Presentation to Parliamentary Portfolio

Committee on Public Enterprises

18 February 2009

Dr A ShawDDG: Transport

Department of Public Enterprises

OPERATIONAL ENVIRONMENT

• SAA is currently facing the effect of the worldwide downturn in economic activity which is expected to continue in the medium term.

• Passenger demand rapidly deteriorated from August/September 2008 and worsened considerably by the end of the calendar year as the global financial crisis intensified.

• Passengers carried in the markets between SA and USA, Europe and India have since September reduced substantially. Passengers in the domestic market have also declined but not as dramatically as in the inter-continental market.

• African regional air travel has over the same period increased. The African market however currently accounts for a small portion of SAA’s total revenue compared to approximately 60% of SAA’s revenue derived in the intercontinental market.

Year on Year Quarterly Passenger Growth for Quarters Ended Mar 01 - Dec 08

-14%

-9%

-4%

1%

6%

11%

16%

21%

Mar

-01

Sep-0

1

Mar

-02

Sep-0

2

Mar

-03

Sep-0

3

Mar

-04

Sep-0

4

Mar

-05

Sep-0

5

Mar

-06

Sep-0

6

Mar

-07

Sep-0

7

Mar

-08

Sep-0

8

Month

Total Domestic PaxTotal International Pax

SOUTH AFRICA HAS EXPERIENCED A DRAMATIC DROP IN PASSENGERS SINCE APRIL 2008

THE RESTRUCTURING PLAN • After failing to meet going concern requirements in March 2007,

the restructuring programme was introduced. • The objective was to improve SAA’s operational competitiveness

through reducing cost and restructuring the company and its network of operations.

• The resulting restructuring plan incorporated the following

elements:• A reassessment of the SAA fleet and network of operations including the

elimination of inefficient Boeing 747-400 aircraft.• Organisational re-alignment and the corporatisation of non-core entities

with a view to finding strategic equity partners in these areas.• Head office staff reductions including voluntary severance packages

across the organisation.• Cost reductions and simplified procedures.• Review of contracts including unwinding certain onerous legacy

contracts.• Improvement in revenue and yield management leading to increased

average revenue per passenger

EFFECTIVENESS OF RESTRUCTURING • The plan was funded by a transfer of R653 million to SAA for labour

restructuring and the provision of quasi-equity in the form of a guarantee for R1.56 billion to cover the costs of grounding the Boeing 747-400 aircraft.

• Restructuring achieved cost savings of R1.141 billion by March 2008; enabling SAA to post a operating profit of R123 (before restructuring costs) at 2007/2008 year end.

• SAA however, failed to achieve effective organisational re-alignment within the proposed time frames:• Corporatisation, outsourcing or selection of strategic equity

partners for Voyager, SAAT, catering and potentially air-freight have not progressed.

• There has been improvements in revenue management, marketing and market share, however these have not achieved the restructuring targets.

• Whilst average fares have increased, load factors have declined as a result of the general economic downturn.

INTERNATIONAL BUSINESS ENVIRONMENT

• Most network airlines have suffered substantial reductions in profitability or losses as a result of the high fuel prices and subsequent fuel hedges and a softening of demand leading to lower revenue yields.

• 35 medium sized network airlines have been liquated in the last year.

• IATA forecasts losses for the airline industry at US$5 billion for the 2008 calendar year with larger losses expected in the 2009 calendar year.

• The continuing recession has resulted in new lows for consumer and business confidence with all traffic markets expected to fall substantially.

• Reduction in costs are offset by larger reductions in prices and yields. Published capacity plans in the airline industry indicate sharp cut-backs and cost saving measures by most airlines; cost cutting measures of a similar nature to the cost savings measures implemented by SAA during its restructuring programme.

GLOBAL AVIATION HAS BEEN HARD IT BY THE ECONOMIC DOWNTURN

Source: IATA Analysis for DPE

Both passenger Revenue Passenger Kilometers (RPK) and air freight

IATA ANALYSIS SHOWS THAT PUBLISHED CAPACITY PLANS INDICATE SHARP CUT_BACKS PARTICULARLY IN THE US

Growth in planned and forecast Average Seat Kilometers (ASK)

Source: IATA Analysis for DPE

EQUITY COMPARISON WITH OTHER AIRLINES

On and Off Balance Sheet Debt/Shareholders Funds (%)

-400%

-200%

0%

200%

400%

600%

800%

1000%

1200%

1400%

1600%

Cathay

Lufth

ansa

Air Fr

ance AA

Delta

Qanta

sBA

Singap

ore

Air Can

adaSAA

Avera

ge (e

xclud

ing U

S)

• SAA has the highest on and off balance sheet

gearing ratio. Higher than American Airlines and Delta currently under Chapter 11

bankruptcy protection at the time of their last financial statements

On and Off Balance Sheet Debt On and Off Balance Sheet Debt to Turnover

On and Off Balance Sheet Debt/Turnover (%)

0%

20%

40%

60%

80%

100%

120%

Cathay

Lufth

ansa

Air Fr

ance AA

Delta

Qanta

sBA

Singap

ore

Air Can

adaSAA

Avera

ge (e

xclud

ing U

S)

• SAA has the highest level of debt to turnover

SAA would need to increase its shareholders funds substantially to be at sustainable debt levels in alignment with industry peers.

• Guarantee for Air Traffic Liability of SAA for R 1 600 million expires on 31 March 2009. Future

requirements to be negotiated with the Air Services Licensing Council and the International Air Services

Licensing Council.• Quasi-equity of guarantees funded by subordinated loans impose conditions that SAA may not utilise

such funds for other purposes.• Funds remain in cash and SAA incurs a higher interest cost than can be earned on current deposits.

Funding utilised

Financial assistance provided

Impact Funds Guarantees for Loan

Subordinated loan

Guarantee provided to assure going concern and restore 2006 balance sheet equity value (Cover losses of 2006/07)

Cash is ring fenced and may not be used by SAA

1 300

Transfer of funds

Shareholder injection for labour restructuring

Only to be used for labour restructuring costs

653

Subordinated loan received from funding banks

Guarantee provided to restore balance sheet after providing for cost of B747-400 fleet grounding

Cash is ring fenced and may not be used by SAA

1 560

Sub-Total   653 2860

Total 3 513

FUNDS AND GUARANTEES SINCE TRANSFER OF SAA TO GOVERNMENT

(R Million)

Background• Two guarantees were issued to

SAA to enable it to raise subordinated loans that are treated as equity and meant that SAA could maintain its balance sheet solvency. • A R1,300 million subordinated

loan issued in March 2007 to cover losses and

• A R1,560 million subordinated loan was issued in March 2008 to cover costs related to the grounding of the B747-400 fleet.

• Benefit was to reduce SAA’s on and off balance sheet debt but in reality interest cost for SAA is retained. SAA incurs interest cost on cash that may not be used in the business

Benefit of R1.56 Bill• Ideally there would be a need to

replace the subordinated loans with permanent equity finance that will require the conversion of the guaranteed subordinated loans into share capital

• The 2008 Budget converts the current guarantee of R1,560 million from quasi-equity to full equity.

• The overall equity position of SAA does not change. However, the current substantial interest burden is reduced.

• It is required that the guarantee is cancelled such that the equity injection is used to pay down loans issued previously using the guarantee as a mechanism for funding the grounding of the 747-400s

CONVERSION OF R1.56 BILL FROM QUASI-EQUITY TO FULL EQUITY

A STRATEGIC CHANGE IN DIRECTION

• SAA is inadequately positioned to deal with recent turbulence in the aviation market. It remains thinly capitalised. The R1.56bn allocated in the budget is not sufficient, but is a good beginning.

• The culture of dependence on government must be reversed. The airline must trade itself into profitability.

• The restructuring programme has reduced costs, but revenue and route profitability remain ongoing challenges.

• Route profitability needs to be comprehensively assessed and routes and schedules need to be adjusted more rapidly in the face of market related changes.

• Support services need to be converted into profit centres with arms length agreements with SAA.

• Operationally the airline requires additional skills and expertise

IMMEDIATE CHALLENGES THAT MUST BE ADDRESSED

• Voyager liability must be resolved

• Negotiations with Airbus on the order must be finalised

• Resolve all outstanding competition matters

• Renegotiation of all internal supplier contracts to market standards

THANK YOU