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Commentary>Market impact of paying AA to fly - What it means for Air Jamaica as a going concernDelroy Hunter - Guest Writer |
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Although the Government has been less than forthcoming about the recent controversial pay-to-stay arrangement with American Airlines (AA), the circumstances leading to the deal portend the challenges that face the Bruce Golding adminis-tration as it contemplates the future of Air Jamaica.
If the deal benefited from reasonable assumptions and rational analysis, then it can be easily justified and there could be similar deals in the future.
If AA, in the absence of the promised payments, would not undertake the affected flights and if other airlines, including Air Jamaica, do not have the capacity to take up the slack, then the Jamaican economy would suffer a loss.
Paying Net Loss
Facing this scenario, it is appropriate to pay AA a maximum amount equal to the net loss that Jamaica would experience in AA's absence. However, the net loss is not the US$96 million from the 3,000 seats from the affected AA destinations, as reported.
It is this amount less the earnings from those seats that would find their way to Jamaica anyway using other airlines.
Paying AA and not Air Jamaica may, perhaps, be justified by the greater number of seats, connecting flights, and generally more reliable service of the American carrier.
The argument that other airlines could threaten not to fly to Jamaica and demand a similar payment misses the essential points: that a promised payment up to a maximum of the net loss of revenues does not make Jamaica any worse off; and that if some airlines were to shed the Jamaican route there would not be a net loss, as other airlines would fill the void.
Hence, they could not rationally expect to be paid.
As it stands now, until the Government provides the details of the analysis underlying the deal, it is inappropriate to conclude that it is either a good or a bad deal.
Let us consider the options that the Government has regarding Air Jamaica. The first is to successfully divest the airline.
If Jamaica can find a buyer, then there should be three critical elements in the terms of the divestment.
Best Price
One, ensure the country obtains the best price for the airline. To this end, the requisite expertise must be employed to appro-priately assess the value of the airline's physical assets, code-sharing and other contractual arrangements, and goodwill.
With regard to the latter, anecdotal evidence is that Air Jamaica has substantial goodwill among its potential passengers.
It is important that this is properly valued and incorporated into the selling price. The divestment of Air Jamaica should not be another fire sale of a valuable public asset. Further, the divestment should avoid any clause that allows for Govern-ment guarantees of its future debt.
Two, as much as is practical, the heritage of Air Jamaica should be maintained. This is important as a part of the overall marketing of Brand Jamaica and a loss of its heritage could lead to a diminution of the goodwill among potential passengers, which in turn reduces the value of the airline to the new owners. Three, the divestment should contain some mechanism to maintain the passenger load to Jamaica, as a significant reduction could mean severe hardship for the local economy.
THINGS TO COME
This is where the AA deal may be the genesis of things to come. If the Government has already decided that in the absence of an investor the airline will be closed, then it could entice potential investors with a contingent subsidy, along the same line as the AA deal, such that in exchange for a fraction of the cost savings to the national budget the new operators maintain the current passenger load and cargo lift.
What should the Government do if it cannot divest Air Jamaica? Several persons have called for its termination owing to the large and perennial operating losses. However, the operating losses of this public entity should not be the sole basis of a decision to close it.
This is because Air Jamaica produces other benefits for taxpayers, particularly taxes, that are not captured in the income statement.
A functioning airline will generate taxes from:
Expenditures of incoming passengers in the local economy value added from incoming cargo for the formal and informal sectors.
Revenues related to local jobs and the use of local products in Air Jamaica's operations.
The economic value associated with the pride of having a 'piece of Jamaica that flies'.
For instance, if Air Jamaica is used as part of a marketing strategy for Brand Jamaica, it could lead to increased consumption of Jamaican products in the diaspora.
Similarly, it could lead to increased willingness on the part of Jamaicans abroad to visit and spend money in the local economy.
For instance, following '9/11', some Jamaicans became concerned about flying on an American airline, but were comfortable on Air Jamaica because of a perceived lower threat of terrorism.
They might have cancelled trips back home if the local airline was no longer around.
Failing to account for the tax intake from these activities understates the contribution of Air Jamaica to the taxpayers of Jamaica and is likely to lead to sub-optimal decisions.
Closing Air Jamaica
Without an investor, the second option is to close Air Jamaica. In this case, Jamaican taxpayers would benefit from:
The short-term cash flows due to the disposal of any assets that Air Jamaica currently owns.
The cessation of budgetary support to the airline, freeing up valuable resources that might create significantly more value in alternate uses.
Given these choices, if divestment fails, what should the Government do?
The crucial issue is, if Air Jamaica is terminated, how much of the passenger load, cargo lift, and employment would other airlines take up?
Careful considerations
If other airlines would fill the breach, then closing Air Jamaica would be the better choice.
That is, there would be no significant net loss to the country from closing the airline and, in fact, there would be a net gain arising from the asset disposal, the cessation of budgetary support, and potential increased taxes from the profits of the entities that would take up Air Jamaica's business.
On the other hand, recent performance in the airline industry could be a signal that this is unlikely to happen.
Imagine how much more we might have to pay foreign airlines over an extended period to maintain a reasonable presence in Jamaica if, in the absence of the local airline, foreign carriers decide to materially scale back operations.
This could make the current losses appear like petty cash. It is for these reasons, therefore, that a decision should be made only after careful consideration of all the issues.
Delroy Hunter is associate professor of finance, University of South Florida. Email: dhunter@coba.usf.edu