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The Crown's Investment in Air New Zealand

Published 18 May 2016

Part 2 of 3 of a Treasury Staff Insights: Rangitaki article by Juston Anderson

The Crown's investment in Air New Zealand, part 2

In part 1 of this article I estimated that the Crown has received a return of 8.4% per year from its shareholding in Air New Zealand, based on an internal rate of return (IRR) calculation as at 9 May 2016.

Part 2 will look at some implications from that calculation: firstly the impacts of movements in Air New Zealand's share price, and secondly, separating the IRR into the realised and the unrealised return.

Impact of Air New Zealand's share price on the IRR

For some historical perspective, here is a graph of Air New Zealand's share price over the last 10 years, from Google Finance. As you can see, the share price has moved significantly over that period. Therefore calculating an IRR would give a very different result depending on when it was done.

Chart 1: Air New Zealand share prices
Air New Zealand share prices.
Source: Google Finance

For example, when I started drafting this in mid-March, Air New Zealand's share price was $2.84 and the IRR was 9.4%. In April, the share price peaked at around $3.04, and it is now down to $2.30.

So in less than two months, between mid-March and now, Air New Zealand's share price has fallen by 19%, and the result of a fourteen-year rate of return calculation has reduced by 1%. Air New Zealand's share price will continue to move up and down, and the IRR will move along with it.

Another example is that in June 2012, the rate of return on the Crown's investment was 1.8% per year. The date was not chosen at random; Air New Zealand's share price was $0.86 at that point, and as you can see from the graph above, near its low over the last 10 years.

The figures on the Crown's investment in Air New Zealand in June 2012 looked like this.

 

Date

$m

Initial investment

January 2002

(892.2)

Rights issue

December 2004

(149.3)

Dividends received

December 2002 to June 2012

508.5

Value of shareholding

30 June 2012

691.6

Net total

 

157.5

The 1.8% per annum IRR return reflects the fact that an investment of $1,042 million had, after around ten years, turned into an investment of $692 million plus $509 million of cash – a gain at that point of around $158 million.

The increase in the IRR from 1.8% in June 2012 to the current figure of 8.4% is because:

  • Air New Zealand's dividends have increased in recent years. The Crown has received another $361 million in dividends since June 2012, and
  • Air New Zealand's share price has increased from $0.86 to $2.30.

For context, if Air New Zealand's share price had stayed at $0.86 and nothing else had changed[1], the dividends paid to the Crown between June 2012 and today would have increased the IRR as at 9 May 2016 to 5.1%.

Realised and unrealised returns

The IRR as at 9 May 2016 of 8.4% can be broken down into 1.9% of realised returns (cash received by the Crown from dividends, and the 2013 sales proceeds) and 6.5% of unrealised returns (from the $1,341 million current market value of the Crown's shareholding).

The Government's policy is to maintain a majority shareholding in Air New Zealand, and so while the $1,341 million in (current, theoretical) market value will change over time as Air New Zealand's share price changes, it will remain unrealised.

This split into realised and unrealised returns has some interesting implications.

A hypothetical scenario

What would need to happen for the Crown's IRR to be zero?

Let's take an extreme, hypothetical scenario where the value of the Crown's shareholding in Air New Zealand is zero[2]. The figures on the Crown's investment would then become:

 

Date

$m

Initial investment

January 2002

(892.2)

Rights issue

December 2004

(149.3)

Dividends received

December 2002 to May 2016

869.1

Partial selldown proceeds

November 2013

365.2

Hypothetical value of shareholding

 

0

Net total

 

192.8

The fact that the net total in this table is greater than zero tells you that the IRR will be positive. In this hypothetical scenario, the initial investment of $1,042 million has turned into $1,243 million of cash, a net gain of $193 million. Over fourteen and a bit years, this works out to be an IRR of 1.9% per annum.

This is the same figure as the realised return on the Crown's investment that I calculated above. Which is not surprising – in this hypothetical scenario, we have removed the unrealised return on the Crown's investment, so all that is left is the realised return.

Even in this extreme scenario, the Crown's IRR is not zero. To make it zero, we'd have to go further. We would need to:

  • have the Crown invest more cash in Air New Zealand, and
  • reduce the value of the Crown's shareholding in Air New Zealand.

One possibility would be for the Crown to invest a further $192.8 million of cash in Air New Zealand (making the cash invested in Air New Zealand equal to the cash received) and then have the value of the Crown's shareholding be zero:

 

Date

$m

Initial investment

January 2002

(892.2)

Rights issue

December 2004

(149.3)

Dividends received

December 2002 to May 2016

869.1

Partial selldown proceeds

November 2013

365.2

Hypothetical future investment

 

(192.8)

Hypothetical value of shareholding

 

0

Net total

 

0

In this scenario, the Crown would have invested $1,234.3 million in Air New Zealand, and received exactly the same amount of cash from that investment ($869.1 million in dividends plus $365.2 million in partial sales proceeds). An investment of $1,234.3 million that returns $1,234.3 million obviously has a zero percent rate of return.

The important point to note about this hypothetical scenario is that the Crown's total rate of return can't drop below the realised rate of return, unless the Crown invests more cash.

While the unrealised return can and does change due to factors outside of an investor's control (in this case Air New Zealand's share price) the realised return can't – it is not at risk, unless the investor chooses to make a further investment.

And this leads into part 3, which will look at the impact of the Crown's sale of some of its shares in Air New Zealand in November 2013.

Notes

  • [1] This is not a realistic assumption. Air New Zealand has been able to increase its dividends because of its financial performance, and this performance has been reflected in an increase in its share price. So it's not sensible to assume higher dividends, but an unchanged share price. The reason for doing this is to show the relative impacts of the higher dividends and the increase in the share price.
  • [2] This doesn't necessarily mean Air New Zealand's share price drops to zero. For example a future government might decide to gift all of its shares in Air New Zealand to New Zealanders.

 

Part 1 was published on Monday 16 May, Part 3 will be published on Friday 20 May.

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