Best case and worst cases for SAA


Travel & Meetings Buyer spoke to an anonymous aviation expert to get a take on what the future may hold for SAA.

Scenario One: Status quo persists

Overview: This is the worst-case scenario where things just literally spiral downwards, costing the South African public a lot of time, money and frustration. It’s bad for everyone, except maybe politicians. This is the pessimists’ most likely outcome.

The airline industry is a very tricky business and many great men and women have failed in trying to run airlines. I do not envy anyone tasked with running a major carrier but less so someone tasked with running a flag carrier. Flag carriers are always in a difficult position, given that they are stretched between the dual mandates of making enough money to break even, while investing money into often loss-making routes to encourage trade. This latter point is something that’s increasingly being considered a bit of an old-fashioned idea in the globalised world we live in.

It’s very hard to actually make money from operating an airline. These businesses are incredibly capital intensive and the margins are very slim. Iata tells us that the industry as a whole only made profits for the first time in 2016 and 2017, but with fuel prices going the way they are, this is unlikely to continue in 2018. This profit scenario has also never been true for the aviation industry in Africa.

So, the task of off-setting a loss-making trade investment route against profitable routes is actually nearly impossible. Depending on how severely the loss-making route loses, an airline would need significant profitable flights just to break even. According to research done in 2017 by the Wall Street Journal, airlines in the US were making 9% profit on their flights. That means that at those same levels of efficiency, to break even, SAA would have to fly 10 profitable kilometres for every one loss-making kilometre.

That’s before anyone dips their fingers into the cookie jar.

But the problem is that the issues run really deep at SAA and undoing those problems will take a long time and result in a lot of politically unpopular moves. One statistic that airlines use to look at costs is how many staff an airline employees per aircraft. SAA is one of the worst offenders here, employing 957 per aircraft, compared with Qantas at 129 or British Airways’ 154. This means that SAA would need to shed four-fifths of its staff and still get the same amount done just to compete. That’s not going to fly. Nor is reducing the pilot salaries that it pays, which are some of the most competitive in the world.

So, what we would see here is:

SAA remains as is:

  • It keeps making losses, and the state keeps bailing them out until a breaking point is reached far in the future. Remember, there is a lot of focus in the press about how much money SAA loses but its numbers are still small when compared with Eskom, so the sub-text there is that the purse strings can stretch further still before they snap.
  • SAA continues to employ far too many staff because retrenching people may make the ruling party unpopular.
  • Beyond staffing, its cost base remains untenable due to inefficiencies in SAA Technical and ‘irregular spending’ dominates.
  • It continues with unsustainable override and commission deals with the trade.
  • Its fleet remains varied and expensive, placing strain on its needs from flailing SAA Technical and increasing its training and stock bills.
  • SA Express and Mango remain separate entities flying different aircraft to the mother-brand, further complicating the situation.
  • Politics continue to get in the way, derailing the efforts of great people who try to turn the entity around until they burn out and get kicked to the kerb.

All-in-all, the story here is pretty simple: the obstacles that need to be overcome to get the airline into a profitable state are just too great and it’ll continue to operate at a loss. The government will never close it down, partly because there’s this notion that we need a national carrier to ensure our own sovereignty and freedom of movement and partly because closing an SOE and effectively destroying jobs is very bad for politics.

Scenario Two: SAA gets a meaningful investor

Overview: This is a good scenario – here SAA becomes a good business, but the government loses control. Some would argue that this is a bad thing because of how airlines are supposed to contribute to economic growth by establishing links for trade. Others, like me, would argue that this wouldn’t be the case, as this is 2018, and it has not hampered any of the countries that have privatised their flag carriers in recent times. Also, less government purse-fiddling, and resistance to doing hard things like retrenching people (which makes political parties unpopular in election years), are probably good things. This is this pessimists’ least likely outcome.

There’s been a lot of talk as to whether SAA would look for an investor to come in and pump some money into the airline. The problem is that it’s only looking to offer a minority share. This is partly about the fact that an airline registered in South Africa cannot have foreign ownership in excess of 25% to get a licence to operate here, but also because the government would like to retain control of the enterprise (to make sure it keeps flying those routes that it believes the country needs).

Now I don’t move in those kinds of circles, but I highly doubt that there are a number of people eagerly waiting to invest billions of dollars into a business that is bleeding cash, is clearly running highly inefficiently, and has a bad reputation for corruption. So, finding a minority investor may be a tricky thing to do.

What could happen, though, is that Vuyani Jarana (SAA ceo) and his team could prop up the airline just enough for it to look salvageable to an investor who could then come in and make a difference.

There would need to be some creative structuring to avoid the 25% foreign ownership rule if the investor were from outside SA. In this scenario, the airline could get back into a reasonable position, but it would be a painful process to beat it into the image of currently profitable comparable carriers.

It wouldn’t be the first time a state-owned flag carrier privatised: British Airways privatised in 1987; Qantas in 1992; Austrian Airlines in 2008; Air Canada in 1989; Lufthansa in 1997; El Al in 2004; and Japan Airlines in 1987. There are very few examples of where airlines went the other way, going from private to public – the only one I could find was Air New Zealand, where the New Zealand government purchased a share, but not the whole thing.

This would only happen if SAA got itself to a position where investing in the business would not be considerably more expensive than starting from scratch. Starting from scratch is not necessarily an option because a licence would need to be secured, and the state could look to protect SAA, so effectively the investor would be buying that licence, but not if it comes with a lot of big bills to pay.

The big risk here is that government likes the look of a limping SAA versus the completely incapacitated business it is today, decides to keep it without getting an investor and then it starts to deteriorate further.

In summary:

  • SAA gets itself into a position where it’s just attractive enough for an investor to get on board and the government follows through.
  • This will probably mean the effective merging of Mango and SA Express into the mother company (whether through an official merger or just an organic shift).
  • An investor comes in and either takes a majority share (if it’s a South African investor) or takes a minority share with some sort of franchise agreement, whereby ownership remains South African but control and profits are channelled to the investor.
  • The airline rationalises sensibly, but follows a profit agenda, just as we’ve seen with other flag carriers that have privatised.

Scenario Three: SAA finds a balance between flying and selling

Overview: This is a fair scenario – here SAA remains an SOE but it finds a way to operate as profitably as possible (this being its primary mandate), while still pursuing government’s mandates as best as possible. This is the pessimists’ moderately likely outcome.

Success for SAA will mean meeting the dual mandates of securing trade routes with establishing a sustainable operation. Getting this right is going to have to mean some compromise, and SAA will need to do a lot of things, including right-size the fleet and staff complement, redefine commercial agreements and find some meaningful economies of scale.

The airline will need to look at focusing on the dual mandates with different solutions. To find a profitable position, SAA will need to focus on getting sustainable deals on aircraft and fuel. It’ll need to quietly reduce its staff complement and make sure that it sweats their people harder, which will mean giving them better training and tools, and will probably mean retrenching a good number too. Quite how SAA will side-step the bad politics there is unclear.

The fleet will need to be rationalised, focusing on the right number and type of aircraft to operate the desired network. It’ll need to look at reducing its aircraft types to keep spares and training costs down. This will probably mean merging SA Express and Mango into the main entity too, in order to get these efficiencies across the full network.

It’ll also have to address its schedule to ensure it is making maximum use of its aircraft assets: flying the right aircraft on the right routes and using them as efficiently as possible.

Addressing these things, SAA will get the operating part right, which should help it to get the profitability part right.

When it comes to addressing the public trade-route mandate, SAA is going to have to get creative. This will likely see SAA becoming more of a sales agent than an operator – building on its codeshare and interline agreements to ensure that flights are available, and affordable to South Africans without necessarily operating them as SAA. Chances are it would be cheaper to subsidise tickets to London on BA flights sold through SAA than it would be to operate loss-making flights to London themselves.

In summary:

  • SAA remains in government ownership, but actually actively works to become a profitable business all on its own.
  • We’ll probably see Mango and SA Express fold into SAA mother brand – either by official merger or just an organic sort of attrition of the two smaller companies while the mother grows.
  • The trade-route mandate becomes a secondary focus and SAA pushes it via codeshares and interline arrangements with other airlines rather than by trying to fly itself.
  • We’ll find SAA to be a much smaller airline in terms of the fleets and route network that it operates.

 



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