Will SriLankan Airlines as a smaller carrier retain a sustainable competitive advantage post-COVID-19?

SriLankan Airlines is currently managed post-COVID, under the directions of a professional Board of Directors. Despite the collective capabilities of the new Board, in reality will they be empowered to make courageous and meaningful turnaround decisions in the best long term interests of the airline and the nation by those with power and purse strings?

This is a response to the question ‘Will SriLankan Airlines as a smaller carrier retain a sustainable competitive advantage post-COVID-19?’ raised by a recognised academic deeply committed to the socio-economic wellbeing of the nation and its people. This op-ed is also an opportunity to recognise and pay a tribute to a civil society activist, late Rajeewa Jayaweera, an expert on airline industry issues, who was a person with whom the writer debated many issues connected to SriLankan Airlines.

In answering the question it is an important priority, to review the current external environment and also asses the current state of affairs of the airline industry globally and locally.

Industry issues post COVID

“By the end of May, most world airlines will be bankrupt states a posting in CAPA, the Centre for Aviation. Coordinated government and industry action is needed – now – if catastrophe is to be avoided. As the impact of the coronavirus and multiple government travel reactions sweep through our world, many airlines have probably already been driven into technical bankruptcy, or are at least substantially in breach of debt covenants. Cash reserves are running down quickly as fleets are grounded and what flights there are operate much less than half full. Forward bookings are far outweighed by cancellations and each time there is a new government recommendation it is to discourage flying. Demand is drying up in ways that are completely unprecedented.

Normality is not yet on the horizon”.1 

A large number of global airlines have begun restructuring, with significant layoffs based job cuts. Virgin Australia has filed for bankruptcy, several others have gone in to administration, airline leasing companies are in severe stress with several plane returns, and business models with long haul activity is being examined under microscopes. A significant number of aircrafts on order have been cancelled. Some of the more profitable state-assisted airlines, especially of Middle Eastern origin, are investing heavily to meet the new normal health and safety requirements. They stand ready to commit to both capital expenditure and added costs under the ‘new normal’, despite having to fill the planes with passengers of lesser capacity than before. The aircraft bone yard in the Mojave Desert is filling up and new additions to this yard include the British Airways, the world’s largest operator of Boeing 747, with its entire jumbo jet fleet retired due to the downturn in travel industry caused by the coronavirus pandemic.

Annex 1 makes reference to airlines devastated by COVID. It is a sad case study of the severe challenges facing a high profile global industry. It signals a ‘Red Light’ warning and all stakeholders of the industry need to worry about the future and take strategic and courageous decisions before it is too late.

Airline casualties due to coronavirus includes Chile’s LATAM, the second-largest carrier in South America – Avianca, the British regional airline Flybe, Miami Air International, Alaska’s largest regional air carrier RavnAir, St. Louis-based Trans States Airlines, regional carrier Compass Airlines, Air Deccan—a regional airline that used to be India’s largest low-cost carrier, Swedish airline BRA, Air Mauritius and SunExpress Deutschland, A Turkish airline jointly owned by Lufthansa and Turkish Airlines, whilst South African Airways was shut down by the Government. 

Some of these airlines have been shut down, whilst some have filed for bankruptcy, and others have applied for administration or chapter 11 restructure, at times yet whilst flying. The United States’ five largest airlines Delta, American Airlines, United, Southwest and Alaska – are now pushing for a $ 50 b-plus bailout to help them survive the COVID-19 crisis. It is believed that these five giants of the industry had previously handed out more than $ 45 b to shareholders and executives over the last five years2. There has even been talk of ‘American Airlines’ demise. 

An article titled ‘An early assessment of the impact of COVID-19 on air transport: Just another crisis or the end of aviation as we know it?’ quotes: “Along with other sectors of the economy, air traffic is vulnerable to external factors, such as oil crises, natural disasters, armed conflicts, terrorist attacks, economic recessions and disease outbreaks. These outside influences seem to have a more severe and more rapid impact on air traffic numbers as sudden increases in flight cancellations, aircraft groundings, travel bans and border closures which are quickly felt in lower load factors and yields for airlines, while airports lose non- aeronautical revenues3.

“Before COVID-19, the most important disease outbreak in terms of impact on air traffic was SARS in 2003. According to IATA (IATA, 2020a), in May 2003, at the height of the SARS outbreak, monthly revenue passenger kilometres (RPKs) of Asia-Pacific airlines were 35% lower than their pre-crisis levels. Covid-19 has gone well beyond these levels and is currently taking the aviation industry into uncharted territory. As of 24 March 2020, 98% of global passenger revenues were accounted for by air transport markets with severe restrictions (i.e., quarantine for arriving passengers, partial travel bans, and border closures), many airlines have been brought to a complete stop and, to make matters worse, the provisionally-observed recovery pattern for Covid-19 is turning out to be slower than the short-sharp V-shaped pattern observed in 2003. The significance of air cargo has been vindicated by the Covid-19 crisis. Shipments of food and medical supplies have been protected by governments to ensure the supply of basic necessities. Thus, even though air freight tons quickly dropped in Asia Pacific in late January, a partial V-shaped recovery pattern was observed soon after. Later, freight tonnage progressively decreased from the beginning of March in Europe, North America and the Middle East4.”

“Sustaining the low-cost model, however, will likely be a big challenge. The model is built on optimising and maximising aircraft utilisation: Keep the seats filled and the planes in the air. But in the recovery phase, a certain number of jetliners will remain grounded, and cabin cleaning procedures will keep the airplanes that are flying on the tarmac longer. The International Air Travel Association last month projected that global demand for air travel would regain its 2019 level only by 2024, slower than the previous projection of 2023. This year’s global passenger numbers are expected to decline 55% compared to 2019, it said5.”

Will the external environment spelt above resonate as a fundamental core medium term background realism of the airline industry in the minds of the key political leadership of the day in Sri Lanka?

SriLankan Airlines post COVID

It was heartening to read the recent press coverage, where the SriLankan Airlines Chairman in an interview with Bloomberg Markets Asia, discussed how the National Carrier was coping with the impact of the COVID pandemic and highlighted the following key points:

• 75% drop in turnover compared to 2019 due to COVID
• Negotiating with lessors in reducing costs
• Saves $ 100 m per annum by reducing lease costs
• Slashes staff from 7,000 to 5,000, VRS in the offing for further reductions
• Pandemic was a blessing in disguise to restructure organisation
• Hopeful of profit-making or at least break-even level post-COVID
• Dealing with $ 1 billion of debt, owed to State banks and on International Bonds
• Negotiating with Govt. to convert debt into equity to reduce costs
• Explores travel bubbles with UK, Singapore and China
• In today’s context, don’t need 30% of the fleet and negotiating with Airbus for best options
• Optimism that the organisation will be in better shape post-COVID, as compared to most of the larger airline companies
• The Government’s vision is not to sell the company
• In a much better position to turn into profitability – not immediately, but in two years

Can SriLankan realise its dream?

SriLankan Airlines is currently managed post-COVID, under the directions of a professional Board of Directors. Despite the collective capabilities of the new Board, in reality will they be empowered to make courageous and meaningful turnaround decisions in the best long term interests of the airline and the nation by those with power and purse strings? Will they also be able to convince the political leadership to recognise the medium term realism of the airline industry? With ‘coordinated Government and industry action is needed – now – if catastrophe is to be avoided’ being a pre-requisite as noted earlier, can we expect such an environment with SriLankan Airlines?

Those in political and executive authority and those representing the key shareholders of SriLankan Airlines in the past gave unacceptable and ego driven directives to the then Board; and set objectives impossible to achieve, especially without required capital infusions. They yet remain in such positions and the top management team too possibly yet comprises persons who misdirected, misrepresented and supported blindly corporate decisions and aided and abated committing the costly mistakes, gross violations and avoidance of best practice standards in the past. It is hard to imagine that strategic change management leadership actions will emerge in the short to medium term from the capable new Board of Directors who will remain arm twisted; and thus restricted in making courageous change management decisions.

With the present fleet not being fit to leverage and focus on expanding significantly cargo handling and the inability to accommodate present costs and overhead structures in exploiting short haul regional flight options, important turnaround opportunities are not open for implementation. SriLankan Airline’s human resource management policies and practices do not encourage a work ethic matching its regional competitors. Its overhead structure, long haul routes and sales and administration structures are challenges in converting to a low cost carrier with competitive advantage. 

It is most unlikely that the key shareholder of SriLankan Airlines will have deep pockets matching the Middle Eastern airline shareholders. With a looming debt crisis, both at a national and airline level, with the airline’s ‘going concern’6 status challenges alongside the national exchequer most likely in a negative ‘fiscal gap’7 status and unable meet its future debt obligations, a deep pocket lifeline to the airline in the longer term is very doubtful.

It is therefore very unlikely that a turnaround promise built on SriLankan Airlines achieving at least a break-even level post-COVID and thereafter turning into profitability in two years will be deliverable. 

Strategic million dollar question and lessons from history‍

In order to critique the question ‘Will SriLankan Airlines as a smaller carrier retain post COVID a sustainable competitive advantage?’ it is essential to look back and learn from missed opportunities and unprofessional management case study of the airline in the past. 

The professional Board of Directors now in charge of the destiny of SriLankan Airlines must remember and even frame at the entrance door of the Boardroom the quote attributed to both writer and philosopher George Santayana and Winston Churchill: “Those who fail to learn from history are doomed to repeat it.”

Unless the future of SriLankan Airlines is based on professional management, with Directors, officers and auditors, exercising transparent good governance and adopting global best practices, with integrity, in good faith and solely in the interests of the airline; and they are ring fenced from political and executive interference, pressure and unprofessional direction by those representing the key shareholders, there will be no future for SriLankan Airlines, either under the present business model or any other business model specifically designed to meet the ‘new normal’. 

In addition the Government must be committed to and be able to provide continuous funding of liquidity shortfalls expected in the longer term. This commitment can be supported only if the State itself has deep pockets and its own solvency and fiscal gap red light signals are under stringent control and its future net cash flows can meet its present and future debt obligations.

Strategic next steps for the attention of the leadership team

Looking back at the history of the more recent past, the missed opportunities of SriLankan Airlines are many; its present dire financial state is regrettably due to unprofessional and non-transparent management and corrupt practices condoned by the Board, aggravated by unacceptable State directed policy prescriptions and significant failures in the exercise of effective Boardroom governance, including failures in oversight by Directors. From these instances there are many generic lessons to be learnt and specific action steps to be pursued by the present Board and these include the following:

Core commitments for improved boardroom governance

• The core principles of good corporate governance must be practiced by the Board at all times 
  
   
  • Boards of Directors are responsible for the governance of their companies. 
  • The shareholders’ role in governance is limited to the appointment of the Directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. 
  • The responsibilities of the Board include setting the company’s strategic aims (including strategic and operational planning and deployment of capital and assets and assumption of liabilities), providing the leadership to put them into effect, supervising the management of the business (including cash flow/funds flow management assuring solvency and going concern status) and reporting with transparency and accuracy to shareholders on their stewardship. 
  • The Board’s actions are subject to laws, regulations and the shareholders in general meeting. 
    
     
• Directors must at all times act in good faith and solely in the interests of the company, avoiding situations of violation of laws and regulations as well as being in situations of conflicts of interest;
• The Board must neither accept nor implement unprofessional and unjustified directions of political and executive authorities nor allow these external forces to interfere in management decision making 
• Directors must exercise due diligence, skill and care reasonably expected of them and provide necessary oversight and management control; they must avoid reckless actions, grossly negligent actions, oppression and mismanagement and misrepresentation of facts.
• Tightly administered systems, procedures, internal control and risk management must be in place: In addition an extra caution must be exercised in the avoidance of conflicts of interests, bribery, corruption, waste as well as noncompliance with laws and regulations; 
• International best practices and appropriate technology must be deployed in management; with capable and committed professional managers and advisors of integrity and proven track records being selected to assist the Board.
• Directors must abide by and strictly enforce effectively procurement guidelines, limits of authority and must enable processes of oversight reviews by the Ministry and the Cabinet where appropriate; The Directors must further strictly comply with financial regulations and corporate governance codes issued by the Ministry of Finance; 
• The Directors must exercise due diligent oversight over high value procurements and long dated contractual commitments, ensuring that corruption and waste are eliminated and internal control/risk management processes are effectively in place 
• Directors and top team must refrain from in-fighting with divided loyalties to different camps and thereby disloyal to the core interests of the airline
• The auditors must be regularly rotated and must be encouraged to act with independence and apply best standards and practices of the profession. The Directors must create space for auditors to express independent opinions. The auditors must preserve their professional independence at any cost; and they must never facilitate nor allow Directors to present financial statements with misrepresentations nor be pressured by Audit Committee Chairmen to vary professional qualifications, highlights and reporting framework of audit reports

Operational/financial management and compliance commitments of the Board

• Airline must not be operated heavily under-capitalised and must never be allowed to operate and even expand, diversify and re-fleet whilst in a technically insolvent stat, withholding such information
• Airline must not incur expenses nor commit to long term contracts nor create new liabilities nor resort to temporary borrowings, prior to receiving supportive capital infusions 
• Annual Report executive reporting content as well as all other published information and communications must strictly be in alignment with the associated financial statements prepared adopting consistent accounting policies and in line with accounting standards; Directors must avoid the publication of any statements which are false in any material particular nor use changes in accounting policy to distort true and fair reporting of financial results
• The provisions of the Companies Act and Articles of Association must be strictly complied with, paying special reference to approval of major transactions, borrowing powers, serious loss of capital and going concern and solvency status assessments, true and fair assessment of the state of financial affairs, and in the publication of prospectuses and other reports
• Financial forecasts, feasibility assessments, budget estimates and cash flow/funds flow projections must be accurately and transparently computed, maintaining professional integrity, using reliable and deliverable assumptions, all of which must be benchmarked to similar businesses in the industry; Directors must never accept hockey stick forecasts (i.e. where the pattern begins with two years of reducing losses with the break even after two years and returns sharply rising in years four and five)

Footnotes

 https://centreforaviation.com/analysis/reports/covid-19-by-the-end-of-may-most-world-airlines-will-be-bankrupt-517512

2 Guardian Research

3 https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7269949

4 https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7269949/

5 https://asia.nikkei.com/Business/Transportation/AirAsia-and-its-LCC-rivals-seek-post-COVID-rebirth

6 Financially stable enough to meet its obligations and continue its business for the foreseeable future

7 as the difference between the present value of all of government’s projected financial obligations, including future expenditures, including servicing outstanding official federal debt, and the present value of all projected future tax and other receipts, including income accruing from the government’s current ownership of financial assets.

• All high value capital commitments (e.g. wide body re-fleeting), diversifications (e.g. establishing a Maintenance-Repair-Overhaul (MRO) facility consisting of a purpose-built four-bay hangar at Mattala), vertical and horizontal expansions (e.g. SriLankan Aviation College, Acquiring Simulators and secondary hub at the Mattala Rajapaksa International Airport, Hambantota and Improvements at Katunayake Airport), establishing new routes (e.g. Russia/Ukraine, Australia) and overseas offices and assumption of long term liability commitments (e.g. sale and leaseback contracts and issue of international bonds) must be preceded by Board oversight led professionally and diligently developed feasibility reports, free cash flow projections, internal rates of return computations and risk assessments, with all decisions being made based on risks weighted free cash flow positive reliable outcomes being assured
• Avoid unprofessional decision making and approving unaffordable business diversification, route expansion and capital expenditure and ensure all decisions are made optimising free cash flow returns
• The Board should avoid accepting assumptions and financial forecasts without adequate due diligence and professionalism, especially when assumptions which do not bear any relevance to comparison with international benchmarks and the past achievements of the airline, recognising that budgets and timelines to profitability and key drivers of profitability have never been realised in the recent past (e.g. failing to meet revenue targets, optimise passenger/cargo revenues, achieving year on year growth in load factors and yield, etc.)
• The Board should be conscious to assure that accounting policies and notes to accounts are not misstated (e.g. going concern status) and must avoid the possibility of trading in a state of technical insolvency. 
• The Board must be committed to avoid the serious management lapses of the past where decisions were made in bad faith (e.g. committing to re-fleeting contracts, whilst the airline being in a state of serious loss of capital and with route profitability estimates based on totally misleading fundamentals: and further transgressing the important provisions relating to major transactions requiring formal shareholder approval

Action steps in recovery and resolution planning 

• Taking timely action to investigate and seek civil compensation from all those perceived or evidenced to have been associated with conspiracy, bribery, corruption, breach of trust, gross violation of Company Law and Articles of Association, in connection with re-fleeting of aircrafts and other major contracts/commitments; and aggressively pursue to recover any proceeds of crime associated with the re-fleeting and other investigated acts of criminal nature, pro-actively seeking assistance of the law enforcement agencies, external agencies and assisting parties offering mutual legal assistance and best advice.
• Post COVID pandemic seek options for timely action to re-negotiate all active aircraft leases and take optimum steps to return leased aircraft, even using force majeure clauses and other contractual cancellation options
• Pursue civil recovery compensation options arising from the acceptance of lower gross weight A330-300 aircraft not meeting with fit for purpose specifications in RFP found unable to carry optimum number of passengers and cargo throughout the year, direct on Colombo-London-Colombo route.
• Exercise caution to avoid future situations, where whilst being aware that the most fit for purpose aircraft for the airline re-fleeting in the wide body class was A 330-neo, proceeding to acquire other aircraft for the fleet; not having opted for interim lease of aircraft till order fulfilment with best fit aircraft available; and thus causing extensive losses on both subsequent cancellations as well as by continuous use of such aircraft
• Pursuing options to renegotiate lease rentals of aircrafts acquired and now believed to be out of line with competitive market rates at acquisition and also where route profitability at variable cost level are negative, (including those aircrafts subject to buy-sell and lease back without continuing to operate them on routes where the route profitability is known to be negative).

Non-compliance with rule of law, regulatory and good governance commitments

• Any members of the senior management team who are perceived to have been persons accountable for past management failures to exercise due care, skill, and adopt best practices based professional management in good faith safeguarding the interests of the airline and further failing to avoid transactions with third party interests, must be weaned out
• Evaluate action options where noncompliance with rule of law, regulatory and internal governance procedures are evident: 
  • being grossly negligent and in bad faith not taking any steps consequent to discovery within 6 months of re-fleeting contracting that the feasibility report computations and route profitability data forecasts relied upon by the Board had serious errors which significantly impacted on the viability of the re-fleeting and resulted in over 90% of the route profitability to be negative
  • wilful disclosures tainted by misstatements and those which are false in material particular, in Annual Reports, a published prospectus, in balance sheets and accounts and other public disclosure reports, 
  • contravention of applicable company law and accounting standards; and thus making false and nonfactual representations of the financial position and going concern status of the airline, as well as the true nature of and restrictions placed on Treasury bonds issued by the State in satisfaction of consideration due for issues of shares
  • significant long-term liability creating contractual commitments (e.g. Total care agreements, Reconfiguration) and memorandum of understanding being executed without formal Board concurrence, misusing powers of attorney and other delegations of authority
  • ordering special conversion kits to be fitted for VIP travel, using valuable memorandum credits available on aircraft acquisition; and later upon cancellation of contract failing to recover the net credit available on resale of the kits
  • manipulation and misstatement of accounts in the extension of leases/restructure of leases including using sale and lease back lease rental changes, to facilitate the airline getting cash contributions to meet funds flow deficits
  • failing to exercise due care and skills in effective cost and waste control, capex management, advertising and promotions costs, cash-flow management, risk management and payroll management resulting from unjustified recruitments and extending unwarranted benefits to some categories of staff.