IMPERATIVES OF PIA'S FLEET REPLACEMENT PLAN
By MUHAMMAD BASHIR CHAUDHRY
Sep 16 - 22, 2002
Pakistan International Airlines (PIA) is poised to commit $2 billion on its ambitious fleet replacement plan over the next 10 years. The Chairman, PIA on 26th August 2002, disclosing details of the plan in a press conference in Islamabad, said that new technology long-range wide-body aircraft like B-777 family, A-340-300, 500, and 600 will be inducted, with seven Turboprops. Two A-310-300 freighters and up to seven B-737 family or Airbus A-320/321/330 family of aircraft will also be purchased. He said six Cathay Pacific B-747-300 aircraft have already been purchased, though five of them were already on lease with the PIA. He added that the PIA Board has taken the decision, with transparency as hallmark of the shopping of the aircrafts on competitive rates. He added that on the recommendations of the Aircraft Acquisition Committee (AAC), aircraft have been identified for purchase of long-haul (Europe, USA, and Far East), regional/short and medium range (Middle East, South Asia, and Far East, Domestic), feeder/socio-economic routes, and freighter operations for the cargo market. He further added that the PIA Board would now deliberate over the mode of purchase of these aircrafts.
IMPERATIVES OF SUCCESSFUL EXECUTION
Large capital outlays might be handled very carefully. Procurement in Pakistan — of ships, tanks, submarines or other high-value items — is often not without problems. Buying of PIA planes is a major capital investment, mostly in foreign currency. Price, delivery time, buy, hire or lease options, loan and equity funding, new or used aircraft, sovereign guarantee and other securities, etc. are matters that need careful scrutiny at various levels before the orders are placed. PIA should strive to get full worth of the money spent. In case there are problems in procurement, now or afterwards, eventually Pakistan will suffer. To assist the government and the PIA in better execution of the replacement plan, attention is invited to the following critical areas:
FINANCIAL RESTRUCTURING OF PIA: It is good that PIA has turned around and posted profit of Rs 552 million for Jan-June this year. The national flag carrier is expecting to close the year 2002 with profit of Rs 2.4 billion, as against loss of Rs 2.2 billion during 2001 and bigger loss of Rs 5.3 billion during 2000. In the face of daunting challenges after 9/11, PIA management evolved turnaround strategy based on cost-cutting measures and restructuring of its overall operations to save it from total collapse. This is all very well, but will it be possible for PIA to finance, from its own resources, the rupee cost associated with the plan. It cannot be said with certainty that PIA's cash generation would support fully the debt servicing pertaining to the loans used for replacement of ten aircrafts during 2003. Continued stringent cost control and revenue enhancement measures are imperative throughout the plan period, supplemented by major capitalization restructuring of PIA. The plan may face problems without such restructuring.
PIA AUDITED ACCOUNTS — 2002: PIA's financial strength and profitability will largely determine the cost of borrowing and loan security. GOP and PIA credit ratings will be considered, as most probably GOP will be providing the guarantee. The bankers always wish to see the prospective borrowers' profits and strong financial position depicted in a properly audited annual account, without any qualification — specific or implied. Otherwise, mostly they do not deal or quote unreasonably high fees and strict terms as to security and repayments. PIA management is urged to work with the existing creditors and the government with the aim to resolve / streamline major financial issues and properly reflect the same in the audited annual accounts for year ending Dec. 31, 2002. PIA may take up the matter with its external auditors for early finalization of the audit, possibly before the start of formal negotiations with the creditors.
MODE OF PURCHASE OF THE AIRCRAFT: PIA's immediate attention might be on progressing the aircraft acquisition arrangements for the three Boeing and seven turboprops scheduled for 2003, as announced by the PIA Chairman in a conference on 26th August 2002. This is the major area of concern and must be handled with caution. In this context, PIA might consider the following:
1. Due to worldwide slump in the air travel market and consequently over-capacity, aircraft prices are low and there is an opportunity for PIA Board to get favourable terms on financing and aircraft prices, including deep discounts. PIA might stand a better chance if the airline had strong balance sheet and rest of the funds were already lined up.
2. There are four probable mode of acquisition for the new aircrafts scheduled for 2003. These modes are: (i) lease-purchase, (ii) hire purchase, (iii) outright purchase through buyers credit and (iv) cash basis. Selection of a particular mode might be made after comparison of net present value of costs and benefits under each mode. PIA and the government might also keep in view the chance to utilize part of the substantial foreign exchange reserves for the profitable placement of which the State Bank of Pakistan is presently contemplating. The proposed interest / profit rate in the lease or hire rental or the interest rate applicable to the buyers' credit must not be too divergent from the expected profit on placement of foreign exchange reserve by the SBP. Export credit insurance fee, delivery schedule and extensiveness of security / legal documentation might be the other factors that need to be examined for each mode.
3. The negotiation team shall have to do considerable work even after the mode for acquisition has been agreed. For the selected mode, detailed terms and conditions particularly conditions precedent need to be agreed and documentation prepared accordingly.
4. Ministry of Finance has reportedly advised PIA to avoid payment of any commission or fee / brokerage to any middlemen, broker or institution involved. In this context, it may be mentioned that procurement of new capital equipment directly from the genuine manufacturers is the first precaution. Therefore, it would be advisable if the acquisition of the aircrafts were directly from Boeing or Airbus, without involving any middleman. An undertaking from Boeing or Airbus has more value. Undertakings to this effect from any leasing or trading companies do not mean much.
5. Major upcoming events such as general elections may also be taken into account while proceeding with such major capital investment.
6. Security asked by the lenders is also important. Certain lenders may be asking for government guarantee as well as charge on the airplane so financed. The other lenders may not be so strict. So there is possibility of negotiating a better security option for PIA and the government. Sovereign guarantee for PIA borrowings may complicate GOP matters with the IMF.
7. For financing facilities at comparative rates, PIA might as well keep provision for the loan funds from Middle Eastern banks, based on interest or on Islamic mode of finance.
AVOIDING DISRUPTION OF OPERATIONS: As per details released in the press conference, PIA would phase-out its aging aircraft like two B-747-200 (JT9D), eight A-300B4 and 11 F-27 aircraft in 2002-3, two 747-Combi in 2006, three 747-300's in 2008, and seven B-737-300 in 2010/2011. The plan covers gradual replacement of the ageing aircraft models by buying three B-777 by 2003, 7 turboprops to replace F-27 by 2003, a number of A-340 family aircraft and two A-310-300 freighters in 2006. The sale or disposal of existing aircraft with the new aircrafts must not disturb the PIA's local or foreign flight schedules. In addition, it has been reported that delivery of the sixth Boeing from Cathay Pacific will be in December. PIA wants the delivery earlier to use the aircraft for Hajj operations. Such matters need to be sorted out before the transaction is finalized and down payment is released.
MANUFACTURERS' CAMPAIGN: Now that there is decision on make of the aircraft, chances are the selling campaign by Boeing and Airbus will still continue. Each manufacture may offer certain improved features in the aircrafts over the ones in the earlier proposal. They may also offer to add certain frills to help in PIA's advertising or marketing campaigns. Due to such additions, and if agreed to by PIA, they may ask substantial increase in price. This might entail more work for the AAC and another round of approvals.
ELIMINATING KICKBACKS / COMMISSIONS: The Chairman, AAC in the press conference reportedly said that the committee provided the "professional advice" while the decision was left with the PIA Board. The committee weighed the pros and cons of the proposals and recommended purchase of new aircraft since their reliability is good and these do not entail extra expenditures on spares for the initial eight years, and the provision would also reflect on the quality of service, he added. The PIA Board met several times but there was no decision on choice of aircraft. It was reported in the press that as PIA directors could not agree, the Finance Minister would be deciding in the matter. However, the Finance Minister, in a meeting with PIA Board on 12th August, reportedly made it clear that his ministry had nothing to do with the fleet selection but the government would not tolerate any under-hand deal to benefit any individual or group. He also added that PIA might borrow or get planes on lease but everything should be transparent. PIA Board has to take measures so that there is no doubt about any under-hand deals or kickbacks and that all phases in the plane selection, financing under different options, and payment of all fees and charges are fully transparent. If there are requirements to seek prior government approval, the same might be done. The PIA might also note that there should not be any such problems in the disposal of existing aircrafts.
GOVERNMENT FUNDING SUPPORT: A meeting presided over by Minister for Finance and attended by PIA Chairman, Managing-director and its Board members, at Islamabad on 12th August 2002 reportedly cleared PIA's $1 billion financing plan to buy new and old planes to upgrade the airline's fleet. The government has agreed to contribute $ 150 million over three years as equity to help the airline purchase first three planes.
It has been said that the financial package includes short-term debt restructuring, issuance of TFCs of Rs15.4 billion to repay overdue liabilities and repayment of bridge loans and about Rs12 billion mark-up on restructured debts / TFCs which would reportedly be picked up by the government of Pakistan over a period of five years. This would be treated as equity contribution from the government in PIA books. It is suggested that the government approval in all such financial matters might be formalized. PIA on its own might not be able to bridge finance the foreign currency cost in case of delay in the effectiveness of the government support for that purpose.
CAPACITY BUILDING: It is advisable to up-date the plan periodically in the light of actual developments locally or abroad. PIA might set up a multi-discipline team to work in close coordination with the internal departments and the external agencies, with easy access for advice to the Chief Operating Officer and the Managing Director. This team might be supporting the AAC and the PIA Board. The team may be able to develop preparatory reports regarding different aircraft matters such as technical specification, safety, regulatory approvals, cost of spares, engine over-haul, no frills price, fuel consumption, man-power for flying and cabin-crew, seating configuration, credit availability and cost of credit, loan security, down payment, government guarantee, delivery schedule, supplier as manufacturer / middle-man, government / manufacturers certification about price and kick-backs, versatility, comparison of net present value of cost and benefits, etc. Based on PIA's actual experience, the criteria may be further refined. The team may be provided full access to required information and also encouraged to develop proper databank to be able to perform its functions well in future.
ATTRACTING LARGER CLIENTAGE: It is said that PIA would cater largely to Pakistani expatriates working in Europe, North America and Middle Eastern countries. This may be so but PIA must not forget the aim to become the airline of choice by nationals of these countries and regions. Once PIA is able to attract these travellers on all routes, only then PIA can claim itself a competitive airline of the world. For that, PIA shall have to improve its performance in many areas including service, quality of food, security, courtesy and punctuality. More efforts are needed on consistent basis for improving passenger comfort.
COORDINATION FOR EXCELLENCE IN SERVICE: For better service and facilities to the travellers in Pakistan, PIA shall have to work closely with CAA and the Airport Security Agency.
The three institutions together can ensure excellent service and passenger comfort.