Department of Public Enterprise – African Aviation Strategy 12 th August 2009 Dr A Shaw

Department of Public Enterprise – African Aviation Strategy 12th August 2009 Dr A Shaw DDG: Transport Department of Public Enterprises

Contents Government’s Strategic Intent Government Vision for its Aviation Portfolio Envisioned Africa Strategy for SAA Envisioned Africa Strategy for SAX

Current market and industry structure • The current aviation sector in Africa varies between regions • North Africa: relatively well serviced with good airlines and good links to Europe • East: relatively well serviced with at least two good airlines with substantial inter-continental links (i.e., Kenya and Ethiopia) • West and Central: poorly developed • Southern Africa: relatively well developed • At least 1 or 2 countries in each of these regions can profitable support a mainline carrier of significant scale • However, the majority of African countries do not have routes that can sustain supply exceeding 50 passengers per day and thus can only support small regional/domestic airlines linked to hubs in the first tier market above The Developmental ImperativeDespite the importance of aviation for travel around Africa, Africa’s aviation system produces inefficient travel outcomes The need for Air travel Travel Outcomes • Africa is a vast continent representing a physical challenge to traveling • Area : 30 millions km2 and 22% surface of the globe • Promising economic growth (especially in resource rich economies) is forecast to generate steady growth in travel into and within the continent • The continent is highly fragmented into national economies (53 states) and regional groupings • Inadequate road and rail transport system • Resulting in long point to point travel times • The strong hubs offer relatively good connectivity to one or two regional airports as well as inter-continental connectivity • However in terms of intra-Africa travel the system generates inefficient travel outcomes • Long layovers resulting from low frequency of scheduled services • Poor development of hubs and lack of interconnectivity between operators • East to West travel is inefficient (either via Europe or South Africa) • High fares compared to similar sector lengths outside of Africa • Some countries are struggling to build national airlines and their national aviation authorities have also been blacklisted Source: Team Analysis. Source: Team Analysis.

Importance of aviation sector in enabling economic growth South Africa’s Commitment to Africa • South Africa supports the Millennium Development Goals for the aviation sector • Improved fares • Improved number of connections • Improved products and volume of traffic • South Africa is committed to good citizenship in a continental/global sense • Being a catalyst for development in a benign fashion • South Africa recognises that a growing regional economy is good for South Africa • South Africa is committed to creating a conducive environment for private sector lead development • South Africa is committed to identifying and exploiting specific commercial opportunities for its SOE • Business • Increase ease of business • Improve connectivity • Opens up new economic opportunities • Tourism • Unlock developments • Enhance the profitability of existing • Build complimentary service offerings (a package of destinations) • Cargo • Offer fit for purpose mode of transport • Makes particular economic activities possible • Improved time responsiveness in time sensitive industries • Aviation cluster and supply chains The Developmental ImperativeThus in recognition of the sector’s importance to Africa’s development and South Africa’s commitment to Africa, government supports initiatives to develop Africa’s Aviation Sector Source: Team Analysis.

The Commercial ImperativeFrom an commercial perspective, DPE recognises that the financial viability of its airlines can be enhanced by maximising profitable growth opportunities on the continent. SA’s comparative advantage • The profitability on African routes far exceeds that on domestic and inter-continental routes • SA has the dominant aviation capacity in Southern Africa • Most of its neighbouring countries have weak domestic airlines • Of the 13 countries in the circle (diagram opposite) SAA has 21 inter-continental destinations compared to a total of 13 for the remaining 12 countries • SA has developed an ability to operate small gauge airlines which are well suited for the relatively sparse markets outside of South Africa • ORTIA also serves as a major hub linking domestic, regional and inter-continental traffic Source: Team Analysis.

Overcoming Regulatory Constraints It acknowledges that existing national regulatory environments restrict market access and hence the available growth options, but….. The current regulatory environment restricts the ability of non-nationals from exploiting key market opportunities Airlines wanting to grow in Africa must focus on growing volumes to and from or through regions they have the rights to operate in (i.e. growing from home base) Growth Options OR Work in collaboration with partners who have the rights to operate within other attractive regions (i.e. growing from foreign base) Source: Team Analysis.

Higher services frequency and better connectivity Responsive and flexible regulatory regime Passenger volume growth Competitive airline industry Overcoming Regulatory Constraints …..advocates the building of enabling partnerships rather than the full liberalisation of the regulatory environment The focus should not be changing the regulatory regime, but helping countries strengthen their airlines and related industries 1 Enabling partnerships Growth cycle Source: Team Analysis

Government Vision for its Aviation PortfolioFor the immediate future, DPE will maintain two separate airlines within its aviation portfolio • The interdependencies between the two airlines are low and hence a greater focus on each airlines’ core business will create greater value at a portfolio level • SAX only adds 3% to SAA revenue compared to the 50% contribution made by Lufthansa regional and domestic to Lufthansa mainline • 86% of SAX revenue is independent of SAA compared to only 40% of Lufthansa’s regional carriers • The founding acts of both airlines define distinct operational spaces for both airlines which is consistent the gauge of each airlines • SAX is the state’s chosen vehicle to “contribute to the expansion of regional air service capability within South Africa and to the African continent and the surrounding islands” • Whilst SAA is the state’s chosen vehicle to “promote air links with the Republic's main business, trading and tourism markets within the African continent and internationally;” • To add clarity to the intent of the founding acts, gauge size will be used as the dividing line between SAX and SAA operations • SAA will assume business risk* of aircraft over 100 seats (i.e., narrow and wide body aircraft) • SAX will assume business risk* of aircraft up to 100 seats (i.e., turboprops and regional jets) * Assuming business risks includes operating and sub-contracting Source: Team Analysis and SAX and SAA Acts

Envisioned Strategy for SAX Envisioned Strategy for SAA SAA as a leading large gauge point to point operator from ORTIA to primary airports across Africa SAX as an owner or part owner of regional or domestic small gauge feeder carriers across Africa Government Vision for Its Aviation PortfolioThus with respect to Africa, the airlines will be encouraged to pursue mutually exclusive growth strategies + Increased interconnectivity to primary and secondary airports across Africa Collaboration between SAA and SAX should be encouraged but not forced

Government Vision for Its Aviation PortfolioTherefore it is imperative to restructure the agreements* between SAA and SAX in line with the proposed portfolio strategy Overview of Agreements to be completed by airlines and approved by the shareholder before signing Commercial Agreement Service Agreements Voyager Agreement • Be concise, simple and principles based rather the existing lengthy and complex document • Comply with competition rules • Deal with the principles of business focus e.g., • What size aircraft will each carrier employ • What are the typical characteristics of the routes served • Specify the code-share or franchise arrangement • Must specify nature of services, cost and service levels • Services can be reciprocal to benefit from efficiencies • Carriers must be free to source services from other service providers • Minimum condition is that price must be market related • Allow for each carrier’s passengers continued participation; but • Allow for development of an offering specific to each carrier’s customer passenger base • Be transferable to new Voyager owners if need be. Design Principles for Each Agreement Key changes to the existing agreements are included in the appendices

Envisaged Africa Strategy for SAASAA’s primary focus on the African continent should be establishing itself as a leading network carrier from ORTIA to other primary airports across the continent SAA as leading Point to Point Operator from ORTIA Illustrative route network (does not imply SAA should fly to that point) • SAA remains a large gauge point to point operator from ORTIA to primary airports across Africa • Maximises frequencies on key routes using its own aircraft or in partnership with other mainline carriers (e.g., code share) • Partners with regional feeder carriers across the continent to increase its connectivity to secondary airports • Optimises the utilisation of its fleet via code share or wet lease with other airlines whilst retaining ownership of the rights to operate the route • Works proactively with ACSA to ensure that ORTIA remains a competitive hub SAA’s Primary Africa Focus ORTIA Source: Team analysis.

Envisaged Africa Strategy for SAAIts secondary focus should be to opportunistically offer intercontinental services from African countries who grant it such rights SAA as a Fifth Freedom operator from select African Countries Illustrative route network (does not imply SAA should fly to that point) • Establish 5th freedom operations from countries which grant it these rights independently or in partnership with National airlines restricted from flying intercontinental routes e.g., to Europe or America • Where possible, opportunity should be pursued with the view of establishing a long term win-win relationship To Europe SAA’s Secondary Africa Focus To the Americas Source: Team analysis.

SAA’s Strengths • Gauge is suited to primary high density routes be they regional, domestic or international • Frequent flyer programme • Airline can offer a differentiated services (i.e., business class and economy class) • Has a good long-haul network • Operates 21 inter-continental flights per week • Member of Star Alliance (?) • Has an extensive route network across the continent although no of service frequencies could be an issue • SAA serves most of the important high density trunk routes • Excellent safety record Envisaged Africa Strategy for SAAThe proposed strategy builds onSAA’s ability to attract long haul traffic through ORTIA and service high density domestic and regional routes. Source: Team Analysis.

Key Challenges facing SAA • SAA has a weak balance sheet • It’s high on and off balance sheet debt severely impacts it’s net profit margins • SAA’s on and off balance sheet debt is equal to 1200% of shareholder funds compared to an industry average of 61% • Its recapitalisation including disposal of surplus assets and valorisation of assets must remain a high priority • Its EBITDAR margins are still under threat • Increased fuel prices and the global slowdown in passenger volumes will weigh heavily on the airline’s immediate future • Restructuring on sustainable basis should thus remain a priority • SAA is still perceived to have a “dominating” approach to business as opposed to a co-operative approach Timing and Sequencing of SAA’s Africa StrategyHowever, the timing and sequencing of SAA’s strategy must taken cognisance of its weak balance sheet and the vulnerability of its operating margins Whatever expansion and the rate at which it is made must be within SAA’s financial constraints In particular its expansion must be informed by its fleet optimisation strategy (i.e., it cannot assume new aircraft will be acquired) Source: Team Analysis.

Envisaged Africa Strategy for SAXIt is envisaged that SAX will develop into an owner and operator of small gauge domestic or regional feeder carriers across the African continent Vision of SAX’s Operations in 3 to 5 years Illustrative route network for subsidiary - (does not imply SAX should establish operations from that point) SAX’s Primary Africa Focus • SAX as an owner or part owner of regional or domestic airlines across the continent • SAX owns the brand and has significant operational and management control of regional carriers • The regional carriers could provide multiple mainline carriers connectivity to smaller airports Truck routes served by any mainline carriers * Illustrative names Western Express* Eastern Express* Central Express* Southern Express* Source: Team Analysis and SAX Regional Expansion Strategy

Envisaged Africa Strategy for SAXThis strategy build on SAX’s key strengths relative to the African market • Majority of African countries do not have routes that can sustain supply exceeding 50 pax per day • Connectivity between secondary airports and primary airports serviced by mainline carriers is generally poor • SAX’s Gauge and experience is suited for low density secondary routes i.e., • Can offer more frequencies on secondary routes than operator with larger gauge • Lower break even load factor enables shorter time to profitable on developing markets • High fuel costs increase competitiveness of small gauge (regional and turbo-prop) operations Capabilities match market opportunity Relatively well capitalised • Post transfer to DPE from Transnet, SAX will have a strong balance sheet allowing it to raise additional capital for growth • Generally the business has relatively strong profits Potentially an attractive business partner • Not perceived as a threat to home carriers as gauge precludes it from pursuing international routes • Excellent safety record • Sourcing of aligned strategic partners in terms of joint ventures and/or partnerships, e.g. SAX currently has a strategic partner in the DRC and would utilise similar modus operandi in the West and East African regions Source: SAX Regional Expansion Strategy

Envisaged Africa Strategy for SAXSAX will evolve from using the SA code and SAA’s brand into a corporate using its own code and regional brand in partnerships with multiple mainline carriers including SAA Desired Positioning Development of SAX as a Regional Carrier Large Regional operator using its own brand or brands Current positioning Regional operator using multiple mainline owned brand • Code share with mainline carriers • Can also focus on servicing niche markets, independent of mainline carriers Size of Regional carrier • Operate regional airlines for a number of mainline airlines including competitors • Build in ability to code-share with multiple carriers • Brand owner can impose restriction on where and how to operate Regional Operator using a single mainline owned regional brand and/or code • Predominately controlled by mainline operator (i.e., scheduling, routes, services etc.) • Restricted code-share with parent Small > 24 months Today 6 to 24 months Timing Source: OAG

Envisaged Africa Strategy for SAXThe main advantage of a separate corporate identity for SAX is an increase in connectivity for SA Inc as a whole Advantages of a separate SAX corporate identity • With a separate corporate identity, SAX will be able to develop connectivity with other mainline carriers through code-share arrangements • SAA can have access to these arrangements, hence increase its network coverage • However, should SAX operate under the SA code (or SAA’s corporate identity), it will be precluded from code-share arrangements with airlines that cannot code share with SAA • (e.g. airlines not part of the global Star Alliance or that compete with SAA on mainline services) • Further, operating African domestic operations under the SA code will create the impression* that SAA is operating cabotage operations, rather than the SAX’s JV operation • This could also expose SAA to the risk of been banned if SAX operates in countries whose regulatory authorities are blacklisted by EU or the FAA Source: Team Analysis *The SA code is associated with a single airline in the same way as an ID number is associated with the name and identity of a natural person

Envisaged Africa Strategy for SAXTo initiate this evolution, SAX needs to restructure its commercial arrangements with SAA, build its corporate identity and strengthen its capabilities in establishing and operating carriers across the continent Restructure its commercial arrangements • Retain full responsible for its own fleet planning, network planning and scheduling • Position itself as the leading feeder carrier to major mainline carriers including SAA • Thus must be free to enter into partnerships with multiple mainline carriers • In the medium to long term, enter into a regional partnership with Airlink rather than SAA entering into a franchise agreement with Airlink (i.e., Airlink enters into a commercial arrangement with SAX and not SAA, SAA shares in Airlink are transferred to SAX, Airlink operates under the SAX brand) • Be free to choose which services or activities (i.e., revenue accounting, treasury, call centre, sales and marketing etc.) will be undertaken inhouse or outsourced • If outsourced it must be free to choose whom to outsource from Build its own corporate identity • Emerge from under the cloak of SAA • Obtain IATA membership (i.e., IOSA, MITA, Tariff co-ordination) • Begin to use its own code • Begin to build its own brand or brands (i.e., regional and/or domestic • Establish its own market presence and positioning Strengthen its corporate capabilities • Develop its own IP, systems and capabilities and become adept at deploying these across various subsidiaries • Develop corporate skills such as deal structuring, brand and IP management. Source: Team Analysis

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Department of Public Enterprise – African Aviation Strategy 12 th August 2009 Dr A Shaw