Wednesday, Apr 8, 2020
International Finance
Aviation coverstory Magazine

Who will bring the world to Africa?

IFM March 2020 Cover Story
With South African Airways collapsing into bankruptcy, the fight for dominance among African airlines has one clear winner – Ethiopian Airlines

Africa has more than one-tenth of the world’s population but only 2.5 percent of the world’s air travellers. With the global aviation industry facing instability and certain aviation markets staring at a decline, Africa should certainly be the next growth market for global aviation. Considering its fast-growing economies (albeit from a low base) as well as rising business and middle and upper-class population Africa has a compelling case.

In fact, according to IATA, in 15 years, Africa will see an additional 192 million air passengers a year which in turn will lead to a total of 303 million passengers travelling into and out of Africa. The opportunities to increase connectivity within Africa are also immense. For example, the majority of travellers who travel to Kinshasa in Congo from Accra in Ghana have to rely on a connecting flight. Similarly, there are no direct flights between Abidjan in Ivory Coast and Johannesburg in South Africa, despite the cities being centres of commerce and business in Sub Saharan Africa.

In terms of passengers carried in and out of Africa, African skies are dominated by foreign carriers, with Middle Eastern carriers playing a key role. Among African carriers, bringing the world to Africa and taking Africa to the world was once the proud motto and catchline of Africa’s once biggest airline: South African Airways. Today, South African Airways is a pale shadow of its former self and the carrier is literally fighting for survival. Like South African Airways, most of Africa’s local airlines are state-owned and struggling to achieve profitability. A team of business rescue practitioners are set to present a business rescue plan for South African Airways on March 31 this year.

Today, it is clear that the title of Africa’s most successful local airline goes to Ethiopian Airlines. Established by a royal decree by Emperor Haile Selassie in the 1940s, Ethiopian Airlines is today the market leader in seat capacity in Africa with a 9 percent share. In terms of seat capacity alone, the airline is 50 percent larger than Morocco’s Royal Air Maroc and South African Airways. What’s interesting is that In 2010, Ethiopian was smaller than the aforementioned airlines and even smaller than Egypt Air. As the past decade saw South African Airways collapse into bankruptcy, it also saw Ethiopian airlines ascendancy to establish itself as Africa’s dominant local airline.

Ethiopian – a rare profitable African national carrier

According to the latest figures from the Ethiopian Public Enterprises Assets and Administration Agency, to which the Ethiopian Airlines management reports to, Ethiopian Airlines Group generated total revenues of about $4.2 billion in the fiscal year concluded July 7, 2019 with a profit before tax of about $326 million. More than 90 percent of the revenue earned by Ethiopian Airlines Group is in the form of hard cash from customer bookings and services.

Ethiopian Airlines aims to earn a revenue of about $5.7 billion with about $696 million in profit before tax in the fiscal year to July 7, 2020. The airline flew 10.6 million passengers in 2017-18. Ethiopians ambitions are literally sky high today. In addition to enhancing capacity at Addis Ababa’s Bole airport, which is its hub, the airline now plans to build Africa’s largest airport at a cost of $5 billion, 40 miles south of Addis Ababa, according to its Vision 2035.

Ethiopian Airlines has helped revive other African airlines also, thereby positively impacting African aviation and increasing connectivity across Africa as a whole. The carrier owns 49 percent in Malawi Airlines and 45 percent in Zambia Airways. Following upon its Vision 2025, it spread its wings across Africa and established a subsidiary in Mozambique in 2018: Ethiopian Mozambique Airlines that connects destinations within Mozambique. Ethiopian Airlines’ achievements are highly impressive not only for an African airline but any government-owned airline or national carrier in the world.

South African Airways was supposed to be Ethiopian’s top African challenger. South Africa is still the largest aviation market on the continent. It has a large domestic aviation market and is a popular destination for tourism and business travellers. But South African Airways current status is dire and the stark opposite of that of Ethiopian.

The airline last made a profit in 2011. Multiple attempts to revive it have failed. According to an analysis done by Bain Capital in 2018, if the airline was to be liquidated, it had to cover liabilities of between R35 billion ($2.4 billion) and R48 billion. At the same time, from a fire sale of its assets, the airline would be able to generate only R5 billion to R6 billion. It also puts the national treasury under pressure as the treasury has to settle R15.3 billion in bank debt and creditor guarantees prior to the airline’s shutdown, in case it is being shut.

While the South African minister for public enterprises Pravin Gordhan is of the opinion that the airline could be restructured and resurrected, the finance minister Tito Mboweni had once advocated shutting down the airline altogether. Meanwhile, a team of business rescue practitioners working to salvage the airline have suggested eliminating a number of flights from South African Airways’ schedule, which can hit African aviation hard, since they include some of the key connections between leading African business destinations.

Liquidation is among the wide range of interventions thought out by the business rescue practitioners Siviwe Dongwana and Les Matuson. Dongwana and Matuson expect around 8,900 job losses and an immediate liability of R6.3 billion to the government from settling South African Airways’ short and long term debt. The business rescue plan is not yet final and the idea of liquidation might not at all be mentioned when Dongwana and Matuson present the final plan by March 31.

Since 2008, South African Airways has survived on tax-payer funded government bailouts to the tune of R22 billion, because of which the finance minister has a point in saying that the airline must be shutdown. But any decision to shut down the airline will be influenced by the strong unions in South Africa. And, in his budget speech to Parliament at the end of February 2020, Finance Minister Tito Mboweni revealed the government would provide South African Airways R16.4-billion in government support across the next three years to cover debt and interest payments.

How did South African Airways, the carrier that proudly boasted that its duty was to bring the world to Africa and take Africa to the world hit a nadir and how did Ethiopian become the dominant African airline in a decade of airline washouts in Africa? Also, what does this development imply for African aviation? Has the hub of African aviation permanently shifted to the east?

Government control kills South African Airways

As a matter of fact, South African airlines has outlived the utility for which it was established – the isolated Apartheid government started the airline to ensure that the country was connected to the outside world – to survive the isolation imposed by Apartheid sanctions. The airline never had to disclose its financial statements because it performed a strategic role in providing necessary economic connectivity for South Africa to the rest of the world. And even when Africa closed its airspace to South African Airways, it could fly around the coastal route of West Africa.

“Primarily because of these reasons, the airline could never really be profitable and did not indeed know the extent of the subsidy it was getting from the South African government,” Guy Leitch a prominent South African aviation analyst and the publisher of Africa’s largest aviation publication SA Flyer told International Finance. And after Apartheid, the ANC centralised government control over the airline, which was very much in line with the government’s or ANC’s policy of government control over key national assets.

Although there was a period when the government seriously sought to privatise the airline, the airline’s privatisation has been mostly off the table, especially, during the Jacob Zuma presidency. For South African Airways a ‘manageable’ loss of around a billion rand has been the norm since the end of the Apartheid except for a few years here and there. The taxpayers in South Africa got used to the idea of subsidising the airline for about a billion rand per annum for the sake of its developmental objectives such as the South African Airways pilot cadet scheme that was intended to support the development of pilots from previously disadvantaged groups.

The airline made a number of attempts to break even, the most notable one in 2008 when it had two attempts with the first one failing badly. The second one was called the Bambanani programme by which the ANC recruited Khaya Ncqula as CEO to pare down a large part of the organisation that had become deadwood and the airline briefly returned to profitability for two years in 2010 and 2011.

The airline entered a very dysfunctional period when one of Jacob Zuma’s acolytes Dudu Myeni was appointed to the board and she then became chairperson. Along with the notorious state capture saga that engulfed the whole Zuma government, South African Airways and the contracts from South African Airways became the focus of loot and corruption under Myeni and the losses of the airline soared from R1 billion to around R6 billion. Myeni is currently under investigation over the issue but has denied personal responsibility. “The key difference here is that the R1 billion in losses per annum could have been sustainable, however, R6 billion in losses was never sustainable and yet the government continued to interfere,” according to Guy Leitch.

Long protected from domestic and international competition by the state, the business can no longer compete on an equal footing with the competition, especially with the Middle Eastern airlines. “The prominence of the Middle Eastern airlines in the last 10 to 15 years, together with their business models anchored on hubs has laid an assault to the business model of not just South African Airways, but many other international airlines,” Perry Munzwembiri a Zimbabwean economic and financial analyst focusing on sub-Saharan Africa and also the head of research at advisory and consultancy firm GrowthPoint Capital Zimbabwe, told International Finance.

“South African Airways no longer has the economies of scale in terms of route networks, passenger capacity, and cargo freight to compete internationally because of its poor geographic location. Simply put, it is outside the longitude necessary to achieve the efficiencies needed to survive as an airline. Of course, other factors such as mismanagement and corruption cannot be ignored in analysing how the airline is where it is today,” he added.

“South African Airways, essentially, no longer has a compelling economic case for survival as a business, and accumulated losses of over R28 billion over the last 13 years are a testament to this fact. It has been overtaken by changes in the aviation business. This is the basic problem it faces. For long, this reality has been masked by the endless government bailouts, north of R16.5 billion in the past decade alone, for instance. Without these bailouts, South African Airways would long have ceased to exist as a business entity,” says Munzwembiri.

Munzwembiri highlights other key issues plaguing the airline. For instance, as part of the business rescue programme initiated to try and save the airline, a proposal put forth is to cut all domestic routes except Johannesburg and Cape Town, in addition to other international routes. However, the government opposed this proposal, notwithstanding that the business rescue practitioners see this measure as key in ensuring the long-term survival of the airline. Another major factor is just the cost structure of South African Airways brought by overstaffing and rising jet fuel, and fleet management costs. For example, the average employees per passenger at South African Airways is around 200, against an international benchmark average of 100. This obviously means drastic staff cuts have to be implemented. However, this is likely to be opposed by the unions and government, which again brings us back to government interference in the airline.

Can South African Airways be salvaged?

Can the South African Airways be salvaged from its current predicament? Guy Leitch is of the opinion that it can be done. “There are plenty of examples of an airline being saved from a similar predicament,” says Leitch. “The first thing is to identify the fact that South African Airways is a business like any other business that is it has got a topline, a cost to sales, and other overheads. All it needs to do is get the figures in the right proportion and it’s not difficult.” According to Leitch, South African Airways is still quite capable of turning over revenue of around 20 to 25 billion rands per annum.

“It needs to get its cost to sales correct and which is largely happening with the upgrade to a relatively modern and young fleet of A350s, the new A330s and even A320s. Thereafter, what it needs to do is tackle the fixed cost especially the higher overheads. Get those things in line, which is not difficult, and the airline can be turned around.” But Guy Leitch has a warning about the government interference “One another thing that is required to get the cost base in line is to fix up the malfeasance that has crept into the procurement,” says Leitch.

Unfortunately, history has shown that politicians cannot keep their hands off South African Airways. “Despite the glaring evidence that this entity is a black hole that will keep draining the fiscus, the government has kept throwing a lifeline to South African Airways at a huge cost to the taxpayer.

The government often cites the need to preserve jobs and the protect the tourism industry as mitigating reasons for South African Airways to remain in existence; however, the question that begs an answer is at what cost, especially given the quantum of money that has already been spent on this flailing airline. This is money that could have been better spent elsewhere,” says Munzwembiri. As to the alternative financing arrangements going forward, the recent R3.5billion loan from the Development Bank of South Africa, approved in just under five days, without the necessary due-diligence checks provides some clues, according to him.

“DBSA`s mandate in no way whatsoever allows it to foray into financing entities like South African Airways, but instead is meant to fund infrastructure projects meant to reduce poverty and inequality. Unfortunately, such critical funding meant for other developmental projects is likely going to be diverted toward propping up South African Airways going forward,” says Munzwembiri. According to him, selling minority stakes is also not even a guarantee for survival, as evidenced by the recent collapse of Air Italy, partly owned by Qatar airlines, although this is a strategy that can be pursued.

What accounts for Ethiopian Airlines’ success?

The success of Ethiopian Airlines can be attributed to two factors that clearly distinguish it from South African Airways: Clarity of vision and independence from the government in day-to-day operations. In fact, Ethiopian Airlines achieved its Vision 2025 targets in 2018 itself and is now working toward realising its Vision 2035.

“The key to success for Ethiopian has been the approach of the Ethiopian government: In spite of government ownership, Ethiopian has been operating its day-to-day business independently as a commercial entity, further helped by competent leadership and well-trained staff, who are held accountable for their actions,” Dr Sabine Reim, senior vice president airline network strategy, at InterVISTAS, a global aviation, transportation, and tourism consulting company told International Finance. She notes a clear distinction which is highly relevant: while the government is the owner, it is not the manager of the business.

Ethiopia’s geographical location helped it in no small measure in emerging as a hub connecting Africa with the Middle East, Asia, and Europe. Addis Ababa has become a hub, where it is able to attract and transfer much more traffic, particularly from Asia moving on to the American continents. While exploiting Addis Ababa as the hub gave Ethiopian a first-mover advantage, the advantage of its success has really been made effective through a government policy that has enabled a coordinated aviation sector while allowing the national carrier to take a commercial focus in day-to-day operations, said Dr Reim. “This is effectively a brief to fulfil a national strategy sustainably,” she added.

Ethiopia is in a much more natural hub position for the African continent, compared to South Africa, and this makes a big difference for travellers, Marcel Langeslag, director of aviation, Netherlands Airport Consultants (NACO) told International Finance. “Ethiopian Airlines has a relatively young and fuel-efficient fleet. They have also partnered effectively with other African airlines to create a feeder network serving their hub in Addis Ababa,” he added.

Another factor that distinguishes Ethiopian from South African Airways is the way the two countries approach the rights of foreign airlines over their airspace and airports. “The Ethiopian government has provided intense protection to its own airline. It is extremely difficult for other airlines to get landing rights in Addis Ababa and to get third and fourth air freedom rights which are the rights to fly to other places in Ethiopia and operate in Ethiopian airspace. The government is very jealous in protecting those air rights,” says Guy Leitch.

Ethiopian Airlines’ most ambitious project is its recently announced $5 billion mega airport which it intends to make the hub of Africa. Economically, Ethiopia is on a relatively strong footing in Africa to execute such a project. “Ethiopia has much going for it when compared to some other countries – not only the many opportunities, and a solid domestic market potential, but also low corruption, a government that is committed to inclusive growth, and has demonstrated resolve and persistence in developing the country,” Frans Van Schaik, chairman and CEO of Africa Asset Finance Company (AAFC), which is an investor in the continent, told International Finance.

AAFC’s subsidiary Ethio Lease recently won the first financial services licence given to a foreign-owned company in Ethiopia. Van Schaik takes hope from the fact that Ethiopia has the experience of executing mega projects of strategic national interest like the Great Renaissance Dam. But he sees two conditions that need to be met for the project to succeed – reducing the control of the bureaucracy and finding ways to finance the project itself. In this regard, Van Schaik says, “I have no doubt that there will be plenty of takers should the opportunity be offered to international investors to participate in a PPP (public-private partnership), or BOT (build operate transfer), deal especially as and when the government relaxes currency controls.”

Munzwembiri added that to the extent that the airline anticipates growth in its traffic volumes, the mega airport will be a worthwhile venture especially when viewed with a long-term lens. Also, Bole’s capacity is being stretched. “Bole`s capacity is likely to come under pressure, especially as Ethiopian Airlines seeks to compete with Middle Eastern airlines. There will likely be issues to do with time to complete the project, as well as the ultimate cost of the project. That said, benefits will accrue in the long run,” he added.

Dr Sabine Reim of InterVISTAS says that for a competitive advantage in future, Ethiopian might need the newly announced Absera Airport. “In Africa, the growth and ambitions of RwandAir will see a brand-new hub with a growing network opening in Kigali within the next few years, and thus more competition for Ethiopian’s intra-African as well as core inter-continental connecting passenger base. A competitive hub will be key for Ethiopian not just to maintain its current position, but to execute its long-term growth strategy.”

Ethiopian Airlines is poised to dominate African aviation

Will South African Airways be shut down after March 31? A more likely scenario is that a stripped-down leaner version of South African will continue while shifting some of its local routes to regional airline Mango Airlines. But South African’s ability to boast of bringing the world to Africa and taking Africa to the world is thing of the past.

With the decline of South African and the rise of Ethiopian has the hub of Africa shifted to the east from the south? Dr Sabine Reim tells International Finance that South Africa remains to be a very important economy not only intra-Africa, but also globally, with very unique trade links, also relative to other African countries. This is notably demonstrated by relatively large demand to and from South Africa relative to other African countries, including Ethiopia. However, its very southern location lends itself more for supporting a hub with domestic connectivity and airports as end-points in itineraries. On the other hand, Ethiopian has capitalised on its location, essentially competing with European and the Middle East carriers for inter-continental traffic, exploiting the vacuum of an effective airlines in Africa as a first mover.

South Africa is still the largest aviation market on the continent. It has a big domestic market and is a popular destination for tourism and business travellers. Addis Ababa, on the other hand, is more of a transfer hub. “Air traffic growth in East Africa has been particularly strong over the past decade and looks set for continued growth. Countries such as Ethiopia, Rwanda, Tanzania and Zambia are all investing heavily in their airport infrastructure and national carriers. It seems that the centre of gravity of African aviation is shifting from South Africa towards East Africa,” Marcel Langeslag of NACO tells International Finance.

The continued success of Ethiopian Airlines and the liberalisation of the Ethiopian economy can be an important catalyst for the further development of Addis Ababa as a hub – not just for travel and air cargo, but also for tourism, trade, business services and, even financial services, says Frans Van Schaik of AAFC.

What is certain is that Ethiopian Airlines will continue to dominate the African skies into this decade and possibly in the distant future as well given its sound management and robust vision. The airline is moving very aggressively into entering into either joint ventures with other African airlines or buying majority stakes in struggling African airlines. It has a business model that allows it to spread its wings to West Africa, which is absolutely essential because the West African airline market is characterised by the universal failure of all its airlines, even the privately-owned ones.

“We see Ethiopian join in with ASKY Airlines for instance and also down in the south with a couple of other airlines – Malawi and Mozambique for instance. It looks like it will continue to grow and dominate the African skies and perhaps and take over the role that South African Airways used to claim in its advertising which is to bring the world to Africa and take Africa to the world,” says Guy Leitch.

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