Govt approves Air NZ Qantas proposal proceeding to Commerce Commission
FinanceThe government today agreed to Qantas taking a 4.99 per cent stake in Air New Zealand and gave conditional support to a strategic alliance between the two airlines. It has reserved final approval until the completion of inquiries by competition authorities on both sides of the Tasman.
Under the proposal the two airlines enter a Joint Airline Operation to be managed by Air New Zealand including all Air New Zealand’s flights and all Qantas’ flying operations into, out of and within New Zealand. Qantas would end up with a 22.5 per cent shareholding in Air New Zealand. The government would retain a majority 64 per cent shareholding.
In taking this decision, the government has acted to secure Air New Zealand’s long term viability as an international airline. The substantial investment by Qantas of over $500 million will give it a powerful reason to ensure that Air New Zealand is a successful airline.
The 4.99 per cent stake is a first instalment and will cost Qantas $98 million. Air New Zealand will retain that money even if the rest of the deal fails to achieve the necessary consents.
The government is aware that the proposed alliance will reduce competition in New Zealand and across the Tasman and has made it very clear to the airlines that they will need to get authorisation from both the New Zealand Commerce Commission and the Australian Competition and Consumer Commission.
Applications were lodged with these organisations on 9 December. The hearings are expected to run well into next year.
The Ministers leading the government’s response to the Air New Zealand – Qantas proposal are: Finance Minister Michael Cullen as holder of the Crown’s 82 percent shareholding in Air New Zealand, Transport Minister Paul Swain as holder of the Kiwi Share, and Associate Finance Minister Trevor Mallard.
“The government is concerned at the potential impact on consumers of any reduction in competition but has confidence in the ability of the Commerce Commission, and of the regulatory framework in which it works, to deal effectively with these matters.
“In our previous term, we introduced a number of reforms to strengthen New Zealand’s pro-consumer and pro-competition law and are satisfied that we now have one of the toughest regimes in the world,” the Ministers said.
As principal shareholder, the government had to assess whether the Qantas alliance was in the best commercial interests of Air New Zealand going forward. This involved measuring it against other options which might be available to Air New Zealand, and against likely scenarios should the deal fail.
“Our advice from officials, supported by First New Zealand Capital which was employed by the Treasury to advise it on this issue, was that the Air New Zealand/Qantas proposal would not only deliver significant benefits to the company and its shareholders but would also be the best option for Air New Zealand to secure its position as an international airline.
“The alternatives were found to be much less attractive in terms of revenue generation, cost savings and protection of Air New Zealand’s competitive position. This was particularly true given Air New Zealand’s assessment that the most likely scenario, if the alliance was rejected, was that Qantas would enter a war of attrition against Air New Zealand which Air New Zealand would be hard-placed to win,” the Ministers said.
“The reality is that Air New Zealand’s overall profitability is heavily dependent on the profitability of its domestic services. Its long haul services, with one exception, are not profitable.
“There is a risk in the long term that Air New Zealand would shrink to being merely a domestic airline with little long haul capacity.
“There would also be a real risk that the government as the principal shareholder would be called on for further substantial funds, diverting government expenditure away from higher priorities in health and education.
“The second perspective from which the government had to judge the proposal was as Kiwi Shareholder and guardian of the national interest. The considerations we used to guide this judgement were:
·maintenance of effective control of Air New Zealand by New Zealand nationals;
·continuation of Air New Zealand’s ability to exercise New Zealand’s existing and future air rights;
·preservation of the unique New Zealand identity of Air New Zealand;
·provision of effective channels for international tourism and travel;
·provision of a durable domestic air services network; and
·preservation of New Zealand based employment.
“On balance, we considered the proposal cleared these hurdles. The criterion which proved most problematic, and which caused considerable difficulty to the government, was the first one.
“The proposal provides that the Air New Zealand board will retain absolute authority over Air New Zealand and manage the day to day operations of the joint venture. Qantas will have significant influence principally through the Strategic Alliance Advisory Group [which will comprise three representatives from each company]. Qantas will recommend two appointees to the Air New Zealand Board and Air New Zealand will recommend one appointee to the Qantas Board.
“Joint ventures typically provide for such power sharing and consultative structures, and they are to be expected given the size of the investment Qantas is proposing and the fact that it would have to hand over 15 per cent of its air network to Air New Zealand to manage.
“But the government needs to be satisfied that the governance arrangements will preserve Air New Zealand’s autonomy and welfare.
“Air New Zealand considers the best way to achieve this is to protect the company’s ability to quit the alliance at minimal cost.
“The government agrees with that assessment. It has agreed that Dr Cullen, as the shareholding minister, should reinforce the message by setting out his expectations in a letter to the chair of Air New Zealand, John Palmer.
“We are putting that letter on the public record by releasing it today,” the Ministers said.
“The airlines are claiming that the alliance will create public benefits through scheduling efficiencies, new trans-Tasman services, increased tourism and improved freight operations and that these benefits will outweigh the anticipated reduction in competition.
“These claims will be submitted to and tested by the competition authorities on both sides of the Tasman.
“The government expects the competition authorities will carefully assess these claimed benefits and costs. That process will allow for public concerns to be heard and considered.
“Only if the proposal gets Commerce Commission and ACCC approval, will we give it final support,” the Ministers said. “If it is significantly altered during the competition processes or if significant new information emerges, the government will need to reappraise it.”
Contacts: Patricia Herbert [press secretary to Dr Cullen] 04-471-9412 or 021-2709013. Astrid Smeele [press secretary to Mr Mallard] 04-471-9080 or 0274-664438.
Andrew Janes [press secretary to Mr Swain] 04-471-9889 or 021-2709106.
Documents:
Letter of expectation from Dr Cullen to Air New Zealand.
Cabinet minute relating to the Air New Zealand/Qantas proposal.
Commercial: Sensitive
Cabinet Business CommitteeMinute of DecisionCBC Min (02) 11/8Copy Number:
This document contains information for the New Zealand Cabinet. It must be treated in confidence and handled in accordance with any security classification, or other endorsement. The information can only be released, including under the Official Information Act 1982, by persons with the appropriate authority.
Air New Zealand Qantas Strategic Alliance
On 18 December 2002 the Cabinet Business Committee, having been authorised by Cabinet with Power to Act [CAB Min (02) 34/23]:
Background
1noted that on 16 December 2002 Cabinet authorised the Cabinet Business Committee on 18 December 2002 to have Power to Act in considering the submission on the proposed Air New Zealand – Qantas Strategic Alliance (the “Alliance”) [CAB Min (02) 34/23];
2noted that on 25 November 2002 Qantas submitted an application to the Air New Zealand Kiwi Shareholder (Hon Paul Swain) seeking approval for Qantas acquiring 22.5% of the equity securities in Air New Zealand, including unconditional approval for Qantas acquiring up to 4.99% of the equity securities in Air New Zealand;
3noted that on 26 November 2002 Air New Zealand sought approval from the Kiwi Shareholder for changes to the Air New Zealand Constitution arising from the proposed Alliance;
4noted that Air New Zealand has also sought an indication from the Minister of Finance, as principal shareholder, as to whether he supports the Alliance;
Nature of Decision
5noted that an agreement to provide conditional Kiwi Shareholder consents for Qantas acquiring 22.5% of the equity securities in Air New Zealand, and associated changes to the Air New Zealand constitution, would be subject to:
5.1all necessary authorisations for the Alliance being granted by the New Zealand Commerce Commission (Commerce Commission) and Australian Competition and Consumer Commission (ACCC);
5.2there being no material changes to the Alliance proposal, or significant new information revealed, during the competition authorisation and any other regulatory processes;
5.3approval of the Alliance transaction by Air New Zealand shareholders, with respect to any portion of equity securities requiring shareholders’ approval;
6noted that should conditional Kiwi Shareholder consents be granted, and the Commerce Commission and ACCC subsequently grant all required authorisations, then Cabinet will decide whether there have been any material changes to the proposal or significant new information revealed;
7noted that any material change to the Alliance proposal, or significant new information, would only be considered material or significant if it would alter the original national interest judgements made by the Cabinet or substantially shifted the value of the proposal to the Crown as shareholder;
8noted that any agreement to provide unconditional Kiwi Shareholder consent for Qantas acquiring up to 4.99% of the equity securities in Air New Zealand would not be revisited by the government even if there were material changes to the Alliance proposal, or significant new information revealed, during the competition authorisation and other regulatory processes;
Factual and Counterfactual Scenarios
9noted that before Cabinet can make a decision on whether the Alliance should be allowed to proceed through the competition authorisation processes, Ministers need to make a judgement about Air New Zealand’s prospects within the Alliance, and how this compares with its position without the Alliance (the counterfactual);
10noted that Air New Zealand and Qantas have agreed that the competitive environment with and without the Alliance would be characterised as follows:
With the Alliance (“Alliance base case”)Without the Alliance (“stand-alone base case”)
§Alliance provides new Trans-Tasman destinations§Air New Zealand and Alliance total capacity rises between 2003 and 2006§Value-based airline (VBA) has 3 aircraft on the trans-Tasman by 2004, but no entry in New Zealand domestic§Qantas increases New Zealand domestic capacity from five to eight aircraft to improve its market share and profitability§Qantas increases trans-Tasman capacity and on other selected routes between 2003 and 2006§VBA has 3 aircraft trans-Tasman by 2004 but no entry on New Zealand domestic
11noted that Treasury’s ownership advisors, First New Zealand Capital (FNZC), confirm that the base cases in paragraph 10 above provide a reasonable assessment of the competitive environment with and without the Alliance;
Effective Control of Air New Zealand
12noted that the most significant issue raised by the Alliance from an ownership and national interest perspective (and outside of the matters that may be addressed in the competition authorisation processes), is whether effective control of Air New Zealand remains in the hands of New Zealand nationals;
1313.1noted that at an operational level Qantas will have significant influence, but not control, over Air New Zealand through the Strategic Alliance Advisory Group and seconded employees; and
13.2noted that Qantas will have two directors on the Air New Zealand Board and that Air New Zealand will have a director on the Qantas Board;
14noted that the Alliance agreement, and associated documents, include provisions which are likely to discipline the operational behaviour of the two parties, including strong commercial incentives to maximise the profitability of the Joint Airline Operation, provisions designed to facilitate negotiated outcomes, and provisions which would facilitate the efficient termination of the Alliance;
15noted that:
15.1Air New Zealand is likely to face strong financial incentives to increasingly integrate its operations with Qantas, but that such integration carries the risk of attenuating Air New Zealand’s autonomy by increasing its separation costs, potentially to the point where the option to terminate is no longer a credible discipline on Qantas;
15.2the Air New Zealand Board is keenly aware of the need to preserve its autonomy within the Alliance, and that there is an opportunity to reinforce this by sending a letter of expectations (attached) from the Minister of Finance to the Air New Zealand Board if the proposal is approved;
Competition Considerations
16noted that one of the most significant national interest issues raised by the Alliance is the possible adverse effects on competition, and that both the Commerce Commission and ACCC would closely scrutinise the public benefits and detriments associated with the proposal;
17noted that Commerce Commission and ACCC decisions on the authorisation applications would not be expected until July-August 2003, and may not be finally confirmed until much later if appeal rights are exercised;
Ownership Assessment
18noted that the Alliance will bring a range of financial benefits for Air New Zealand, including enhanced revenue, costs savings and efficiencies, a stronger competitive positioning, and an improvement to the company’s balance sheet;
19noted that the likely benefits of the Alliance to the Crown include an improvement to the Crown’s operating balance, and a reduced need to provide Air New Zealand with additional equity;
20noted that alternative options to the Alliance, such as enhanced co-operation with Star alliance members or entering strategic alliances with other airlines, have either little prospect of arising or have little to offer Air New Zealand in comparison with the current proposal;
21noted that given the absence of any interest from other airline partners, the option of deferring the selection of a strategic partner runs the risk that Air New Zealand will be in a weaker negotiating position if, and when, Qantas reactivates negotiations;
22noted that from an ownership perspective the key risks associated with the Alliance include:
22.1the Crown facing greater difficulty exiting its shareholding in the future;
22.2the durability of the Alliance, given industry volatility and the reliance of the proposal on sustained co-operation between Qantas and Air New Zealand;
22.3Qantas’ influence and access to information;
22.4the financial impact of undertakings that may be required from competition authorities;
22.5the likely competitor response;
22.6the possibility of minority buy-out rights being exercised (considered unlikely);
23noted that, on balance, the Alliance proposal would generate significant benefits to the Crown from an ownership perspective;
National Interest Assessment
24noted that on 20 November 2002, Cabinet Policy Committee having been authorised by Cabinet with Power to Act, agreed that the following considerations should be used to assist the Government’s national interest evaluation [POL Min (02) 20/7 refers]:
24.1maintenance of effective control of Air New Zealand by New Zealand nationals;
24.2continuation of Air New Zealand’s ability to exercise New Zealand’s existing and future air rights;
24.3preservation of the unique New Zealand identity of Air New Zealand;
24.4provision of effective channels for international tourism and travel;
24.5provision of a durable domestic air services network;
24.6preservation of New Zealand based employment;
25noted that the Alliance that has been negotiated between Qantas and Air New Zealand represents a framework for future co-operation, and at this time the airlines have not formulated specific plans in areas such as domestic and international scheduling, joint marketing, global alliance membership, and initiatives impacting on employment;
26noted that the maintenance of effective control of Air New Zealand is the most significant national interest issue raised by the Alliance, outside of competition issues, and is discussed in paragraphs 12 to 15 above;
27noted that the Alliance is likely to enhance Air New Zealand’s options to manage its international network profitably, and can deliver a durable domestic network, but reduced competition may adversely affect consumers;
28noted that given the airlines claim that the Alliance will deliver better scheduling, new services, increased tourism, enhanced freight services and other public benefits, the Commerce Commission can be expected to closely examine most of the issues of concern to Ministers with respect to the following national interest considerations:
28.1the provision of effective channels for international tourism and travel;
28.2the provision of a durable domestic air services network;
29noted that there is an opportunity to allow the Commerce Commission’s authorisation process to be the primary mechanism for testing the claims made by the airlines with respect to the considerations in paragraph 28 above;
30noted that the Alliance satisfies the national interest considerations with respect to:
30.1continuation of Air New Zealand’s ability to exercise New Zealand’s existing and future air rights;
30.2preservation of the unique New Zealand identity of Air New Zealand;
30.3preservation of New Zealand based employment;
Decision on Air New Zealand - Qantas Alliance
31agreed that the relevant Ministers should grant:
31.1Qantas unconditional Kiwi Shareholder consent to acquire an interest of up to 4.99% of the equity securities in Air New Zealand;
31.2Qantas Kiwi Shareholder consent to acquire the balance of equity securities they are seeking, up to 22.5% of total Air New Zealand equity securities, subject to the conditions set out in paragraph 5 above;
31.3Air New Zealand conditional Kiwi Shareholder consent to make changes to the Air New Zealand constitution, subject to the conditions set out in paragraph 5 above;
31.4in-principle approval of the Alliance from an ownership perspective, subject to the conditions set out in paragraph 5 above;
Next Steps
32invited the Minister of Finance to advise the Chairs of Air New Zealand and Qantas of the Government’s decisions, prior to any public announcement;
33invited the Minister of Finance, Associate Minister of Finance (Hon Trevor Mallard) and Minister of Transport to jointly announce the Government’s decisions;
34noted that Ministers’ oral and written statements, including media releases, will need to be carefully constructed to manage the legal risks arising from the Crown being an insider with respect to Air New Zealand;
35noted that all Ministers will receive separate legal advice prepared by the Treasury in consultation with the Crown Law Office, on what they can and cannot say in oral and written statements concerning this proposal;
36invited the Minister of Finance to write to the Air New Zealand Board setting out the principal shareholder’s expectation that Air New Zealand will retain the capacity to operate autonomously in the event the Alliance terminates, as set out in the attached annex; and
37invited the Kiwi Shareholder (Hon Paul Swain) to write to the Chief Executive Officers of Qantas and Air New Zealand before 20 December 2002 advising them of the Government’s decision to grant conditional approvals for the Kiwi Shareholder applications made by the airlines, including unconditional approval for Qantas to acquire up to 4.99% of the equity securities in Air New Zealand.
Sarah Egan
SecretaryReference: CBC (02) 170
Present:Rt Hon Helen Clark (Chair) Hon Dr Michael CullenHon Jim AndertonHon Phil GoffHon Annette KingHon Trevor MallardHon Pete HodgsonHon Margaret WilsonHon Parekura HoromiaHon Lianne Dalziel (part of item)Hon Mark BurtonHon Paul SwainHon Marian HobbsOfficials Present:Office of the Prime Minister Department of the Prime Minister and Cabinet
Copies to:
Cabinet Business Committee
All Cabinet Ministers
Chief Executive, DPMC
Mary Anne Thompson, DPMC
Secretary to the Treasury
Solicitor-General
Chief Executive, Ministry of Economic Development (Commerce)
General Manager, Ministry of Tourism
Secretary for Transport
18 December 2002
John Palmer
Chairperson
Air New Zealand Limited
Private Bag 92007
AUCKLAND
Dear John
AIR NEW ZEALAND/QANTAS STRATEGIC ALLIANCE
I am advising you, in my role as principal shareholder, of my in-principle decision to support Air NZ’s proposal for a strategic Alliance with Qantas. As you will be aware, this in-principle decision means that if the proposal in its current form gains all other necessary approvals, I expect to vote for it at a shareholders’ meeting. If there are material changes to the proposal over the course of gaining other approvals or were significant new information to emerge, I would reconsider my decision.
I know the Board is keenly aware of the need to preserve Air New Zealand’s autonomy and to consistently safeguard Air New Zealand’s ability to quit the Alliance at minimal cost. I fully support the Board in this view as I agree it is necessary to protect the best interests of Air New Zealand and of all its shareholders. I therefore expect the Board will ensure that direct and indirect costs to Air New Zealand from any future termination of the Alliance are minimised and that, in the event of termination, Air NZ will be able to operate independently from Qantas within a reasonable period of time.
If the proposal gains all necessary approvals, I will be instructing the Treasury to put in place arrangements with Air New Zealand to monitor the Board’s fulfilment of this expectation. If I am not satisfied that the Board is continuing to meet this expectation I would need to consider exercising my rights as principal shareholder accordingly.
Yours sincerely
Hon Dr Michael Cullen
Minister of Finance