Air Canada deal seen as win-win, with chance of ‘decent return’ for taxpayers

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When talks about airline bailouts around the world were in full force a year ago, there was skepticism that the Canadian government would take an ownership stake in Air Canada, or that the airline would agree to a deal that included one.

On Monday, it was clear that things had changed. The nearly $6 billion aid package announced that evening included a series of credit facilities but also a $500 million equity stake and more than 14 million warrants, which will give the government the option to expand its stake to nearly 10 per cent.

The arrangement also came with what Finance Minister Chrystia Freeland called “strict conditions” to protect Canadian taxpayers, travellers and Air Canada’s workers. This includes caps on dividends and executive compensation, as well as commitments to restart regional routes and purchase airplanes.

But the aid package was also larger than industry watchers were expecting, giving the company at least two years of liquidity to weather the ongoing global pandemic. The government, meanwhile, stands to benefit from potential upside and shares the risk if things go poorly.

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“The package’s structure … provides Air Canada with flexibility about the amount of incremental debt it incurs,” said Jamie Koutsoukis, a senior analyst at Moody’s Investors Service.

Air Canada is expected to have high leverage over the next few years because air travel volumes may take multiple years to recover, but escalating interest rates will give the company an incentive to repay any drawdowns if and when they have the ability to do so, he said.

Kevin Chiang, an airline analyst at CIBC World Market, said the equity dilution of the rescue package is greater than he was anticipating. However, the overall size of the package also exceeded his estimate, with the cash coming in set to reduce dilution to just $1 per share.

A tradeoff is that Air Canada will no longer be disadvantaged in the recovery compared to other global airlines that received direct aid, he said, a benefit echoed by Koutsoukis.

Karl Moore, an associate professor at the Desautels Faculty of Management at McGill University was among the skeptics last year when it came to the idea of the Canadian government taking a stake in Air Canada. But on Tuesday, he said the arrangement is “well designed” to serve the interests of government and the airline, while keeping customers in mind with a $1.4 billion credit facility to allow Air Canada to reimburse them for travel that was cancelled or curtailed.

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“The money to reimburse travellers is a political hot potato,” Moore said, noting that it nevertheless helps the government “to be seen helping Canadian consumers.”

For Air Canada, using the low-interest loan makes “imminent business sense” because it will “minimize the cash outflow in a time of their greatest crisis as an industry,” he added.

The airline aid comes with limits on Air Canada’s ability to pay dividends and executive compensation, conditions other countries have imposed as part of their rescue packages.

“The limits on dividends and executive compensation will preserve cash flow but more importantly, I suspect, make good political sense given the kind of support Air Canada is receiving,” Moore said.

Robert Kokonis, president of aviation consultancy AirTrav Inc., said he thinks the restrictions will be taken in stride because they are likely to be relatively short-term — until the debts are repaid.

Likewise, he doesn’t expect the government to be a long-term holder of Air Canada shares.

“Once the company really starts to get going again, and subject to them posting some good bottom line results and the share price goes up, I can see the (government) cashing out and making a decent return on behalf of the taxpayers of Canada,” he said.

The Canadian government’s last foray into bailing out an industry ended badly. The taxpayer burden of the auto bailout following the 2008 financial crisis was contentious for years and, in 2018, a $2.6 billion loan made to Chrysler was quietly written off.

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Kokonis is quick to point out differences, including how much painful cost-cutting — a key element of the auto bailout — has already taken place a airlines.

Government ownership of airlines fell out of favour decades ago, and state-owned airlines such as Air Canada, British Airways, Air France and KLM were privatized.

But the past year has seen a reversal as governments stepped into to support airlines whose fortunes were decimated by the pandemic. Large government stakes or outright ownership positions have been taken in airlines including German’s Lufthansa, China Eastern, Turkish Airlines and Russia’s Aeroflot, Moore said. The French government took at 14 per cent stake in Air France-KLM, with further negotiations this month that could result in the government becoming the largest shareholder with a 30 per cent holding.

“So (its) not totally unusual in today’s world,” said Moore.