Strikes, terrorist threats, oil prices and erupting volcanoes: what an industry to be in. How do airline treasuries manage the cash (or lack of cash) and the financial risks. Treasury Today introduces a new series on managing treasury and the issues impacting treasurers in different industries.
Although the full impact caused by the eruption of Iceland’s Eyjafjallajokull volcano on the world’s airlines is not yet known, Giovanni Bisignani, IATA’s Director General and CEO, estimated a weekly bill at around $2 billion based on information supplied by its members. “Airlines lost revenues of $1.7 billion in just six days, with the greatest impact on European carriers, at a time when their financial resources are stretched,” the airline industry body reported.
These are certainly calamitous figures for an industry that has been affected by terrorist threats, oil prices, currency volatility, the economic crisis, high government taxes on travellers and, in general, reduced numbers. Nor was the damage limited just to the airlines. The worst hit infrastructure operator, Britain’s BAA, estimated the cost at $28m.
An airline that is not a member of IATA (but is required by law to issue statements of fact because of its US listing) is Dublin-based Ryanair. In a statement filed with the SEC, Ryanair said it expects “its net profit for the year end 31st March 2011 to be impacted by approximately €6m per day over the seven days of these substantial disruptions between Thursday 15th April to Wednesday 22nd April.” That means that Ryanair could not survive for much more than a year before its own cash pile (precisely 389 days on the €2,333.8m in financial assets, cash and equivalents reported in its most recent quarterly filing) is gone.
Even struggling British Airways, which has just reported its second consecutive year of record losses and continues to face strike threats (which cost it £6m a day), has cash and deposits of £1,714m (enough to get through 286 days of strikes). BA’s Chief Executive has denounced its “dysfunctional” labour unions while still working on a merger with Spain’s Iberia to create a new European giant to be known as International Airlines Group.
While all this was going on, the US giants United Airlines (UAL) and Continental announced on 3rd May their own plans to merge in an all share deal with a combined equity value of some $8 billion. On a pro forma basis, the combined company would have annual revenues of approximately $29 billion (based on 2009 financial results) and unrestricted cash balances of $7.4 billion (end of the first quarter of 2010).
Crisis, what crisis?
How do airline treasurers manage the burdens of carrying so much fickle cash in every currency of the world and paying out dollars for assets (the basic tangible assets are aircraft which are mostly priced in dollars) and running costs (principally fuel which again is priced in dollars)?
The challenge facing a US treasurer is relatively simple. Although United and Continental, and their slightly larger rival American Airlines, have substantial international traffic, it is dwarfed by their domestic business. In contrast, the world’s largest international airline by passengers is now Ryanair which has virtually no dollar revenues but mostly euro and sterling income, plus some non-euro European currencies. Airlines which operate across a wide range of countries face the usual problems associated with local regulations and practice.
The key cash management instrument for most airlines is IATA’s own Currency Clearance Service (ICCS) which is currently used by more than 260 airlines of all shapes and sizes, including cargo carriers. ICCS had a turnover of $23.3 billion in 2009. It enables treasurers to have central control and repatriate their world-wide sales funds. Membership of ICCS is not limited to IATA airlines. Eurostar, the railway company, is a member and there is no reason why other non-airline third parties such as hotels, car hire companies and surface carriers could not join.
The system is built on the Billing & Settlement Plan (BSP) and Cargo Accounts Settlement Systems (CASS). These acronyms are the building blocks of ICCS but they represent simply the framework to enable participating airlines to decide how much (in full, in defined amounts or as a percentage) from the clearing system to end up in their home bank accounts. Members sign up to designate which BSPs or CASSs or credit card receivables they want to have cleared through ICCS and also give general (default) instructions with bank account and base currency details. The BSP/CASS Clearing Bank transfers the funds to the ICCS bank account instead of the member’s local bank account.
ICCS runs on a four working day clearing process. Day One is order day when ICCS confirms receipt and acceptance of orders. On Day Two (contract day), ICCS nets out on a multilateral and multicurrency basis all the orders to work out which currencies to buy or sell according to the default instructions.
These currency transactions are for delivery on Day Four (clearance day) and priced according to interbank benchmarks, currently the Citibank London Treasury’s CitiFX. Day Three is closing day when ICCS releases final payment instructions and member airlines can download their final position – all the money is in the system and ready to go the next day. ICCS checks receipt and makes payments for value on Day Four, clearance day.
The most important things happen on Day Two. From order day (Day One) and during the morning of contract day, the money received into ICCS’s bank accounts is exchanged and begins earning interest. The exchange rates that ICCS uses are also available on Reuters and Bloomberg pages as well as the CitiFX interactive website. ICCS then makes translations at previously agreed spreads.
These range from minimal spreads, which reflect easy convertibility and wide liquidity, to the wider but still accepted spreads on less traded currencies. For example, the latest available spread from the mid-market spread was 0.0003 for the euro or sterling up to 0.4 for the Hungarian forint. In all, the system quotes for 28 spreads (two, however, are unavailable at the time of going to press – Iceland’s Krona and the Thai Baht), while there are separate exchange translation policies for non-convertible or not freely convertible currencies.
The cost structure is simple. Members pay just $100 per month for the first BSP or CASS in any country and $25 per month for the second. Credit card transactions are charged at $50 per month, per currency and per sending bank.
Members also have access to the ICCS web-based Information & Netting (I&N) System, which allows them to view and print their reports showing the funds handled by ICCS. They can also choose an accelerated payment option for straight through (no foreign currency exchange) transactions in euro and dollar. This option thus dispenses with order day and contract day for the foreign exchange element and goes straight from closing to clearance. The interest rate and cost structure remain the same.
The advantages of the ICCS are in time, lower transaction costs, netting of some payments together with narrower FX spreads and forecasting. The clearing cycle is relatively fast and the accelerated repatriation of foreign sales funds leads to improved working capital management and reduced foreign exchange risk. Reduced currency conversion costs from transparent foreign exchange rates means lower banking fees and transfer charges. At the same time, advanced access to receivables information allows for more effective cash flow planning.
Doing it my way – and growing
While the ICCS system works well enough – very well for the traditional airlines – the new breed of low-cost airlines has decided on a different route. Neither Ryanair nor easyJet is a member of IATA or ICCS. Instead, they have opted to go straight for the passenger and his credit card.
The internet has been crucial to their approach. Despite the initial scepticism of Michael O’Leary, its ebullient and controversial CEO, Ryanair has moved to embrace the new technology and virtually all its revenues now come through its website. It uses an integrated system from Navitaire, a Minneapolis computer company, whose reservations systems, the company says, “now power a majority of the world’s largest low-cost carriers, and a majority of the industry’s emerging carriers.”
That technology, rather than just cheap fares or O’Leary’s marketing skills, is what has driven the company’s growth. The airline’s discounted fares are “capacity controlled”. Ryanair allocates a specific number of seats on each flight to each fare category to accommodate projected demand for seats at each fare level leading up to flight time. So the airline generally makes its lowest fares widely available by allocating a majority of its seats to its lowest fare categories. This dynamic approach means that the prices can move up and down more quickly than those of traditional airlines which are in the four or two day ICCS cycle. Moreover, it makes an extra hit by taking a cut from the loyalty credit cards it brands for issuing companies.
While Ryanair has continued to grow its immediate cash revenues through such strategies, it has also been ruthless in controlling and even cutting costs. It claims that its operating costs are among the lowest of any European scheduled-passenger airline. Compared to its previous generation European competitors, it has certainly managed its personnel costs.
But it has also outsourced its customer service (ticketing, passenger and aircraft handling) and airport access and handling costs by focusing on airports that offer competitive prices. Some of these special offers and volume discounts have been disputed by competitors with the European Commission but local airport authorities, frequently controlled by local governments, seem happy to use Ryanair as an effective loss leader for their tourism revenues.
While BA’s Walsh is also fighting personnel costs and working on the Spanish deal, his US competitors are looking to grow revenues as well as cut costs. Glenn Tilton, Chairman, President and CEO of UAL estimates that the net annual synergies of their proposed merger could come to some $1 billion to $1.2 billion.
Jeff Smisek, Continental’s Chairman, President and CEO analyses these numbers, “This merger enables us to create opportunities to grow beyond what each stand-alone company or an alliance would be able to deliver. We estimate revenue synergies in the range of $800m to $900m a year. We estimate net cost synergies in the range of $200m to $300m per year. So our estimate of net annual revenue and cost synergies totals between $1 billion and $1.2 billion by 2013.” Those figures go beyond their proposed trans-Atlantic and trans-Pacific joint ventures and could be optimistic.
Managing the risk of diversity
The scepticism derives from the diversity of aircraft in the fleet. The combined United-Continental will have 226 Boeing 737s, 24 Boeing 747s, 157 Boeing 757s, 61 Boeing 767s and 72 Boeing 777s plus 152 Airbus 320s. Contrast that with Ryanair’s all Boeing 737-800 fleet. The company’s strategy is again based on cost synergies. Ryanair’s primary strategy for controlling aircraft acquisition costs is to narrow its fleet of aircraft to a single type of only ‘next generation’ Boeing 737-800s.
Ryanair’s continuous acquisition of this aircraft allows it to increase capacity while limiting the costs associated with personnel training, maintenance, and the purchase and storage of spare parts. It also gives it greater flexibility in the scheduling of crews and equipment.
As the company puts it, “Management also believes that the terms of its Boeing contracts are very favourable to Ryanair.” In fact, Ryanair says it pays a basic price of $51m for each of its aircraft. But that headline price is reduced by “certain concessions” from Boeing (“credit memoranda” to be applied “towards the purchase of goods and services from Boeing or towards certain payments in respect of the purchase of the aircraft”).
Ryanair also gets “certain allowances for promotional and other activities, as well as providing other goods and services to the company on concessionary terms” from Boeing and CFM (a joint venture of the US General Electric’s CF6 and France’s Snecma M56 family), the manufacturers of the engines. The real price of O’Leary’s aircraft is thus “significantly below the unadjusted basic prices.”
Such bulk buying helps keep down costs but where does Ryanair – or, indeed, any airline – actually get its money for such huge capital purchases? The answer lies in the cashflows (and therefore cash balances) which keep the company afloat (or airborne, if you wish), which support the long-term interest payments on financial borrowings.
These include direct borrowings on the basis of guarantees issued by the Export Import Bank of the United States (also known as “the Boeing Bank”), commercial bank debt, finance leases (Japanese Operating Leases with Call Options) and operating leases. In fact, at 31st March 2009, Ryanair owned only three of its 181 aircraft.