for all its 747s and in the meantime found itself short of aircraft after plans to lease three additional Airbus widebodies fell through. Reactivating two 747s "was the pragmatic network decision we took given fuel at this price", Krause says. He adds that up to four 747s will likely remain on SAA's books for about another 18 months and SAA has the flexibility to reactivate all four should it require the extra capacity.

But SAA's rivals question how the reactivation is being accounted for given the ­grounding was covered in its financials for its last fiscal year. In July SAA announced it had generated a 123 million rand net profit for the year ending 31 March 2008, excluding 1.35 billion rand of restructuring costs and only including "ongoing operations". SAA management heralded the return to profitability, which compared to a net loss of 883 million rand the previous year, as proof the carrier was on the path to transformation. But SAA declines to provide any breakdown on what was included in the restructuring costs and says no more financial information will be made available until after the completion of the current fiscal year.

SAA also declines to say if its fiscal 2007-08 financials may have to be restated as the 747 was not part of "ongoing operations" and if it will also have to revise its earlier estimate that the grounding will save 600 million rand in the current fiscal year. Orsmond says as a taxpayer-funded company SAA should be more transparent in reporting its financials, including the financials of Mango, and have the same accounting standards as publicly traded companies. "I'm sure it's not the same standards. We would be obliged to disclose aircraft rentals and full results of all subsidiaries."

Novick adds: "The results speak for themselves. They had a 1.2 billion loss although they tried to tie most of that to restructuring. They're still losing money." Gibson, however, says these claims are unfounded and points out that SAA's financials are audited by Ernst & Young. Morrison suggests that instead of debating the figures everyone should let SAA conclude the restructuring and then wait for the results to settle in before making any conclusions: "I don't think the results will manifest themselves overnight. To be fair to SAA and the US consultants [Seabury] I think we need to give them time to see what results the restructuring process will yield."

While it will likely be a few years before a reasonable conclusion can be made regarding the success of the restructuring, it is clear SAA is in better position today than it was two years ago. Gibson says when Seabury first arrived at SAA's headquarters in Johannesburg in mid-February 2007 "they were facing a real liquidity crisis. Given the path they were they on they would have been out of business in April". Ngqula confirms that "SAA was going to run out of cash at the end of March 2007 if there was not a fundamental change implemented".

Gibson says the first thing the Seabury team did was set up a cash conservation office (CCO) and start "turning over every rock" to identify possible savings at every department. Seabury manned the CCO for the first few months and approved all spending requests. "We watched the cash situation turn around so it didn't hit a wall in April 2007 and by summer 2007 it even had some sort of cushion," Gibson says. "It was quite draconian for an organisation like this to go through such a corporate culture change."

Ngqula adds: "The CCO was the body that approved all final spend given the daily cash balances and the priority spend from a holistic point of view. This ensured that we ­prioritised spend, had a holistic view of spend and made sure that every cent counted."

He says over the next few months Seabury identified 70 initiatives which were grouped under three main categories: global initiatives revenue enhancement initiatives and departmental cost reduction initiatives. Each initiative was led by Seabury but was assigned an SAA programme manager and monitored centrally. Under the revenue enhancement category, air fares were increased after Seabury concluded SAA was undercharging on many routes. Under the departmental cost reduction category, Ngqula says efforts were made to ensure SAA's staff was "focused on value added costs".

The global category included the 747-400 grounding, labour savings, alliance partner optimisation and network changes. Ngqula says that as part of the labour initiative, management headcount was reduced by 30%, putting SAA more in line with staffing ratios at other carriers. In total nearly 2,000 management jobs were cut, with about half of the managers accepting voluntary severance packages and half resigning. Under the alliance initiative, SAA worked with partner carriers, mainly bilateral partners rather than fellow Star Alliance members, to improve schedule connectivity and passenger flows. New agreements with regional carriers were also forged, resulting in increased revenues and reduced costs.

The network part of the restructuring included cutting several unprofitable long-haul routes. Cox says some of the long-haul routes "were losing money hand over fist" and SAA opted early on to cut back rather than "to grow out of this problem". Krause says the new network strategy is to focus on core long-haul routes which have both strong local traffic and good connecting flows. "You won't see us massively grow our international routes," he explains.

Khaya Ngqula, chief executive, South African Airways: "SAA was going to run out of cash in March 2007 if fundamental change was not implemented"

SAA, however, is keen to grow what it calls its regional intra-Africa network, which historically has been the most profitable part of its network. While SAA has cut its international capacity by 14% over the last two years (see chart), this includes a slight increase on flights to other African countries. "We'll definitely look to add more frequencies and more routes to Africa if we can," Krause says.

In April Seabury"completed our part of the restructuring and handed it back to the company", says Cox. Ngqula adds that SAA has since made several additional steps in line with the second half of the restructuring effort.

These include implementing a customer service programme aimed at improving the carrier's on-time performance, baggage pilferage rate and call centre performance. Ngqula says SAA has also moved forward with outsourcing and selling non-core businesses, re-engineering business processes and reducing distribution costs.

Meanwhile, Krause says the new business plan will include a major new aircraft acquisition that involves replacing all 50 of SAA's aircraft by 2020 and accommodating growth. SAA plans to hand Airbus and Boeing a request for proposals early next year and select around mid-year one manufacturer to supply aircraft for the entire programme.

Source: Airline Business