Business World
Friday-Saturday, December 11-12, 1998
By MICHAEL ALAN
President Joseph Ejercito Estrada's first big success wound up back on the Palace doorstep this week with the submission of a limp stand-alone rehabilitation plan by Philippine Airlines (PAL) to the Security and Exchange Commission. However this dilemma plays out in the days before this article appears, the prospects for rehabilitating the national airline are exceptionally remote.
According to the plan submitted by PAL Management, the airline has total liabilities of US$2.28 billion, with about half this amount secured by aircraft. Partially secured and unsecured creditors, if the plan is approved, would be required to wait anywhere from three to five years to a maximum of 15 years to recover obligations owed to them, depending on operating results and the recruitment of a strategic partner. Twenty-two aircraft would be retained to service I3 international and 17 domestic destinations.
The overall viability of the plan will reside in three crucial factors: 1) smooth labor relations; 2) better economic conditions; and 3) a strategic partner. In apparent good faith, PAL Chairman Lucio Tan will infuse up to US$150 million in operating capital, US$90 million upon approval of the plan and the balance in six months.
Smooth Labor Relations. Under the plan, the 20% stake promised by Mr. Tan to airline employees would be diluted to 5%, significantly eroding labor's equity interest. The impact of the dilution on labor’s willingness to live up to the 10-year strike moratorium in return for the equity stake is unclear so far, but is likely, given past history to result in further unrest. Although another strike will immediately kill off the airline for good, Mr. Estrada 's repeated promise to keep the airline going — "I'll do anything," he says – may convince labor leaders that government will come galloping to the rescue with fresh funds, despite earlier vows not to do so. Indeed, Finance Secretary Edgardo Espiritu has said that government financial institutions may have to provide bridge financing for the airline, committing taxpayer revenues to a dubious, at best, borrower that cannot pay its existing obligations. It will be difficult to justify employing national resources for the airline as a wise use of funds.
Better Economic Conditions. Although economic conditions are expected to improve in 1999, the increase in growth will not be dramatic. Even if it were, improved economic conditions do not guarantee a significant boost in visitor arrivals. The Philippines has consistently trailed its Southeast Asian neighbors by significant — even embarrassing — margins in tourist arrivals. Nothing has taken place to improve prospects for increased tourist interest. In fact, continuing controversy over whether the Philippines should host the World Expo is not a confidence builder, whether the Expo eventually takes place or not. Tourism infrastructure remains unsophisticated and underdeveloped, from transportation to communication. It is hard to be a tourist in the Philippines, and the importance of being competitive in this regard does not yet seem to have taken hold in high government circles.
The other reason an improved economy doesn't necessarily bode well for PAL is the management issue. When faced with increasing competition, the airline lobbied government to restrict access to the Philippines by foreign carriers, rather than work to significantly improve operational efficiency and service standards. It has been fiercely opposed to any open skies agreement. Yet every year since Mr. Tan acquired the airline, PAL has posted increased losses despite higher revenues. If the trend holds, a better economy may mean that PAL will just lose money faster.
Recruitment of a Strategic Partner. PAL is the wallflower of Asian airlines that refuses to bloom. Every remotely conceivable partner has been asked to take a look at the airline. So far, the only interested airline has been Cathay, also troubled by the downturn in Asian tourism and the financial crisis. The notion that everyone should want to buy the airline simply because it is available needs to be put to rest. Singapore Airlines said as much this week in a blunt statement denying any interest in the airline. Northwest Airlines, which may actually demonstrate the best strategic fit with PAL, has also said "no deal” clearly and repeatedly. There are good reasons to shy away.
First of all, PAL is no bargain. It is a deeply, deeply troubled organization that desperately requires rescue. Unlike most mergers these days, any alliance with another airline will not be a merger of dominant, successful players in the industry. This will not be a union of champions. The strategic partner that invests in PAL must show shareholders how an investment of at least US$I00 million in an airline that has US$2.28 billion in restructured obligations is a prudent use of funds.
And making PAL healthy will be far from easy, even for one of Asia's most admired airlines. PAL's problems are significant and deeply rooted. Although as we've seen, not entirely of its own making. But most of the problems are its own, and range from low productivity to lack of industry experience among senior management as well as basic managerial competence in a competitive environment. What, therefore, is a strategic partner asked to acquire? And the answer is, a long-shot opportunity.
Cathay, despite PAL's problems, appeared to be willing over the past eight weeks to bet on that opportunity: that it could turn the airline around. But only on condition that it would be in control of PAL•s destiny. Given the record of Mr. Tan's management group and the desperate condition of the airline, it is impossible to fathom, on the surface, why this should be an issue. The partnership with Cathay presents Mr. Tan the best prospects he will ever have to regain a significant portion of the investment he has made in the crippled airline. So, what's the problem?
Entitlement. Despite much talk about free markets and level playing fields, it is often excruciatingly difficult to shake the notion of entitlement among well-placed friends of incumbent administrations – not just here of course, but in most emerging economies. And in the Philippines, this has been the case for all three post-Marcos administrations. As insane as it should sound, therefore, could it be that Mr. Tan has convinced himself — with or without the encouragement of Mr. Estrada – that he's entitled to control on the basis of his relationship with the president?
Supply Contracts. To what extent does Mr. Tan want to retain management control? Over operations? Purchasing? People? Finance? Subsidiaries? It might be that Mr. Tan seeks to retain control of segments of the airline's business that impact his related interests. That scents a lot more likely than any sudden compassion for the airline's employees.
Whatever the reason, none of them are good enough to jeopardize what should have been a done deal. It is true that in negotiations, it is important to argue from a position of strength, even when that is not the obvious reality. But it is also important not to overplay one's hand, especially on the basis of something as unreliable as some feudal sense of entitlement, or the prospect of retaining business probably not in the best interest of the airline.
All this means that it is time for Mr. Estrada to act presidential again. And solve this problem for good.
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