National Airline or National Burden??

By Gene Won.

Do we need a National Airline?

I was recently sitting in the departure lounge at the international terminal waiting to board the plane for Brisbane. At check-in, I was told that the plane was full, and looking around, I saw a mixture of passengers. There were tourists, local residents, and a lot of seasonal workers. Full planes mean good loadings and this is good for Air Vanuatu. However, Vanuatu’s embattled airline has had its fair share of problems and the problems go deeper and further back into its thirtyplus years of existence. In its 2020 financial statements, the numbers are quite concerning. As of 31st December 2020, Air Vanuatu has accumulated losses of VT7.785b with a negative equity position of VT3.12b. Its solvency has only been possible with the support of the Vanuatu Government and, therefore, the taxpayers of Vanuatu.

There are many arguments for and against having a national airline. National pride, its importance to the tourism industry, the need to provide air transport links to the outer islands, and other benefits need to be balanced against the cost to taxpayers for the financial support that the Government has provided. There has been much criticism recently of the current senior management of Air Vanuatu but the root of the problems could be much deeper and more complex than what has been seen to be happening in the last few years.

Background and history CEOs

Air Vanuatu was originally set up after independence in 1981 through a joint arrangement with Ansett Airlines who provided the aircraft and staff under a 5-year agreement. Ansett took a 40% stake in the airline with the Vanuatu Government the remaining 60%. After the agreement with Ansett ended, the airline was re-established in its current structure in 1987, with the
Vanuatu Government taking 100% shareholding in a new agreement with Australian Airlines. The first CEO
of the re-established Air Vanuatu was Peter Roberts. He was succeeded by Jean-Paul Virelala in 1995 who held the CEO position until 2005. Terry Kerr succeeded Jean Paul Virelala for the next two years but was terminated by the Board early in 2008. He was replaced by Hollingsworth Ala who then held the CEO position for the next 2 years.

In 2009 Joseph Laloyer was appointed CEO replacing Hollingsworth Ala, and he held that position until 2018 when he was replaced by Derek Nice. Nice, a Canadian with extensive airline experience was appointed by the Board in 2018. Just before the pandemic, and the border closures, Nice left the country and did not return. He was subsequently replaced as CEO in May 2020.

The current CEO is Atu Finau who has a background in Aircraft Engineering and was appointed in January 2021 taking over from Joseph Laloyer who held the acting CEO position after the departure of Nice.

Fluctuating Financial performance

After the merger in 2004 of Vanair, the domestic operation, with Air Vanuatu’s international operations, the airline had fluctuating financial results. In the 15 years since 2006, the airline was able to make an operating profit in seven of those years. However, three major setback events appear to have had a great lasting impact on the financial performance of the airline. In 2008, there was the Global Financial Crisis. The GFC was to seriously impact airline profitability, affecting revenues and operating costs. In the two prior years to 2008, the airline had made operating profits but in the following years 2008 and 2009 the combined operating losses were VT1.96b. These losses were also made worse with one-off write-offs of VT611m but the airline was able to gradually return to profitability with a VT314m profit in 2012.

Then, in 2015, Cyclone PAM a category 5 cyclone hit Vanuatu causing extensive damage to the country and the Tourism Industry. There was an immediate downturn in revenues and the operating loss that year was VT1.55b.

There was a strong recovery in the following years again and subsequently saw a return to profits in 2016 and 2017 . When the reins of the airline were handed over from Laloyer to Nice, in 2018, the airline had made a profit of VT296m the previous year with historically high revenues of over VT6b. In the first year of Derek Nice’s stewardship, revenues rose again to VT6.3b but so did operating costs, and again, there was an operating loss. One-off write-offs and provisions of just over VT1b made the loss in 2018 look worse than it appeared. In 2019, all-time high revenues of VT7.56b were achieved and the airline was able to generate a profit. It was during this period that the VTO launched the 2030 Market Development Plan and Nice conceived his ambitious plan to dramatically alter the course of the airline by entering into an agreement to purchase 4 Airbus A220s.

The third major setback was when COVID arrived in early 2020 and the country closed its borders. The worldwide effect on airline finances was dramatic with revenues plummeting and the operating loss in 2020 for Air Vanuatu was VT2.25b.

The Audited 2020 financial accounts of Air Vanuatu show the following. Accumulated losses of the airline as of 31st December 2020 were VT7.786b and the net equity position of the company was a negative VT3.175b. Air Vanuatu has been technically insolvent since 2008 and it was clear that without the support of the Vanuatu Government, the airline would have shut down many years ago.

An accountant will tell you that losses need to be funded. There are three main ways to fund losses. When a business incurs negative cashflows due to operating losses, any reserves will be used up and surplus assets will be sold off and liquidated. If there are insufficient assets to liquidate, then
the losses can be covered by increased liabilities, primarily through more debt.

In the case of Air Vanuatu, it borrowed from banks, the Government, and also the VNPF. Then, when there are no more assets to sell and the banks are not willing to lend any more money, the shareholders have to inject more capital to keep the organization solvent or it is placed under receivership. It would appear that our National Airline has arrived at the last option. The Vanuatu Government recapitalized its loans to the airline twice. In 2013 and 2019.

Air Vanuatu Changes Course. Time to Go Big or go Home

It was during the Nice term that huge changes happened. Derek Nice conceived the ambitious plan to purchase 4 new Airbus A220 aircraft. In a 2019 Vanuatu Business Review interview with Dan McGarry, he is quoted as saying that it was “time to go Big or Go Home”. The ambitious plan which he put forward was not just to improve the airline’s profitability but to grab a much larger share of the region’s tourist market. The reasoning behind this plan was based on his argument that the Airbus A220 was a more suitable aircraft for the region. Up until that point in time, the airline had been operating on a single Boeing 737 aircraft for the Australian and New Zealand markets.

“The 220 is a breakthrough technology,” said Nice. “All the airlines operating in the South Pacific… we’ve all been forced to operate aircraft larger than what we need, because we needed aircraft that operated on the sufficient range, to be able to get to Australia, New Zealand, and other destinations. So we had no choice but to get these very big, very expensive aircraft like the Boeing 737.”

He argued that whilst the 737 was suitable for the large Sydney market, it was the other destinations that could have been better catered to with smaller aircraft flying with increased frequency. The A220 had the same range as the Boeing but with vastly better economics. With the additional aircraft, the other destinations could be serviced with increased frequency without paying for the increased cost penalty and provide better connectivity between Vanuatu and its passenger markets.

It all made sense to decision-makers in the Vanuatu Government and the plan was endorsed by the Council of Ministers. At a joint press conference on the 28th of February 2019, between Air Vanuatu and Airbus Cooperation in the Bauerfield Airport VIP lounge, Nice, confirmed that Air Vanuatu would be acquiring four of those aircraft for a total cost of approximately US$350 million. He continued to say that the additional aircraft to the fleet would bring 300,000 + visitors to our shores by the year 2030, three times more than tourism numbers at the time. On March 2020, Air Vanuatu announced that it had finalized its A220 project financing with the selection of a major international aircraft lessor to finance its new Airbus A220 aircraft fleet. A Vanuatu bank would also be providing a working capital facility, supplementing a VT2 billion investment made by the Government of Vanuatu. The timing of this was unfortunate. In the same month, the Director General of the WHO announced that the COVID-19 outbreak that had started in Wuhan China had now developed into a worldwide PANDEMIC. The rest is history.

The Hangover

The vision of Nice to commit the airline to purchase 4 Airbus A220s coincided
with the launch of the VTO’s 2030 Market Development plan. This wildly ambitious plan projected that by
2030, the airline would be bringing in 300,000 visitors per year. There was a lot of fanfare and publicity surrounding the launch of the Plan amongst stakeholders in the Tourism Industry. The problem was that the airline had been insolvent since 2008 and its ability to finance the purchase of the aircraft was in serious doubt despite backing from the Vanuatu government. The party ended before it started and
in March 2020, COVID arrived.

The Nice plan was heavily criticized. In October 2020, the government
announced that there would be an investigation into the purchase of the A220s, and in December 2020, a commission of inquiry was set up headed by John Path as chair. The COI report was tabled to the Minister of Justice in April 2021. The COI concluded that the A220 aircraft was not suitable due to a lack of pilots and engineers to fly and maintain the aircraft, but there was a problem. A deposit had already
been given to Airbus of VT1.278b and purchase agreements had been signed in 2019 committing the airline. Sources within Air Vanuatu have advised that discussions with Airbus are ongoing on
how this situation will be resolved with a possible option of another type of Airbus being considered as a different option to the A220. It should be noted that QANTAS who provides codeshare and engineering support to Air Vanuatu has 20 of the same A220 aircraft on order, so there is little doubt as to the merits of this plane. The situation is quite complex and discussions are still ongoing.

The Future of the Airline

Without the Vanuatu Government’s financial support, the airline would close. It is insolvent and has been
since 2008. Aircraft options aside, based on the 2020 balance sheet, to recapitalize the balance sheet of the airline and clear its debt, would require an injection from the shareholders of over VT3b. Assuming that losses in 2021 are similar to 2020, a further VT2b would be required bringing the total funding needed to more than VT5b, just to draw a line in the sand for the future operations of the airline. The
Vanuatu Government needs to decide on the future of our airline before even considering the question of what type of aircraft Air Vanuatu needs to be flying. Our national airline should not be seen just through the eyes of the Tourism Sector. There are many other considerations regarding the airline that cannot be ignored.

Some critics have proposed the closure of the airline and entering into underwriting agreements with other regional airlines to bring tourists into the country through a subsidy. This arrangement is currently being used with success between the Cook Islands and Air New Zealand costing $4.4m for the Sydney – Rarotonga and $7.7m for the Los Angeles – Rarotonga service.

Economists have speculated that based on the accumulated losses to date, Vanuatu taxpayers have been supporting the airline through loans from the government by subsidizing tourism arrivals of between $100-150 per visitor.

The supporters of the Airline point out that there is much more to the Airline than how much profit it makes and how many visitors it brings to the Country. The history of the Airline has demonstrated that it can sometimes be managed properly and that profits can be made. Of the 15 years from 2006 – 2020, profits were made in seven of those years. It is just that the weight of the losses in the other eight years has far exceeded any profits made. The airline is also a major employer in the country with annual expenditure on wages and employee benefits exceeding VT1b every year. Just prior to the COVID pandemic, employee numbers for the airline stood at 448. Any closure of the airline would result in large numbers of Ni Vanuatu losing their incomes.

Lastly, the National Airline provides a domestic air transport service to remote island destinations in Vanuatu. This concept is called Community Service Obligations (CSO) and is an unwritten agreement between the Airline and the Government that obliges Air Vanuatu to fly to unprofitable destinations and in doing so enables those remote communities to be able to connect with other parts of the country. Any closure of the airline would jeopardize those services and affect remote communities. In effect, profitable routes subsidize unprofitable routes.

With new elections in October, there is a strong possibility of a change in the leadership of Vanuatu under a new government. With the new leadership, urgent decisions will need to be made not just for the future of our National Airline but how it will affect the future of the country.