A Critical Analysis of Regional Airline Competition: How it’s Done

In its April 11, 2019 edition The Economist magazine, one of my favourite reads, published the following article Turkish Airlines takes on Emirates, Etihad and Qatar Airways. I can’t comment on the conclusions that it arrives at because the analysis is meaningless. It is important for readers to understand why this is so to better enable them to make judgements about the content. In my article I am not arguing for or against a particular airline, I wish them all the best. I am simply pointing out the flaws in the article’s arguments, with all due respect to the author and to a great magazine.

Source and Copyright: The Economist magazine

Using the right measure for growth rates

The first issue is the following statement “Turkish [Airlines] is growing at an annual rate of 30%, unlike its Gulf rivals, whose expansion has stalled or gone into reverse (see chart).” 

As always, when comparing growth rates one needs to look at multiple factors. An important factor is the base one is starting from. In this case the measure used in the article is passengers carried in absolute terms and the base seems fair enough. The question is does the measure make sense? It doesn’t for several reasons. With regards to presenting the graph the main issue with the base is that Turkey has a population of circa 79 million whilst the UAE and Qatar have a combined population of 12 million. Turkish (the airline) is carrying circa 100% of its population per annum whilst Etihad, Emirates and Qatar (airways) are carrying circa 900% of their populations annually. That is a huge difference.

The second issue is what does total number of passengers mean? Clearly in the end success will be measured financially. But even intermediate measures would be more meaningful. Carrying the same number of passengers but with lower plane occupancy rates and / or higher number of flights is a bad thing.

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Startup Fundraising: Entrepreneurial Blind Spots

The trouble with entrepreneurial fundraising is that it is an activity which most entrepreneurs will engage in only a few times and yet it has a massive impact on their startups. Unlike other, predominantly managerial, activities which are performed weekly if not daily, fundraising is relatively so infrequent that it is hard to build up a skill set and / or experience effectively.

The most important step is the first time you go raise money. This is not something you’ve done before, and you will be at a massive disadvantage as you will likely have never previously met with prospective investors. There are some great resources covering issues such as preparing the business plan, preparing the pitch, delivering the pitch, networking, etc.

There are, however, some important gaps which I will cover in this article.

You’re probably talking too much

Sales 101: Know your client (investor). How do you get to know your investor? Reading about them and asking about them is a good first step. But nothing beats asking them direct questions and listening to the answer.

Think about it: If you go to a 50 minute meeting and you’re busy pitching for 40 of those minutes, then at the end of the meeting who knows more about who? Of course the investor now knows a lot about you but you know little about the investor. Some might argue that this is what is needed to get an investment, but the truth is you need to make sure that the investor gets the information that they want, not the information that you think they want.

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Profit without Value

The debate of value creation versus value extraction is an important one when markets are developing and is a crucial driver of share prices. The danger, however, is that the impact on share prices is opposite to the impact on the value of the company. The result can be business destruction to the benefit of a single stakeholder.

What do we mean by value creation versus value extraction?

Value creation is developing the ability to keep producing value, e.g. building a productive asset.

Value extraction is monetizing, or liquidating, value, e.g. selling a productive asset.

Value Creation versus Value Extraction

Value creation is clearly not controversial. It is value extraction that is problematic. The core issue is why is value being monetized and what is the revenue going to be used for? I’ll clarify with two examples.

We are at the dawn of an era of electric vehicles. A car manufacturer who owns four factories that manufacture petrol based cars decides to sell one, which is monetizing it, and to invest the proceeds in developing an electric car factory. Two factors point to a good use of value extraction: 1. The asset that is liquidated is likely to begin losing value, and 2. The revenue extracted is re-invested into value creation. Some might even say that the value creation is greater than the value extraction, so on a net basis the company is creating value.

Consider another car manufacturer that has two factories, each manufacturing electric cars. Seeing a rush to the electric car market by established car production companies, they sell one of their factories at a great profit and use it to pay dividends and launch a share buyback program. Here, the company liquidated a valuable asset that was likely to be productive for some time. Worse, it did not try to replace the value it liquidated. Instead it gave shareholders a short term boost, and because equity markets are short term the share price also gets a boost. Which also boosts executive compensation. Continue reading

Shuaa’s Profit due to Negative Goodwill

Shuaa reported a 2018 net profit of AED 28.5 million. AED 31.4 million of that is attributed to negative goodwill, an intangible asset and not part of recurring ordinary operating income. This means that if you use the market values of assets as opposed to their accounting treatment based on appraisals of the value, then Shuaa’s P/L could be considered a loss of AED -2.9 million.

In effect Shuaa uses the theory of accounting to override the experience of investors in the Kuwaiti stock market so as to turn a loss into a profit.

But don’t take my word for it. Only a coward would say things without supporting it with credible arguments, based on known facts, and reliable public sources.
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Foreign Companies are Good for the Economy

I previously tweeted about an interview in which Mohammed Alabbar, Chairman of the e-commerce company noon “ called for new legislation that imposes 51% local ownership of e-commerce related businesses ranging from payment service firms to logistics companies, in order to protect the national economy from global giants such as Amazon.” I pointed out that the article only looked at one stakeholder, noon, and didn’t consider other stakeholders such as consumers. This led to a lively debate on the subject across the twittersphere and is worthy of a revisit.

Noon’s Shareholding and Souq’s Rise

The most glaring inconsistency in the arguments raised by Alabbar is the idea that nationals should own 51% of the companies and payment systems in e-commerce. The company noon is not held 51% by local shareholders, at least according to the announcements about noon. I understand that the other 50% is held by the Saudi government, a close ally of the UAE, but it still contradicts Alabbar’s arguments.

The second, and also glaring, inconsistency is the fact that the e-commerce company Souq built their business to a value of around USD 600 million without any help from, and in spite of, “global giant” competitors. Souq is a resounding success as a local startup and didn’t need any government protection. This is true entrepreneurship. This is true capitalism.

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GFH Buys Backs Shares, Issues Bonus Shares

Last week, Gulf Finance House (GFH) announced that it would recommend distributing bonus shares. That comes on the heels of a share buyback program launched last year. The idea of a share buyback program is that shares of GFH are cheap and so it makes sense for the company to buy them back. The reverse, issuing bonus shares, makes sense for GFH when shares are expensive. So the two are, on the face of it, inconsistent if executed at the same time.

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Is UAE Economic Productivity Declining?

Economic production, usually measured using gross domestic product (GDP) or gross national product (GNP), is not the same as economic productivity. Production is creating goods and services. Productivity is what you do with goods and services. To gain insight into the difference let’s look at a simple example.

GDP is a flawed measure

Simplistically, if you produce a widget that nobody uses then you’ve produced something but it is not productive. A little more realistically if you build a building at a cost of AED 60 million and valued in the market at AED 100 million then you have contributed AED 40 million to GDP (local resources involved that contributed to GDP would be counted in the AED 60 million cost). However this contribution to GDP is the same regardless of what is happening with the building. Regardless of whether you fully rent out the building or if it remains empty the GDP contribution remains the same. A reasonable person might argue that a GDP whereby the economy uses the production is healthier than the same GDP whereby the economy does not use the production.

So although GDP growth is often used as the main measure of the health of an economy it is clear that this does not give the full story. How can we clarify the picture further? One way to measure productivity, or if goods and services are being used, is by looking at the total value of transactions in an economy. The idea is that the greater the value of transactions the greater economic activity and, presumably, the greater use of goods and services.

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The UAE’s Equity Market Performance Bank deposits have a place in your portfolio

My last article regarding the effect of rising interest rates on the UAE’s equity markets sparked quite a bit of debate on LinkedIn and got me to thinking about how the equity markets have been performing. So I looked at the year to date (YTD) return for Abu Dhabi’s market at found out it is 9.82% as of today (source Bloomberg). For Dubai’s financial market the YTD return is -12.62% (source Bloomberg). This doesn’t tell me much about the overall equity performance on a national level. Continue reading

Interest rates are a threat to equities The rise of EIBOR

The major theme for equity markets over the last couple of years has been the oil price. That was a valid issue as it affected the fiscal side of the economy tremendously (i.e. government spending).

Various other issues have cropped up in terms of looking at the market, such as the tightening fiscal policy of introducing VAT and the investor trust levels post the Abraaj issues. Fiscal policy will have an impact, Abraaj is really about learning from their mistakes.

But there is another threat, one that is growing, and that is interest rates. The US Federal Reserve (Fed), the central bank of America, has been countering Trump’s loosening fiscal policy of reducing taxes by moving towards a more contractionary monetary policy of increasing interest rates. This makes sense for the US which has a robust economy these days. For us, and other countries pegged to the US dollar and facing a challenging economic environment, increasing rates are a problem. Continue reading

Abraaj’s flawed operating model

A lot has been written recently about Abraaj Capital, the private equity company based in the Dubai International Financial Center. The current focus is around Abraaj’s actions with regards to the potential co-mingling of client funds with its own operating funds. News is updated on a relatively frequent basis about the subject and there is clearly a lot to learn on many fronts. However, it is too early to do a full post-mortem as investigations and legal cases have not come to a conclusion. But there are some things that can be gleaned that could be instructive for investors. The aim of this post is not to judge Abraaj, the courts will do that. The aim is to try to see if there are lessons that can be used by investors to better manage their portfolios. Continue reading