I am starting a blog series exposing myths in the privatisation debate. It could become a lengthy exercise.
This one is on Air New Zealand.
Since Air New Zealand was effectively nationalised by the Labour government (I’ll leave aside here arguments about that controversial decision) it has often been regarded as a success story. Thus Finlay MacDonald in the Sunday Star-Times of 30 January described it as “a glamour product” and a letter in Friday’s Herald said “Air New Zealand is a classic example of a government/private partnership working well.” The government has also referred to Air New Zealand as a model of partial privatisation.
Under Ralph Norris and subsequently Rob Fyfe, I think it is fair to say that the airline has been innovative and performed well operationally. But the bottom line for any commercial business is just that: its bottom line. How has Air New Zealand performed for investors, the majority of whom are taxpayers?
The answer is, not well.
One source of information is the Treasury’s Crown Ownership Monitoring Unit which published the 2010 Annual Portfolio Report in December last year. It tells us that for 2009 and 2010 Air New Zealand’s return on equity was 1.3% and 5.2% respectively. While this period includes the recession, total shareholder returns in three of the last five years have been negative. Air New Zealand’s total market capitalisation has more than halved since 2007 – from $2,776 million to $1,152 million in 2010.
Air New Zealand itself has reported in the past that it has not met its cost of capital. It appears that again in 2010 it failed to do so by at least 2%. Given the most favourable WACC of 8.4% and the operating return of 6.3%, the shortfall is 2.1% and equivalent to close to $100 million (NOPAT).
A private firm that persistently under-achieves its cost of capital eventually gets restructured (like Fletcher Challenge in the late 1990s) or goes out of business.
What does a failure of a firm to meet its cost of capital mean?
First, it means that resources have been misallocated – scarce capital could have been employed where it yielded higher returns.
Second – which is saying the same thing – the poor profitability of a firm means that it contributes less to national value added or GDP (profits are a component of GDP). In other words, material living standards are lower than otherwise.
Third, a lack of profitability means that competition (with other airlines and transport modes in Air New Zealand’s case) may be distorted, reducing potential national income further.
Fourth, in the case of a taxpayer-owned business, taxes (or borrowing) will have to be higher, other things being equal, to make up the profit shortfall.
Some people may be happy to see governments owning unprofitable airlines, rail businesses or other enterprises out of nostalgia and for other reasons.
But they should recognise that investing in socially unprofitable activities (like Think Big) has been an important part of New Zealand’s economic problems and will hold back economic growth and increases in living standards.