Recent suggestions that the enabling Bill for the Aer Lingus initial public offering (IPO) may face a slow passage through the Dail must be of grave concern to the company's board, management and staff. It is a short Bill and surely cannot be seen as particularly contentious.
The current industrial relations unrest and criticisms about the Eircom price should not become a smokescreen to justify delay. The overriding Government objective should be to achieve a flexible position to take advantage of stock market timing. By 2001 Aer Lingus will urgently need additional share capital if it is to prudently finance its short and medium-term aircraft acquisition programme, costing about $1 billion (€1.18 billion).
Otherwise the company could end up undercapitalised with a higher risk premium on its cost of capital. Last year's Salomon Smith Barney Report commissioned by the Government, indicated Aer Lingus had already fallen behind its peer group of European airlines significantly in equity capitalisation and interest/ rentals coverage.
The report estimated that at least €190 million in new equity was required during 1999 and 2000 and that a further equity tranche would be necessary between 2001 and 2003. I estimate Aer Lingus should raise almost €400 million in new equity at the time of its IPO, because its fleet structure is too dependent on short-term operating leases.
This would strengthen its relatively weak balance sheet and interest/rental coverage position - particularly in case there was a downturn in this cyclical industry. It must be remembered that the exchequer is precluded from investing any new share capital in Aer Lingus because of EU protocols. This leaves Aer Lingus with the weaker alternative options of a trade sale, or finding a significant minority investor in Europe. These would also need legislation.
Delays could lead to financial vulnerability. Also, its business strategy and links with the Oneworld alliance of airlines require financial underpinning.
Aer Lingus has benefited from the buoyant economy, lower fuel prices (until recently) and better productivity and yield. It has also transformed its corporate culture and strategic focus since the crisis in the mid-1990s.
The aggressiveness of Ryanair's competitive stance and its strategic positioning undoubtedly forced Aer Lingus to sharpen its product offering and innovate. It has coped well with US competition because the overall numbers of transatlantic passengers have increased by 50 per cent in the last five years - with these services making higher profits than the short-haul UK and European services.
The net worth of Aer Lingus at current book value €297 million. Depending on capital market conditions, its market value could be around €550 million - if profitability and cash flows continue to improve. Institutional investors would probably classify it as a value rather than a growth stock.
Consequently Aer Lingus would be expected to pay a dividend that would initially yield between 4 and 5 per cent. Institutional investors have bought shares in other smaller airlines, so there is no reason why they will not buy Aer Lingus if the proposition is attractive.
With a market capitalisation and free float (assuming the Government sells its entire holding) in the range €750-€900 million ,there should be sufficient stock liquidity for realistic pricing and investor interest. The big question is whether management can deliver sufficient shareholder value over the business cycle.
With an assumed cost of capital of about 10 per cent, it would need to deliver a total shareholder return of around 14 per cent, on average. This fundamental financial goal rests on the success of the Aer Lingus business model in terms of pricing, quality service, customer mix, yield per aircraft and route configuration. The Aer Lingus strategy and profit dependence on the transatlantic routes may be less robust in a recession - another reason for a solid capital structure.
Linked to the need for new equity capital is the necessity to restructure the board of directors as soon as possible to ensure corporate governance credibility if institutional investors are to be attracted.
The Government gave Aer Lingus a clear mandate to operate to commercial criteria and perform in line with its industry peer group. As controlling shareholder, the Government has responsibilities. It should urgently get on with its business to achieve a successful IPO.
Edward Cahill is Professor of Accounting in University College Cork
