Why a Sh51bn billion bailout of Precision Air is a bargain

In August 2013, Tanzania’s largest domestic airline, Precision Air, was reported to be in such dire financial straits that it was urgently seeking funds from investors and banks. The firm had also approached the government of Tanzania for a Sh51 billion ($32 million) bailout. A month later, the airline reported a Sh30.5 billion ($18.9 million) net loss for the financial year ending March 31, 2013. It blamed high fuel and equipment costs for the loss. It has subsequently announced plans to cut its workforce as a cost saving measure.

Birds of a feather?

Precision Air is in good company. Fastjet, a new low-cost airline that entered the market in November 2012, at first seemed to be flying high. It too hit stormy weather. After igniting a price war with Precision Air on domestic flights, Fastjet attracted many passengers, including numerous first-time fliers. However, the airline, which is listed on the London Stock Exchange, has also been struggling financially.

Its share price has been trading at just over one pence per share (Sh25), a share price so low that stock market regulations almost prevented the company from raising more funds from investors. In August 2013, it was reported that Fastjet was planning to cut 12 per cent of its workforce in Tanzania in order to reduce operating costs.

Why are both airlines experiencing such financial turbulence? Running an airline profitably anywhere in the world is inherently challenging. Doing so in Africa is especially difficult. Despite growing passenger numbers and increasing demand for low-cost flights, airlines find it hard going in Africa because of much higher operating costs. In addition to higher fuel and ticket taxes, African airlines have to pay more to lease planes than carriers in other regions of the world. A five-year-old Boeing 737, similar to those that Precision Air used to fly, can cost an African carrier up to $400,000 (Sh645 million) a month to lease, compared to just $180,000 (Sh290 million) in Europe. Why?

Leasing companies blame African airlines’ comparatively poor safety records, and African courts’ slowness in dealing with corporate bankruptcies as reasons for the higher perceived risk that leads to high leasing charges. Additionally, the cost of insuring African carriers is also very high. While these factors certainly affect airlines financial fortunes, good management is even more important for the successful navigation of such a turbulent environment. Precision Air may have made some unforced errors. Its expansion into several new international routes such as Johannesburg and Lubumbashi may have been too much, too soon.

Should the government rescue Precision Air?

Given Precision Air’s dire financial position, should the government of Tanzania come to its rescue? Should Tanzanians’ taxes be used to prop up this private airline? The short answer is yes!

As a country that aspires to middle income status in the near future, Tanzania cannot afford to let its leading domestic air passenger carrier collapse. Precision Air has the most extensive and inclusive domestic route network. Its collapse would severely disrupt Tanzania’s transport sector, re-isolating major emerging economic centres such as Kigoma and Mtwara and raising the cost of doing business across this large country. It would be an unmitigated disaster.

In its current state, the company is unlikely to secure loans from the commercial banks, particularly without an explicit guarantee from the government. Its two largest shareholders - founder and chairman, Mr Michael Shirima, and Kenya Airways - seem unable to provide additional capital. Kenya Airways is fighting to get its own financial house in order after reporting a Ksh10.8 billion ($127 million) loss for financial year ended March 2013. Mr Shirima is unlikely to be able to cover the funding gap alone. If Precision Air is to survive, it seems like the government has no other choice than to come to the rescue.

How should government intervene?

State intervention is often not pretty but it can be made to work. The government should step in for the medium term to effectively recapitalise and help to refinance Precision Air. The explicit aim would be to sell whatever stake it bought in the airline, back to the private sector for a profit in about five years. In broad terms it could be done as follows:

First, the government could buy into the company and dilute existing shareholders. While this may irritate them, they would have little choice if they were unable to participate in the recapitalisation. At Precision Air’s share price of Sh475 ($0.30), unchanged since its IPO in 2012, Sh51 billion ($32 million) would buy a sizeable share of the equity in the company, almost twice the 58.8 million shares that were floated at its initial public offering. If it did so, the government would not only bail out the airline, but also the 7,057 investors who bought its shares.

Secondly, the government (through the well-capitalised Tanzania Investment Bank for example) could provide new long-term loan facilities and credit lines to the company at cheap interest rates. These funds can be used by the airline to repay expensive loans, calm its creditors and pay its workers.

Thirdly, Precision Air needs to set out a clear strategy for itself. Should it focus on international routes? How will it compete with Fastjet in the domestic market? Whether the successful execution of a new strategy requires a new Board and management team is open to debate. As its potential saviour, the government would be well within its rights to demand a leadership review of Precision Air if it so wished.

Sh51 billion is a small price to pay

These steps ought to bring Precision Air back from the brink of immediate collapse, and give it sufficient time to put itself onto a stronger footing. Such state support is not without precedent. All four leading African airlines by seat capacity - Kenya Airways, South African Airways, Ethiopian Airlines and EgyptAir - are backed by their respective governments in one way or another.

If Tanzanians wants a national flag carrier to be proud of, a crucial provider of domestic air services, and an important enabler of our much-vaunted national cohesion, then Sh51 billion is a very small price to pay for it all.

Manzi Rwegasira is CEO of Zoop and principal author of “Gearing for Growth: Tanzania Banking Survey 2013” published by Serengeti Advisers Limited.