Flyqual Airlines Business Proposal

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CHAN CHI YEE, LIAN YE CHEN, LIM SWEE LING, NG KIM TOH, TEE YANG WEI

ABMD5055 FINANCIAL DECISION MAKING – ASSIGNMENT 1 2AAC(7) Team 1

KOLEJ TUNKU ABDUL RAHMAN

ABMD 5055 FINANCIAL DECISION MAKING

No. Student Name Registration Number

1 Chan Chi Yee 08WBA12624

2 Lian Ye Chen 08WBA12418

3 Lim Swee Ling 08WBA10687

4 Ng Kim Toh 08WBA11482

5 Tee Yang Wei 08WBA12303

Academic Year: 2009/10

Course/Year: Advanced Diploma in Business Studies (Accounting)/ 2AAC

Tutorial Class: Group 7

Lecturer: MR. CHIAU CHOON KIAK

Tutor: MR. WONG YOKE MENG

Date of Submission: 16 DECEMBER 2009




Introduction to Flyqual Airlines (FQA)

Flyqual Airlines (FQA), established since 1945, is a national airline in home country with a

principal business of providing long-haul air flights services which take passengers to USA and

Europe. FQA’s business includes passenger service and cargo service. Besides this, FQA

undertakes some short-haul schedules in Asia-Pacific region. FQA is being controlled by 2 large

major shareholders, which have a combined shareholding of 60% in FQA. FQA holds a 45%

shareholding in a smaller airline which engages in short-haul scheduled and cargo flights around

the Asia-Pacific region.

FQA targets the high quality end of the market only and price for its air ticket sales are at a

premium. FQA operates a fleet of 170 aircraft which consists of sixty three F 858, thirty one F

888, forty-four C 440 and thirty two C 450 models. Of the entire fleet, seven F 858 aircrafts are

specifically used for cargo flights, forty-four C 440 aircrafts used for short-haul routes while

thirty one F 888 aircrafts are configurable for long-haul routes.

There has been a steady growth in new emerging markets like China and India, Brazil, Russia

and ASEAN markets. A large growth in air travel among these emerging markets is expected

over the next two decades as they continue to attract large investments. It is estimated that 80%

of air traffic between Europe and Asia is carried between only 17 major cities. Demand for air

cargo services is expected to grow significantly as more emerging markets demand the air

transportation of high technology equipments and perishable goods quickly. In terms of financial

value of goods to weight of goods, these equipments represent about 75% of financial value of

exports from Asia but only 40% of exports in terms of weight. This is a very profitable area of

business as a trip of air cargo can yield in more financial value compare to other air flight

services.




FQA will be reaching out to capture the emerging markets by entering into strategic alliances

with existing airlines in the emerging markets to boost its market share and visibility of its brand

in the regions. FQA will operate long-haul routes to the emerging markets while emphasizing on

short-haul routes through its subsidiary.

The next generation of aircrafts are built taking into account of the increasing trend for larger

aircraft carrying more passengers and having a greater range capability. Currently there are two

leading manufacturers in the industry which have produced prototypes of the next generation of

passenger aircrafts. The aircrafts built in the current market are largely manufactured by ompany

C and F.

FQA is a leader in the airline industry and has a significant influence on other airlines in regards

of the choice of next generation aircrafts. FQA is committed to gradually replace its fleet of

existing aircrafts over the next 20 years.




Airline Industry Issues

Airline is one of the most prospective business industries and remains a large and growing

industry. It facilitates economic growth, world trade, international investment and tourism and is

therefore central to the globalization taking place in many other industries.

Although the industry had experienced several economic downturns in the past 20 years, yet it

grew by an average of around 5 percent per year. It is believed that the continued dependence of

people and businesses around the world on timely, reliable and efficient air transport will result

in a similar growth trend over the next 20 years. But however there are many challenges faced by

the airline industry towards the shifting of market trends, economy slowdown and fuel unstable

price.

Airline’s profitability tied closely to the economy growth rate and trade. World recession during

1990s had caused the number of international passengers to drop for the first time in

1991.IATA’s member airlines suffered cumulative net losses of $20.4bn in the years from 1990-

1994. Since then, airlines have had recognize the need for radical change to ensure their survival

and profitability.

Competition from budget airlines

Budget airline have adopt cost leadership strategy rather than differentiation strategy to lower

their operating cost and to increase the sales and profit margin. Successful story of budget airline

have drawn more player into the business. Budget airline offers low price fares and basic with no

extra services. In order to make up the loss in revenue for decreased in ticket sales, the airline

may charge for extra like foods, priority boarding, seat allocating and baggage.




Despite the tough economic condition the budget airline are growing strong at 13% growth rate.

It targeted segments of market which are student, first time flier, leisure and business traveler

who requires no frills service travel at an affordable price. In the past, budget airline focused

primarily on short haul route of no more than 400 miles. At present, budget airline are expanding

their routes to include longer transcontinental and non-stop flights with in flight service that

parallels their competition. Although the targeted market of budget airline and traditional airline

are different, still it places a stiff competition towards traditional airline as certain customers are

shifting to budget airline.

Travelers, even those richest one beginning to realize that paying double or more for a ticket just

to receive a sandwich or meal on board are not in the sensible category.

Traditional airline in turn to meet the requirements of their increasingly discerning customers,

have to invest heavily in the quality of service that they offer, both on the ground and in the air.

Ticketless travel, new interactive entertainment systems, and more comfortable seating are just

some of the product enhancements being introduced to attract and retain customers.

Pressure by World Trade Organization

World Trade Organization deals with the rule of trades between nations at a global level to

promote free trade and stimulate economic growth. WTA is seeking to eliminate subsidies and

protectionist practices from domestic government for airlines and aerospace manufacturer for

fair competition. Examples of protectionist practices offered by national government are:

• soft financing for capital investment

• reduced duties on aviation fuel

• cheap infrastructure(airports, air traffic control, maintenance facilities) or preffered

terms of use




• cheap currency of tax concessions for importing planes and engines

• state assistance with training, software development etc.

• regulations excluding foreign airlines from certain airports or from offering internal

flights

World Trade Organization is pressuring national government to open landing rights to more

airlines in support of globalization. National government under the pressure adopts policies to

open up their airways to competition. This is an opportunity for foreign airlines and a threat for

national airlines as they usually get exclusive slots in airport.

Future Market Demand

The emerging markets in the global are the future market of airline industry. There will be

growing markets from ASEAN countries, BRIC (Brazil, Russia, India, China) the largest

developing countries, and Africa (particularly South Africa). The 2 largest emerging markets,

China and India are likely to be the largest markets over the next two decades. It is expected to

result in large growth in air travel to and from, and within these countries. This is likely to be

generated by rapid growth in economies and the continued inward investment from other parts of

the world.

Unstable Fuel Cost

The constant challenge faced by airline is the unstable cost of fuel. Fuel is one the largest cost

expense in airline industry and the value of a barrel of oil has a direct impact on the company.

Increasing fuel price may affect the airline in two ways, the cost of fuel has obvious and direct

impact on the operating cost and second fuel cost increases continually and triggered economic

recession, which in turn result on decline in demand for air travel and cargo.




Airlines are able to counter increased fuel charges in a number of ways. These include being able

to make surcharges to the customer on fuel cost increases and by seeking ways in increasing

efficiency in the fuel consumption on their fleets. Many of the airline use the hedging techniques

to stabilize the fuel costs.

Replacement of Aircraft

Technology advancement in aircraft manufacturing has cause large scale of aircraft replacement

in the industry. Fuel prices also have a major influence on the aircraft replacement. Market

conditions, legislation on noise and exhaust emission and demand for quieter aircraft have also

contributes to the replacement. Improved aircraft and engine design has the potential to reduce

costs as it is more fuel efficient, less noise pollution and release less emission.

F 898 is an aircraft which has a significant order from China, totally up to 25% of overall orders.

It is designed to handle 300 seats, thus having greater flexibility. It is able to consume less fuel

while producing fewer emissions. Besides this, it is expected to achieve a 35% reduction

maintenance costs compared to similar aircrafts.

C491 on the other hand is the first in the world to have a full upper and lower deck for passenger

transport. It is able to consume less fuel and adheres to internationally accepted quality standards

on noise emitting from it. C491 can be manned by less staffs while able to carry 600 passengers

as compared to F898. Besides this, C491 is able to carry cargo too.

It is expected by mid of 2020s’, only about 15% of the fleet which currently operating will still

be operated by airline across the world. The trend of the industry is moving towards replacement

and therefore many airlines are replacing their passenger aircraft before the end of economic life

to take advantage of the new technology.




FQA Issue

Debt

FQA has a high level of debts which are maturing within the short period. Should FQA fail to

obtain sound funding for its debts, FQA have a very high chance of going into liquidation.

Failure to repay its debt on time will have an adverse effect on the company’s credibility as it is a

sign that the company is unable to meet its obligations. A ripple effect will be generated, causing

credit rating agencies to lower the credit rating of the company. This is a serious problem as a

poor credit rating will deter financial institution from lending money to FQA.

Maintenance Procedure

Aircraft maintenance procedures are under funded, causing some of the aircrafts are not

complying with safety checks, thus led to an adverse safety report on the maintenance

procedures employed by FQA. An independent report produced by independent engineering

consultant concluded that there were serious faults with the maintenance procedures and that the

budget for maintenance is inadequate to carry out the required maintenance procedures.

A recent accident had happened to FQA’s aircraft where FQ302 had plunged into the Indian

Ocean when flying from home country to London on 8 April 2007. Although the reason for the

crash is unknown as of now, but judging from the independent report on the maintenance

procedures employed currently in FQA, the likelihood of the reason for the crash can be traced

back to non compliance with aircraft safety checks. This will in turn deter a lot of customers

from using FQA’s services.

Therefore, it is essential for FQA to ensure all its aircrafts are in top notched shape for its

customers and its company’s image to sustain. This includes compliance with existing regulatory




requirements and having regular and effective checks on the aircraft’s safety features before and

after the flights.

Government Aid

Previously, FQA as the national airlines of home country has exclusive landing rights in the

home country. This represents a unique resources for FQA to leverage itself against its

competitors.

However, currently the government attempt to encourage competition in the industry. They have

awarded another landing right to FQA’s competitor. The government of home country has also

indicated clearly that the landing rights might not be awarded to FQA in the future . Therefore,

the lost of this unique competence poses a threat to FQA as it now faces competition among its

rivals and less government support. FQA will face a more intense competition.

Code Share Agreement and N Alliance Position

FQA is a member of N Alliance which enables it to provide wider destinations for its customers.

Through the N Alliance, customers of FQA are able to enjoy various convenience throughout the

whole air flight.

However, there are certain drawbacks from this N Alliance such as:

• Differing levels of service quality leading reputation of good airlines to be dragged down

by bad service from others;

• Potential break-up of alliance as individual airlines try to grab business by expanding

routes to compete with other alliance members;




• Political risk if authorities rule that alliance is anti-competitive because it permits price-

fixing or restriction of competition;

• Disputes over sharing out of ticket money and costs; and

• Commercial risk from ‘dirty tricks’ if codeshare enables one airline to hack into client

details of a rival and persuade its customer to change airlines.

The alliance partnership brings convenience for its customers but does not draw in much revenue

for FQA. So we should review FQA’s position in the N Alliance.

FQA’s current code share agreement is not adequate right now as FQA is targeting new

emerging markets. Thus, FQA should review the code share agreements it have right now and to

have strategic direction on its code share agreement policies.

Financial Issues

Share Ownership

Currently, FQA is being controlled by 2 large institutional shareholders who hold 60% of its

shareholdings. This effectively means that the 49% dividend paid was being paid under pressure

from these 2 institutional shareholders as their combined shareholding is able to get a majority

vote in the Annual General Meeting (AGM). This action of declaring high dividend essentially

means that FQA has a low level of retained profit for the year.

Besides this, this 2 institutional shareholder are putting pressure on the board to reduce the

running cost to boost profits. This includes pressuring FQA to reduce staffing levels.




Replacement of Aircraft

Some of FQA’s fleet of aircraft is reaching the end of their lease term. FQA is facing an issue of

replacing its aging aircrafts which accounts for 85% of its entire fleet. Another issue faced by

FQA is the choice of aircrafts to be used as replacement as they have to take into account the

way the airline industry is moving and the increasing trend for larger aircraft carrying more

passengers and having a greater range capability.

Besides this, FQA has to decide on which area of business are they focusing on, whether short-

haul or long-haul.

Human Resource Issue

FQA has been well-known with their high quality service whereby they have a group of staff

who are professional and dedicated in their working performance. But in this period of time, the

board has been facing a downpour where they are pressured to reduce the human resource costs.

As a method to overcome this issue, the board has set a higher level requirement on individual

and company performance than current status to determine the human resource and remuneration

policy. Resulting from this, the staff feels discomfort on the working environment for the last

two years.

There is a torn of relation between FQA and their employees. The employees demand for a

higher wages, to provide a better working conditions and reducing their working hours. This led

to a hard negotiation with the trade unions where all the staff and crew are the member of this

unions. The trade union uses the threat of strikes to gain their demand.

As a results, the cost and the side effect of strike action is extremely high. The finance Director

has come up with a summary of cost whereby if the whole airlines were to be close down, it is

estimated to bear loss of $30million per day. Losses of intangible assets of the company are the

goodwill whereby the reputation of FQA will be in doubt if strikes were occurred. Besides that,




the government may take action against FQA if there is a strike and the government may refuse

to continue their financial support in upcoming period. If FQA would like to have a settlement

with the trade unions demands, it will cost $220millions per year.

Another issue which further damaged the relation between the staff and FQA is the issue in the

maintenance department. The engineering director who is employed by the FQA has written a

false report accusing three technicians for not doing the job properly and the FQA has dismissed

the three of them without further investigation. In the other hand, the engineering director

concludes his report that the maintenance procedures were perfectly safe and good to go.

According to the independence engineering consultant, they have a thoroughly check on the

maintenance procedures and found out that there is a serious fault in it. The trade unions were

unhappy because the three technicians were use as a scapegoat to cover up the failings at a more

senior level. Poor maintenance by FQA may loss reputation and customer confidence which

definitely affect company’s revenue. Furthermore, FQA dismissed employees without prompt

investigation to carry out whereby to cover up the failings made by the FQA. This may lead to

loss of loyalty of the employee towards the company and the motivation level to perform will

drop.

The Director of Sales and Marketing made a confidential comment after the press where the

strike held by the unions is an unreasonable action. Supporting this comments, she said that the

staff employed by FQA enjoyed very satisfactory pay and condition of service. One of the

employees of FQA tells the media that the statement made by the director is unreasonable and he

was dismissed after the remarks were made and this lead to a negative press comment.

Proposal

Debt

There is 2,720 million of bank loan to be repaid in 2008, 2009 and 2012. In this coming 2008,

FQA need to pay 1,000 million to the bank which currently could not afford by FQA. It is crucial




for FQA to solve this problem in order to turn around the company. Here are the solution that we

recommend to tackle the problem:

1) Right Issue – FQA can exercise rights issue to encourage its existing shareholders to take

up the new shares issued to raise capital.

2) Appeal to creditors – FQA is unable to repay its obligations within the coming financial

year, thus it would be essential if FQA can strike a deal with its creditors to appeal for a

delay of debt repayment by a period of 6 to 9 months. The deal can include more

collateral or refinancing option which includes refinancing of aircrafts or building.

3) Issue of Bond – The new Chairman of FQA is a former transport minister of the home

country. FQA can utilize this political background of the new chairman to convince the

government to take up bonds issued by FQA. In our opinion, the government would more

than likely to take up the deal because FQA is the national airline of the home country

and should there be a liquidation of a national airline in the home country, it would spell

a economy disaster in the home country as this would sent a negative confidence signal to

investors.

Issuance of bonds and convincing the government to take up FQA would be a better choice

as by utilizing this method of financing, FQA is able to avoid its company’s share from

getting diluted and able to retain its control of the company.

As result, FQA will reduce the risk of loan default

FQA will be entering into new emerging markets that include Brazil, Russia, India and China

(BRIC), Africa, and ASEAN countries. These markets are situated far apart from each other on

the globe. Thus, we propose that FQA focus itself in the long-haul business.

As for the short-haul operation which is gaining significant importance in FQA group, we

propose that FQA acquire the remaining 55% of the smaller subsidiary as this would allow FQA

to take full control of it and direct business strategies easily through it. The subsidiary has been




in the short-haul route market all these while and are experienced in providing short-haul

schedule and cargo transportation among Asia Pacific countries. After the acquisition, it is

expected that the consolidated profit and equity of the new FQA group will increase.

The air travel demand in emerging markets (China, India) will begin with increase in domestic

demand and follow by international demand as income rises and greater investment take place in

the said market. For the domestic airline, we will form join venture with the local airlines which

has already establish in the market. This is because the government in these countries are

practicing protectionism towards their local airlines, thus we are not able to acquire shareholding

in their airlines because of our status as foreign company.

The outcome of the joint venture is that the profit of the new group and market share will

increase globally as the joint venture enables us to penetrate the emerging markets easily through

the partnership programs and agreements we have entered with the local airlines. Our reputation

and brand name will gain a significant boost as the consumers will get to know about FQA

through the local brands in the market.

N alliance is not beneficial for us as it only convenient for customer while it does not favor us as

we shift our business strategy to focus on the emerging markets. Therefore, we proposed to leave

N alliance. As for the new markets which are far away from FQA home country, we suggest to

enter into a code share agreement with the local airline.

These strategies that have been employed enable FQA to expand its market in regards to the shift

in market trends of airline demand and is able to reduce risk of not being in the new market. This

will enable FQA to boost its revenue in line with its expansion of market share. FQA is able to

reduce risk of not being in the new market.

The government has been pressured by WTO to open up the sky for other airlines. Therefore, the

government has awarded another landing right to another airline. This puts FQA at disadvantage

as FQA does not enjoy exclusive privilege in the home country market anymore. Our proposition




to mitigate this problem is to use the Chairman’s influence in the previous government cabinet to

exert pressure to the current government administration to stop the issuance of new landing right.

Expansion Financing

Financing of the acquisition of the remaining 55% of shareholding in the subsidiary can be done

using share swap method. FQA can issue new share and swap with the subsidiary (eg. A fix

amount of share for every share remaining in the subsidiary).

Share swap method is a preferable choice for FQA as it is able to dilute the shareholding of FQA,

thus reducing the shareholding of the two major shareholders with the entrant of the subsidiary

and thus FQA is allowed to extricate from the control by two major shareholders. Moreover,

while the issuance of new share will reduce the earnings per share of FQA, however, the

earnings per share will increase back after the share swap has been complete as the profits of the

new group will increase significantly after consolidation, thus boosting earnings per share. Due

to this FQA is allowed to extricate from the control by two major shareholders.

Replacement of aircraft

Due to the current financial position of FQA which is at a high gearing level, therefore it is

unable to acquire aircrafts. Therefore, FQA can only lease aircrafts. Leasing is a good method for

FQA because if the aircraft is leased and anything happen to it, FQA does not to bear the loss.

Due to the rapid advancement in technology, aircrafts have no resell value in 10 years time. Thus,

it is not worth to buy the aircraft.

We propose to lease C491. This is in line with the industry trend where demands for larger

aircraft capacity and greater flexibility. FQA is focusing in the long-haul business and C491 is




able to provide sufficient comfort for its consumers who will be boarding a long hour flight. The

future demand for air cargo will increase significantly, and C491 can fulfill this demand in future.

Based on capital investment appraisal of the two aircrafts, the Net Present Value (NPV) of C491

97million while F898 is at 26million. There is an additional insurance premium which would

need to be covered by FQA if it chooses C491. The annual additional insurance for C491 aircraft

will be at 6million, rising by 5% compound per year. The revised NPV for C491 is at 59million

for C491, which is still profitable. The returns for F898 will be at $0.17 per 1 dollar

($26m/$150m) while the C491 will be at $0.24 per 1 dollar ($59m/$250m). Again the C491

seems more acceptable on economic grounds.

Acquisition of new aircraft enables FQA to create competitive advantages that allow FQA to be

competitive in this high competitive industry. This can help FQA to reduce the risk of failure to

meet the growth in market in future.

Maintenance

Maintenance of aircraft is essential for FQA because FQA prides itself in the safety of its

passengers. Therefore, we propose FQA to reverse back the budget cut on maintenance of

aircrafts because FQA. This is because aircrafts cannot compromise the safety checks on its

aircrafts for profitability. Therefore FQA have to ensure that they are complying with existing

regulatory framework and requirements such as Occupational Safety and Health Administration

(OSHA). These compliances include regular and effective checks on plane’s safety features

before and after the flight.

For planes which are found to be at fault during the maintenance procedure, FQA can set its own

standard which is above the basic requirement by the regulatory law. This ensures that the

condition of the aircrafts is always at top notch. Based on the above, FQA may mitigate the risk




of non compliance to the regulatory framework that is set by government and it may help to

enhance reputation of FQA.

FQA should reappoint the three technicians which were dismissed by mistake and given

compensation to them. FQA should dismiss the engineering director who is irresponsible with

his duty that put the safety of our customer into risk. A proper investigation should be taking any

action against the employee and a higher standard of maintenance procedures must be taken into

account to ensure that our airplane is safe.

Human Resource Issue

The management should negotiate with the Unions on the amount of settlement so that they can

come out with a price where is fair to both parties. FQA can rewards their employees by shares

of share option which will not impair the company’s cash flow. FQA can provide more

employees’ allowance to have a more comfortable working environment. Besides that, FQA can

restructure remuneration policy and introduced a bonus scheme where best employee of the

month will be rewarded so that it can motivate them to perform better. Through these solutions,

FQA may address a potential risk of strike by trade union.

The sales and marketing director should make a public apology for the settlement made. And the

employees dismissed by the company should not reappoint back, as a warning to the other

employees not to expose out the confidential issues of the company as this will affect the

company’s reputation.




Balance Scorecard

Finance FQA is having debt problem now. Therefore, FQA is looking for ways to refinance the debt. One of the methods is to have rights issue, issue of bonds to government and to appeal to creditor for a standstill of debt repayment period. In order to sustain profitability, FQA has decided to enter the new markets by fully acquiring the subsidiary which it currently holds through the means of share swap. FQA targets more than 3.4% net margin. Customer Based on research, there is a shift in market trends towards new emerging markets such as China, India, Brazil, Russia and Africa. It is expected that demand for cargo flight will surge in the coming years. To serve the different segment of customers in the new market, FQA will operate the new wholly owned subsidiary to focus on the market. Internal Process In line with the technological advancement and future demand, we suggest leasing C491 aircraft compared to F898 because of its greater benefits as compared to the latter. Maintenance and aircraft safety is the top priority for FQA and should not be neglected. Therefore, we suggest that FQA enhances its maintenance procedures and set it above the minimal requirement from OSHA. The management of FQA will review the remuneration policy and renegotiate employment scheme with the Trade Union to strengthen the relationship between them. FQA review the existing alliance partnership with N alliance and therefore proposed to leave the alliance. Innovation FQA enter into a code share agreement with local airline of new market which is far away from FQA home country. Internal process - what is the future trend of Aircraft (see pg 220 of your material), how do you improve your internal issues (safety, union dissatisfaction, Code share and Alliance startegies, etc.) Innovation - what has FQA learnt from its recent business experience and how is this reflected in the Business Plan)

Flyqual Airlines Business Proposal

Documents

air cargo services

generation of aircrafts

generation aircrafts

air travel

trip of air cargo

air traffic

new emerging markets

longhaul air flights