Special Assignment

5th April 1998

• Hatched in secrecy and suddenly voila!
• What the professor promised
• We are now ready to reveal-PERC

Hatched in secrecy and suddenly voila!

AirLanka – Emirates tie up

By Frederica Jansz with additional reporting from Asantha Sirimanne

Despite a last minute hiccup when Emirates Chief of Finance Durmott Manniol wanted to stall the signing of what has unfortunately turned out to be a controversial partnership with Sri Lanka's national carrier, AirLanka, other senior officials from Emirates prevailed on Mr. Manniol.

With the hours ticking towards the scheduled signing ceremony, on Monday March 30th these officials who were very keen that the new partnership commence with the new financial year i.e. April 1st, argued that Mr. Manniol's fears of a court case against Emirates by Peaceair, a relatively unknown cargo carrier, with an issued capital of Rs. 20/= only, were not to be taken seriously.

On Thursday the 26th March, Emirates officials hit the panic button as news filtered through that Peaceair intended filing action and would challenge the Emirates-AirLanka partnership in court.

In fact Peaceair had deposited stamp fees for a Fundamental Rights application in the Supreme Court. They had obtained a number for the case and by Friday the 27th, the matter was to be listed for support on the Monday, March 30th.

One of the Supreme Court judges listed to hear the case having seen the case number had asked for the brief of this application, but was told by court officials that there was no brief filed in court.

Lawyers appearing for Emirates at that stage by then realised that there would be no case against the airline at least on Monday March 30th, the scheduled day for Sheik Ahamed Bin Said Al Makoom, from the ruling family of Dubai and Chairman of Emirates Airlines, to fly down to Colombo to sign the partnership agreement.

It was only on that Monday morning however that Emirates officials already in the city made a telephone call giving the green light for Sheik Ahamed Bin Said Al Makoom, to board his private jet and take-off for Colombo. Aboard the VIP aircraft were the British born top executives of the Airline of the year 1997.

Upon touchdown at Katunayake, Sheik Ahamed Bin Said Al Makoom was whisked away to the Colombo Hilton while Emirates officials in Colombo were running around (as one of them said "like mad dogs") trying to arrange the signing ceremony.

Lawyers, representatives from Airbus Industrie, the American valuers, PERC officials, AirLanka Chairman, Directors and staff, the President's Secretary K. Balapatabendi, her Economic Advisor, Britto Muttanayagam et al were rustled up and summoned to the office of the Secretary of the Ministry of Finance at 6.30 p.m. for the signing ceremony. In the gloom of the panelled room of Secretary Dixon Nilaweera, a glum looking Harry Jayawardena signed on behalf of AirLanka and a solemn Sheik signed on behalf of Emirates.

Only two pennants from the airlines on the otherwise bare table, and a room full of people, the clock showing ten past seven, no-one sporting a smile, the air-conditioning contributing to the icy atmosphere, it was clear as clear can be that it was anything but a happy and joyous moment.

Leave alone the champagne that should have accompanied such an eventful, momentous occasion, there was not a glass of water offered.

People were still trooping in when others were leaving, for 'The Gables' the plush fine dining restaurant at the Hilton where Emirates hosted an equally hurried reception.

With Kandyan dancers blowing conch shells, those few invitees had to rush through their fruit cocktails as Sheik Ahamed Bin Said Al Makoom's next whistle stop of his crowded programme was "Temple Trees" for a private dinner with President Chandrika Kumaratunga.

Why the indecent hurry? As someone remarked this signing ceremony reminded him of the indecent hurry in the way the 1987 Indo-Lanka Accord was signed and sealed the fate of Sri Lanka.

In Colombo, controversy raged that the Public Enterprises Reform Commission, (PERC), the government agency in charge of the privatization programme had made a mess of things.

They stood accused of hiding behind the PERC law that guarded it from divulging details of the negotiations. Their secrecy matched the secrecy maintained in the hush-hush corridors of the Kremlin in the bad old days of not so long ago in the old Soviet Union. In fact, once when The Sunday Times asked, some months ago from a senior PERC Public Relations official with whom they were negotiating to privatize AirLanka, she said specifically that it was not with Emirates.

In Parliament, UNPs General Secretary Gamini Atuk-orale asked during the budget debate what was going on. Two ministers promised the august House, the representatives of the people of Sri Lanka, whose monies are voted for its national airline, that the government would make a statement before the partnership was eventually signed. It was not to be. (See separate story).

The Cabinet had approved and virtually rubber stamped on Wednesday March 25 the Memorandum signed jointly by President Kumaratunga and Aviation Minister Dharmasiri Senanayake to engage in this partnership. From all accounts there was hardly a whimper, nary a question raised as the Ministers all raised their hands to what was made out to sound a great deal that had nevertheless been hatched in secrecy, incubated in darkness, and suddenly Voila! The egg itself was now parcelled and ribboned.

Just less than 24 hours earlier, the czars of PERC were being grilled by the Committee on Public Enterprises (COPE) on the AirLanka negotiations. Director General Mano Tittewella was repeatedly asked for details, and repeatedly the MPs were told details could not be divulged because negotiations were still in progress.

But it has now come to light that Aviation Minister Dharmasiri Senanayake signed the cabinet memo long before March 24 when Mr. Tittewella, told COPE, that "negotiations are still going on."

His answers to The Sunday Times in an interview on Thursday April 2, explaining the position (see separate story) is unconvincing. There obviously has been an attempt to suppress the details of the negotiations until cabinet approval had been obtained. Had Mano Tittewella maintained that he could not divulge details until cabinet approval had been obtained, and that under the PERC law he was not obliged to divulge information, he could have been excused somewhat. But to say that negotiations were still in progress on March 24 was too much.

That is what is unfortunate. PERC's constant ducking from giving details has resulted in giving a very suspicious nature to this entire exercise. Now what of the negotiations itself? First, the biggest question that The Sunday Times found in all this was the agreement to purchase six new A330-200's from Airbus Industries.

It is interesting to note here that Emirates Airlines had already placed an order with Airbus Industries for the purchase of a fleet of A330-200's, before negotiations even began with PERC. Both PERC and Emirates Airlines have remained evasive when asked if it is this same fleet which is now being purchased at a cost of US$ 550 million by AirLanka.

PERC confirmed to The Sunday Times that on March 31, the day after the signing, AirLanka paid US$ 26 million as down payment for the six new airbuses.

At a news conference when quizzed as to whether PERC was aware that Emirates Airlines had ordered a fleet of A330-200, aircraft, which Emirates now intended Air- Lanka to purchase, Mr. Tittewella said he did not know. Mr. Tittewella however admitted the next day in his interview with The Sunday Times that Emirates had negotiated the order for the six A330-200s with Airbus Industries even before talks with PERC were fully underway.

The question that needs asking is why did Emirates Airlines decide not to use this particular fleet for themselves, and instead of paying a massive cancellation fee passed the option onto AirLanka. Emirates had also negotiated the refund of US $ 300,000 AirLanka had paid to Airbus for an option to buy an A320.

PERC are proud to announce that each new aircraft is being purchased at a discount of 25%. The total cost of the six new aircraft is US$ 550 million. PERC told The Sunday Times that unlike in the previous airbus purchase for AirLanka where commissions were paid a plenty, neither Emirates nor AirLanka will pick up any payoffs this time. The 25% discount in has been written off as adequate pay off to the buyer.

Emirates insists it is imperative that AirLanka refleet and buy new aircraft that share a commonality with the A340's. Emirates say they will advise AirLanka to sell the A320's and Tristar L1011's. AirLanka at present have a total of 9 aircraft. Three A340, Two A320 and Four Tristars.

Some analysts believe that AirLanka will be subjected to a new technical risk which it had previously not been subjected to after AirLanka goes ahead with the purchasing of the six new Airbus A 330s. The Airline will then have nine airbuses, and its fleet will comprise exclusively of one make of aircraft.

Though there are cost savings through operating the same aircraft, analysts point out that a technical failure of an A 330 or A 340 could result in the whole airline being grounded. It is not un-common, technical defects, emerge years after aircraft are put into service. Though aircraft are subjected to rigorous checks after a designated amount of flying hours, and makers specify lifetimes for components, problems such as metal fatigue crops up unexpectedly.

However PERC officials say the technical consultants SH & E had not warned them that such a type risk was material.

There are also questions over the cash value realised for AirLanka. Though PERC claimed the government had obtained a cash price of US $ 70 mn, only US $ 45 mn has actually been realised so far. The balance US $ 25 mn could be realised as late as two and a half years later. If so the actual cash value of the delayed payment (the net present value of the US $ 25 mn discounted semi-annually at the US two year treasuries yield) could be as low as US $ 21 mn, though it could be slightly higher if Emirates pays up earlier. The government would therefore have realised only US $ 66 mn from the sale, despite claims made to the contrary. But AirLanka also paid a dividend to the government of US $ 10 mn, just before the sell-off, pushing net realisations to at least US $ 76 mn.

Meanwhile controversy has raged over AirLanka's recent profitability. The management of AirLanka went so far as to release two press releases while negotiations were on with Emirates Airlines claiming the airline for the financial year of 1997 had made a surplus profit of Rs. 8 billion, resulting in fixed deposits to the tune of US$ 140 million.

AirLanka with a total of 19.7 billion assets is in debt for over Rs. 16 billion -i.e. 90% of AirLanka assets are in debt. This in effect has been the main stumbling block to the privatization of AirLanka. The airline has effectively run at massive losses almost since its inception. Claiming an operational profit does not, senior airline accounts staff said, compensate for the airlines massive debt structure.

Much as the nation would like to have seen AirLanka placed at some considerable value, it has not been possible to do so. An international financial advisory group comprising of SH&E, Chase Manhattan Bank and People's Merchant Bank placed the valuation at a range of US$ 50-80 million. It is on this financial assessment that Emirates bid of US$ 70m for 40% equity shares of AirLanka was accepted by the government.

The Sunday Times was told that Emirates financing officials after having made a careful study of the balance sheets of AirLanka made a tactful query as to whether Sri Lanka accounting standards were different from internationally adopted accounting systems.

"Certainly some creative accounting has been the order of the day at AirLanka." Emirates officials were heard to quip. Depreciating values have been reversed to be brought in as assets showing profit.

No doubt AirLanka has made some operational profits last year. Let us now examine how this could be possible given that the airline has not increased any flight routes, though AirLanka did cut back on a loss last year, mainly the South African initiative, which proved to be a disaster. Mr. Tittewella asserts a reduction in oil prices worldwide has contributed to this profit. At least 30% of the cost of an airline is in its fuel consumption.

Recently the government introduced a Market Development Programme (MDP) supposedly to increase the yield to the airline. However with this introduction airfares went up by as much as 45 percent. The price of an air ticket out of Colombo is astronomical in comparison to the purchase of the same ticket on AirLanka, from London, Singapore or any other outside destination.

An air ticket from Singapore/Colombo/London/Colombo is sold at Rs. 41,800. A Bombay/Colombo/Dubai return air ticket is cheaper than a Colombo/Dubai return air ticket. AirLanka in effect is undercutting MDP fares in neighbouring markets. There appears to be no deregulation of the airline industry which has failed miserably the travelling public of Sri Lanka. When all the main airlines are charging exactly the same fare out of Colombo, there is no hope of bringing air travel within the reach of people of modest means. Deregulation encourages competition, which would perhaps allow for cheap, high frequency flights departing more frequently enabling higher passenger capacity. This discrepancy in Sri Lanka will no doubt be yet one more issue for the new management to address in the future running of AirLanka.

AirLanka will continue to receive subsidised fuel from the Ceylon Petroleum Corporation for the next ten years. However the volume has been fixed at the consumption level of 1997. Additional fuel will have to be paid at market rates.

The PERC also claims that the government had got a benefit of US $ 126 mn from the sale. This is arrived at by adding up the cost savings on aircraft, management fees that PERC would have had to pay (Sri Lanka Telecom pays a management fee to NTT but Emirates does not charge a management fee) and operating cost savings, throughout the management contract period, and suitably discounting it to arrive at the present value. Though PERC has rightly seen it fit to discount perceived future benefits in this case, it had strangely failed to discount the US $ 25 mn deferred payment. No attempt has also been made to deduct the loss to the government from the fuel subsidy when arriving at the US $ 126 mn. U.L. Kadurugamuwa, Senior Partner, F.J. & G. De Saram acted for "Allen & Overy" a multi national firm of lawyers retained by Emirates Airlines. Mr. Kadurugamuwa told The Sunday Times that under the present circumstances the government had negotiated the best possible deal for AirLanka. "If not, my firm would not have agreed to assist and represent Emirates Airlines in the ongoing negotiations," he said.

AirLanka, he said, has unfortunately been beset by political interference. The management being handed over to Emirates Airline would reduce such interference, and allow space for the airline to grow. Amidst widespread specula tion that the government has given Emirates Airlines a monopoly over its bilateral agreements already signed with other countries, Mr. Kadurugamuwa asserted, bilateral agreements are negotiated state to state and cannot be sold to any other carrier. However a government can name more than one carrier as its national airline. For example the United Arab Emirates have named two carriers as their national airline. Emirates Airlines and Gulf Air. This does not mean to say that the government will name Emirates as its national carrier, he added, but certainly the airline will share the benefits of those agreements together with Air Lanka. Emirates Airlines will further co-ordinate route sharing with Air Lanka.

According to the agreement all disputes between Emirates and Air Lanka will need arbitration before an independent tribunal in Singapore.

There is no provision for the termination of this 10 year agreement. If one party fails to implement its obligations, the other can take the defaulting parties to arbitration tribunal under ICC rules.

If there is a termination by way of a Breach of Contract by one party, the other can go to this tribunal in Singapore and get an order for specific performance of this hurriedly arranged agreement. Compensation should be paid for damages incurred by one party to the other in such an event.

But the one major problem that remains outstanding is whether the 10 year partnership agreement that has been signed will be honoured by a future UNP government.

As there is no bi-lateral Investment Protection Agreement (IPA), between the United Arab Emirates and Sri Lanka, this Emirates-Air Lanka partnership will not receive the protection usually guaranteed by Sri Lankan law.

The UNP has already decided to review this agreement, but as modern commercial business goes, Emirates obviously feels confident that as the airline is owned by the ruling family of Dubai, and as thousands of Sri Lankans work in that Gulf Emirate even a future UNP Government will not be able to abrogate this agreement with the stroke of a pen.

What the professor promised

The Parliament of Sri Lanka and the nation were virtually kept in the dark regarding negotiations on the sale of a divestiture of 40% shares of AirLanka to Emirates Airlines, while the deal was made official last Monday March 30. Parliament has yet not been briefed on the agreement between Emirates Airlines and the government of Sri Lanka.

Prof. G. L Peiris promised to table the motion in parliament before it was made official but this too has not been done. Following are excerpts from the Hansard quoting Prof. G. L. Peiris where he promised to brief parliament before the agreement between AirLanka and Emirates was finalized.

Gamini Atukorale: I like to know one more thing. There is some talk on the privatisation of AirLanka. I want the Deputy Minister to give us some details of this.

G.L. Peiris: I will not say anything on that now. I will make a full statement later. I will say something on PERC and negotiations they are engaged in. On all other matters, I will make a statement prior to Feb .15 1998, and I promise to table all relevant documents.

We are now ready to reveal-PERC

Dr. P.B. Jayasundera, Chairman of the Public Enterprises Reform Commission (PERC), Mano Tittewella, Director General (PERC) and Ms. Chaya Aluwihara, Transactions Manager (PERC) spoke to The Sunday Times on what the partnership between Emirates Airlines and Air Lanka entails. They dismissed allegations that PERC has not negotiated the best possible deal for Air Lanka saying under the circumstances the government has concluded an extremely favourable investment in restructuring the national carrier.

Q. Dr. Jayasundera, your negotiations with Emirates Airlines has been extremely secretive. This has given rise to speculation and suspicion that this deal has been a sell-out. Can you explain why it was necessary to be so secretive?

Dr. Jayasundera: The question here is at what stage can certain information be shared. Negotiations information are basically not revealed. For example when the Business Plan was submitted by Emirates Airlines, that itself is a confidential, secret document where two parties agree with each other, that such information will not be disclosed because it undermines the competitiveness of the whole transaction. In the case of AirLanka what we have done is that upto the stage, where various bids were submitted, that information was made general to the public. What was not revealed was the actual negotiations process. This can be revealed to the public only after the negotiations process is over. This is why we are now explaining now to the public the terms of the negotiations. A document will now be produced by PERC and tabled in parliament on the entire negotiations process.

According to the Public Enterprises Reform Commission Act within three months of the transaction all documents relating to the transaction will be tabled in parliament including the agreement signed between the two parties.

I can agree there is no transparency if we continue to keep the relevant information under our control after the transaction. However that will not be so. We are now ready to reveal all the necessary information to the public. It is impossible to conduct negotiations in full view of the public.

Mano Tittawela: In fact it is a completely ridiculous requirement. It is impossible after each round of negotiations to release perhaps a press statement giving points of the negotiations. All the strong points of the deal would then be given away. In any negotiations process, confidentiality needs to be assured between the two parties. You cannot get all 18 million people in Sri Lanka to be lending their views on the process. It would only undermine the entire deal. Transparency comes in the process after. On every deal negotiated so far by PERC a comprehensive document is produced which provides every detail of the entire negotiations process. This document is made available to every member of parliament.

Q. What exactly does the agreement with Emirates Airlines entail?

Mano Tittewella: Well apart from the 40% share divestiture, and like in

Sri Lanka Telecom, the management of AirLanka has been handed over to Emirates. They will run the day to day management according to a businessplan, which has been tabled at cabinet and now tabled at the AirLanka board and approved. Emirates for the next ten years will run AirLanka according to the business plan. The board of directors will review this operation from time to time and ensure that the business plan is effected in that way.

The next thing that comes up in this agreement is that they follow certain practices. Basically when they are given free management control it is subject to board review. If they want to raise capital they have to come back to the board, if they want to change the nature of the business they have to come back to the board but within those major parameters Emirates will run AirLanka. There are safeguards also put into the agreement.

Because Emirates is also another airline, in the agreement there is a very tight clause which says that Emirates cannot directly or indirectly commit any action that does not benefit AirLanka or Emirates Airlines. The agreement states that Emirates cannot take AirLanka routes, parking slots or frequencies. Those are anti-competitive clauses that have been put in, that are very strong.

Q: But will Emirates share AirLanka flight routes?

Mano Tittewella: Yes, they will share routes. This does not mean that Emirates will fly on AirLanka routes. They will practice code-sharing. This means anyone could now purchase a ticket on AirLanka and fly Emirates, or vice versa.

Q: Is there any possibility of AirLanka becoming a regional carrier?

Mano Tittewella: What nonsense. In fact it will become more of an international carrier. They are opening up routes to Australia, South Africa and Jakarta. AirLanka will fly to these destinations.

Q: How can either party terminate this agreement?

Chaya Aluwihara: Through arbitration. The arbitration award would in an independent court in Singapore. This recommendation was accepted by the Attorney General of Sri Lanka too.

Q: Has AirLanka already paid US$ 26 million down for the six A330-200's?

Chaya Aluwihara: Yes. this was part of the agreement because we wanted it that way for the airline. You have to have a certain lead time for delivery. The order was made on the 31st of March after the agreement with Emirates was closed the previous day, and that was when the money was paid.

Q: Are the six A330-200's being purchased by AirLanka, a fleet that was initially ordered by Emirates Airlines for Emirates, which they did not want and convinced AirLanka to buy? After all when placing an order for aircraft it does take a considerable period of time to negotiate the order itself. How did AirLanka manage to do this so fast?

Dr. Jayasundera: When Emirates made their offer they had already thought about this aspect. They had done their own market research and decided what would be the best way to address AirLanka's concerns. We would not have accepted their offer without a refleeting programme. So they themselves did their own research.

Q: So does this mean that Emirates had already placed an order for six A330-200 airbus for AirLanka even before negotiations had begun with PERC?

Mano Tittewella: Yes, Emirates had already arranged this order and it was subject to this deal being finalized. If this deal had not been approved the order would not have been confirmed. In fact Emirates managed to get back US $ 300 thousand for AirLanka which was an option lost with Airbus.

AirLanka had an option with Airbus on the A320's which they had not utilized.

Q: What exactly do you mean by Emirates Airlines retaining throughout the management period a minimum 30% stake in AirLanka?

Mano Tittewella: Before a two year period from now Emirates have to acquire the entire 40% equity shares of AirLanka. On the other hand at the appropriate time there is a school of thought we may make AirLanka public.

This is not confirmed it is just an option. In the event of such a situation we will require shares to go public. However we will allow Emirates to retain a 30% stake releasing 10% into the market. Emirates will not be able to go below this 30%.

Q: The Chairman of AirLanka has written to you asserting AirLanka was showing significant profit which would enable PERC to negotiate a better deal for the airline. Was this taken into consideration in your negotiations with Emirates?

Mano Tittewella: The investor was aware that they were taking on a profitable airline. But on these profits we have also to be careful. Some of these profits can be just a one off. AirLanka is at present carrying forward a loss of 2.7 billion rupees. These accounts have to be audited and then it is necessary to take sustainable retainable profits. You cannot take just the one off in one year. Once the audit is done we will have to see whether it complies to proper accounting standards. All that has to be assessed. We certainly do not want to pre-empt anything now until a full audit is done. We have to follow Sri Lankan and international accounting standards.

Editorial/Opinion Contents