Interim CFO: South African Airways
Worldwide the airline and travel industries are currently in free fall and SAA’s interim CFO will need to steer the state-owned entity through the perfect storm.
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This is CFO Talks and today I am delighted to have Deon Fredericks, who is the interim chief financial officer at South African Airways, with us in the studio. Welcome, Deon.
DEON FREDERICKS: Ciaran, thanks for the invite, it’s my pleasure to be here.
CIARAN RYAN: SAA is in difficult times at the moment and this is one of the reasons we wanted to talk to you. It is, in fact, under business rescue as we speak. So you have got some bosses that are sitting above you but just to set the stage here a little bit, you joined SAA in 2017 when it was already in pretty dire straits, before that you were the CFO at Telkom. I guess the question is, why did you go to what looks like s sinking ship at SAA?
DEON FREDERICKS: It’s an interesting question, at that stage my boss, Sipho Maseko, asked me if I would be interested, as he was approached by the minister to look for management and leadership skills that can be utilised in the SOCs, state-owned companies, in general. So ultimately I thought about it and at this point in my life I would like to give back, I am involved in various initiatives as well to give back to not only the industry that I am in but also to South Africa because I think all of us need to contribute to a lesser or greater extent. After I thought about it, I thought that it would be a good challenge. One of the things that Telkom has always been every year, as you would know, it was quite different, so there was never time to get bored. Ultimately I am a person who is a workaholic and I thought this would be a good challenge to try and make a difference because, as you know, the SAA brand is actually a very good brand, with all its challenges it is probably the fourth or fifth well-recognised brand in the world.
CIARAN RYAN: That’s interesting, I do have a high opinion of SAA having flown it many times, just in terms of the quality of the service compared to some of the airlines that I have flown elsewhere in the world and I always felt that it would be a terrible pity to see that disappear. So for people who are overseas and who don’t know, just give us an extent of the financial damage that you surveyed when you moved in there in 2017, what was the scene on the ground?
DEON FREDERICKS: Look, they were in a very challenging position at the end of the day and one of the key challenges was funding. As you know, if you have a company making losses and you don’t have funding it’s very difficult to operate on a drip feed basis. So my key focus in the last, and probably still now, was to make sure that we have sufficient funding to operate because if you don’t have sufficient funding then suddenly you need to decide what is a priority. So you only address issues of today, you can’t really plan forward in terms of initiatives that you want to implement and from a capital investment perspective, you would delay certain initiatives that would be critical for the future of the airline. So it’s been quite challenging. I think on the other side is what they called the long-term turnaround plan, which I think is a good plan, it had various elements. I will share the key elements with you, the first one was liquidity and funding to ultimately get the balance sheet in shape to support the organisation and to grow the organisation going forward. The second part was in terms of revenue stimulation and that also includes making sure that you have the right fleet because in this industry if you don’t have the right fleet you may have very high load factors but you will not make money. Just to put it in context, if you look at the margins in this business it’s probably 4% to 6%, so you need to make sure that you co-ordinate focus and align so that you are able to be profitable in this environment. The third part was our technical environment that we had to reshape, refocus and making sure…because the key for them is to make sure that they provide aircraft so that the airline can be on time, so the turnaround time is critical and, as you know, unfortunately with state capture some of those processes were completely broken, the relevant expertise has left the organisation, so it is to a great extent a rebuilding. But the challenge always in a situation like this is not like a green field, in a green field you can start and say this is what I am going to focus on, this is what I will do, these are the people who I will bring in. Unfortunately, you have a legacy organisation and to change certain things is very challenging. I think just from my perspective the biggest challenge within the organisation, and even when we started the turnaround at Telkom, was culture and culture doesn’t change over a year or two years, it takes at least four to five years, and similar in the South African Airways environment and you have various stakeholders, this is one of the organisations that you need to deal with in order to make sure that you are aligned and inform – and we could have done better in terms of communication – inform all stakeholders because there were some stakeholders that believed that government will always bail us out and didn’t understand the bigger macro environment that government, firstly, is not in a position to bail us out and we need to make sure that we are effective, efficient and provide a reasonable service at a reasonable price to be competitive. The whole focus a full-service airline and a low-cost airline, your normal person in the street doesn’t see the difference. So if you are significantly more expensive because of your cost base, you will struggle to increase your load factors.
R46 billion bailout
CIARAN RYAN: How much has the government provided in terms of bailout funds over the last decade, the last figure I saw was about R13 billion?
DEON FREDERICKS: No, if you look in the last five or six years it’s probably about R30 billion.
CIARAN RYAN: R30 billion and now the taps are closed.
DEON FREDERICKS: What government has indicated, as you would have seen in the budget, is that they have provided R16.4 billion to pay the legacy debt. They have also indicated within the budget that they will fund the implementation team, which the BRP will put in place from the budget. The shareholder has now confirmed that they are fully aligned up to the president and that they want to make sure that we make a success of the airline. So it’s key that all stakeholders actually take hands and make sure it works. That’s the only way it will work.
CIARAN RYAN: That R16.4 billion, is that included in the R30 billion that you mentioned or is that over and above?
DEON FREDERICKS: That is over and above.
CIARAN RYAN: So at the end of the day it will be R46 billion.
DEON FREDERICKS: Yes, about R46 billion.
CIARAN RYAN: That’s a huge bailout figure. First of all, did you finish, you were running through the turnaround plan.
DEON FREDERICKS: The third one was in terms of organisational design, it means making sure that you have the right organisational structure, the right people in the right positions and the right skills. As you would have seen, the business rescue practitioner has now implemented that with a Section 189 [of the Labour Relations Act], where 4708 people will be impacted. At this stage it will be a consultation and negotiation with organised labour, which can give inputs and proposals, and that will determine ultimately what the final structures will look like but also in terms of the number of people who may be impacted.
CIARAN RYAN: Right, so about 4700 people could potentially lose their jobs?
DEON FREDERICKS: No, remember, that’s the full complement, so part of those people will be impacted.
CIARAN RYAN: And it hasn’t been decided exactly how many…?
DEON FREDERICKS: Because there’s a process of consultation taking place at this stage.
CIARAN RYAN: Right, which you have to do in terms of the Labour Relations Act.
DEON FREDERICKS: That’s correct.
CIARAN RYAN: Okay and the other pillars?
DEON FREDERICKS: The others were in terms of governance, in terms of making sure that we are much more flexible. Unfortunately, as you know, we have to comply with the Public Finance Management Act, where if you take our competitors like Comair or BA doesn’t have…so the moment you slow in a market then it would be a challenge. As part of the process of the business rescue practitioner they have received certain exemptions, which will enable them to streamline and accelerate the implementation plan.
84 Contracts identified as irregular or suspicious
CIARAN RYAN: Of course, in the middle of all of this, I do want to come back to one or two of these points that you’ve raised…
DEON FREDERICKS: The last one is in terms of procurement, as you know, that’s where a lot of state capture, if I can use that word, took place. So that’s all being reviewed, aligned and challenged, you would probably have seen that the president made presidential proclamation for 84 contracts that we identified that look irregular and suspicious, and that will enable the Special Investigating Unit to actually investigate it and go into people’s personal bank accounts to see if there’s been any kickbacks or any involvement. So at least there are some of these things that are continuing but unfortunately these processes take much longer than one would like. But it’s critical that a detailed analysis and that there will be full focus on that ultimately.
CIARAN RYAN: Right, so these 84 contracts have been flagged as suspicious, have they been suspended and cancelled?
DEON FREDERICKS: Look, you can’t do that until you have done the full investigation because in certain cases it could be that it’s not the case. There are certain red flags that you would look at and only after that then you can conclude on that.
CIARAN RYAN: In terms of your last audited results what was the wasteful expenditure or irregular expenditure figure?
DEON FREDERICKS: We haven’t published for the last two years and as it’s not publicly available at this stage I wouldn’t like to put it out there.
CIARAN RYAN: In previous years did it come up as an issue?
DEON FREDERICKS: It’s always been an issue and in the different years it has been different amounts. In many cases it’s been contracts, like for example at one stage because there was a funding issue the board decided to enter only into six-month contracts, which means that some of that has been rolled and when it gets rolled and not gone through a process of a tender it will be classified as irregular.
CIARAN RYAN: Right, so suspicious transactions can go under the table much more easily when you have a shorter-term contract?
DEON FREDERICKS: If you have to extend for that period, yes, and your challenge in certain cases is also that it doesn’t take a month or two to put an alternative provider in place, which means that in certain cases you will have to extend contracts while you go out on tender.
CIARAN RYAN: You must have felt when you walked into this that you were walking into a bomb site?
DEON FREDERICKS: Not really, I think if you look at Telkom’s history, we have been through significant and many challenges over the years and, as I indicated earlier, every year was different, so many of these things I have experienced previously, which means when you are in this situation you need to keep calm and you need to look at what are really the critical issues and take all the noise away. On the other side how do you prioritise because the challenge when a company is in distress is that the people want to do everything that they have done previously but the challenge is that you can’t do the same things and expect a different result. As a result of that the focus was more on what are the practical things that we need to focus on and make sure what are the big drivers that will turn the organisation around.
CIARAN RYAN: You also have business rescue practitioners now who are sitting above you, so you have bosses, even though you are the chief financial officer, albeit interim, but you do have bosses ahead of you and they are making the key decisions, for example, on what to do with the fleet. This is something that you and I have spoken about before is the fleet that SAA has and I do want to touch on IFRS 16, where you are having to now account for these perhaps in a radically different way because those are the main assets for SAA, are they not?
DEON FREDERICKS: Yes, agreed and I think the significant impact of that would probably be less because we have cancelled certain routes, as a result of that you will have fewer aircraft going forward…
CIARAN RYAN: Can you just summarise what percentage of flights have been cancelled?
DEON FREDERICKS: I will have to just firm up that number for you.
CIARAN RYAN: Roughly speaking.
DEON FREDERICKS: As I said, it’s round about 30% to 40%.
CIARAN RYAN: 30% to 40% less flights and those are obviously the less profitable flights?
DEON FREDERICKS: That’s the less profitable flights.
Aggressive advertising campaign
CIARAN RYAN: Okay, in terms of revenue stimulation, which is one of the pillars that you identified or that you mentioned a little bit earlier, how does one go about that in an airline, how does one start to stimulate additional revenue?
DEON FREDERICKS: The big challenge was, as you would see before we went into business rescue, first we had the strike, which was unfortunate and untimely because at that stage the airline was experiencing significant challenges already and it just pushed us further towards the precipice at the end of the day. The second part was when the reinsurance was withdrawn, which suddenly meant that people would not necessarily buy from SAA or fly with SAA, and Flight Centre also indicated that they are withdrawing. I am happy, and we have announced it previously, that the insurance companies are back, Flight Centre is back, so at least that will assist us in the process, and we have seen that there’s progress and growth. We have also, as you would have seen, gone aggressively into the market with advertising now, there was the Journey Blitz where you can use 10% of your miles for significant benefit for flights going forward and there was a significant reduction in flights that we’ve advertised. The unfortunate thing now is the coronavirus, where we have seen many of the conferences cancelled, many of the big corporates putting bans on flying, which immediately will impact SAA. You would probably have seen in the newspapers that Virgin, for example, is flying what we call ghost flights to keep their slots specifically in London…
CIARAN RYAN: Basically, empty flights just to keep the slots open.
DEON FREDERICKS: To keep the slots, there are discussions going on around that. So from our side we are looking at everything that we can do to stimulate the revenue growth but also on the other side in terms of the business rescue process, very keenly focused on what costs we incur going forward.
CIARAN RYAN: It really is a perfect storm, the coronavirus coming on top of all of these other things that you’ve mentioned and Lufthansa, for example, cancelling about half of its flights. You talked about Virgin Airways with their ghost flights, world tourism has died in the last month.
DEON FREDERICKS: Agreed, if you look in terms of the Lufthansa situation, they have indicated that they will have to approach their government to support and assist them and you’ll see more and more airlines making these announcements because if they don’t have support they will struggle going forward. We are a little bit fortunate but if it’s going globally then probably at the end of the day it’s not going to make such a significant difference that we don’t fly to countries…like we don’t fly to the East…
CIARAN RYAN: All flights to China cancelled?
DEON FREDERICKS: Cancelled, we are not flying to Italy that’s on lockdown at this stage, so some of these things will help but unfortunately people will reconsider flying and in the short-term it will definitely have a negative impact on your revenue.
CIARAN RYAN: At what point do you reevaluate and say it’s safe now to open up flights to China and to Italy?
DEON FREDERICKS: For us, we didn’t fly to Italy, if there’s an opportunity for us in the future and everything is back to normal you will always look at opportunities where there is growth in the market and where you would be able to operate profitably. In terms of the East, that will be the same as well. I think the key focus is to make sure that you have an effective base and a profitable base so that you can get profitable and first start off there. So if you get the base right then you can grow from that because you will start generating working capital and funds to fund growth going forward.
CIARAN RYAN: Do you have any sense of what impact coronavirus has had on SAA’s revenue at this point?
DEON FREDERICKS: Look, it’s difficult, we are trying to quantify it but it’s a difficult situation at this stage. As I said [a couple of weeks ago] we were reasonable, not so much impacted but I think as this thing has now expanded, as corporates are taking action it will definitely have an impact going forward.
CIARAN RYAN: For example, in terms of your occupancies on flights, are you seeing a decline on that, on the international flights, even if it’s to London?
DEON FREDERICKS: Ja, you would see that because of the impact.
CIARAN RYAN: Are you discounting seat prices to try and fill them up?
DEON FREDERICKS: We will discount to a certain extent, but you need to be careful that you need to at least recover your variable costs at the end of the day.
Where to from here for SAA?
CIARAN RYAN: Where to from here for SAA, if you lay out the path for the next six months, what do you see happening and will you be staying through this whole business rescue process, which I imagine could last some years?
DEON FREDERICKS: It will take time, it’s difficult for me to comment what the business rescue practitioners will finally do but the process is that ultimately they will, as they have indicated, put a plan to creditors by the end of March, the creditors will then vote on that and then the plan will be implemented. Depending on the plan, there will be certain milestones that need to be reached at which stage and at what stage the business rescue practitioner will say okay, SAA is in good order, in a good state and based on that normal operations can then continue from a board and management perspective. But it’s important to say that management and the board is using and working with the business practitioner.
CIARAN RYAN: One of the big issues, of course, is the negotiations with the trade unions that have to happen in terms of the Labour Relations Act, there was a strike late in 2019, that calmed down, I think it only lasted for about ten days or two weeks and then it calmed down. How is that relationship with the trade union and are you involved in that?
DEON FREDERICKS: I am not directly involved, it’s being managed through the business rescue practitioner. Unfortunately, some of the unions have different agendas that doesn’t really take the airline forward. As I have indicated previously, we need to take steps now to at least make sure that we save the airline and afterwards we can address any other outstanding issues and concerns that the unions may have. But ultimately this is being dealt with, with the business rescue practitioner at this stage.
CIARAN RYAN: Right, what do you say to those people who say SAA has sucked too much money out of the Treasury, R30 billion plus another R16 billion to come, that it should be allowed to just fold up, it’s gone to far.
DEON FREDERICKS: I think sometimes it’s easy to stand outside, it’s like when you watch a soccer game, you sit on your chair there and you play better than the players…
CIARAN RYAN: Yes, I always felt I’d make a great Springbok coach [laughing].
DEON FREDERICKS: Agreed and sometimes people don’t have all the information but ultimately it will have a significantly bigger impact than SAA. The key is if you look at all the implementation plans there was never anything wrong with the implementation, the elements as I shared with you previously is mostly the same, with some small changes. But ultimately it was all about implementation, getting the right skills in place, making sure that you are flexible, governance processes that you can make decisions quickly, making sure that you reshape the organisation, addressing the technical part of the organisation and strengthen the sales part, which is critical in an airline.
SAA a clear target for state capture
CIARAN RYAN: If you read the press, SAA was a clear target for state capture over the last decade and under then chairwoman Dudu Myeni it seems to have just fallen off the edge of a cliff completely. I think you came a little bit after her time or during her time?
DEON FREDERICKS: After her time.
CIARAN RYAN: Okay, so this is not something that you had firsthand experience of. Do you think SAA will survive?
DEON FREDERICKS: SAA can survive, I think there’s a reasonable plan on the table, it’s for all the stakeholders to work together and not against each other. Unfortunately, as I said, there are various agendas with various stakeholders and currently the business rescue practitioner is driving it, and if he manages it in accordance with normal business practices it can be a successful company again. Some difficult decisions will have to be taken and if these decisions are taken, then SAA will survive.
CIARAN RYAN: I guess it’s one thing to be a chief financial officer in an organisation that is solvent but quite another when you’re relying on state support the way SAA has. This is like a Telkom, you have a functioning business, you have a business that has got positive cash flow, but you come to SAA and it really is quite something. This is a great thing to add to your CV, to go into a bomb site and fix it up. If SAA is turned around, and hopefully that is the case, this will be a hell of a feather in your cap as a CFO. This is an unusual job for any CFO.
DEON FREDERICKS: I agree and I think one needs to look a little bit bigger in the context if you look currently at how many of the companies are in distress or challenging, good companies, and the belief is always that you need conservative CFOs in organisations, you need to put something away for a rainy day and you must make sure that you plan for the worst and hope for the best, and sometimes you need some luck as well. So I think in SAA’s case we need to do the right things quickly and urgently, and if you can do that you will survive. Is it a challenging environment, yes ultimately the role of the CFO has become significantly more to get involved strategically and, as I always say, any action within an organisation has a financial impact, so having overall responsibility for finances you need to make sure that you are on top of that. Sometimes in an organisation it’s not so easy in that the culture was that we don’t include finance to look at some of these decisions and understand what the implications will be.
CIARAN RYAN: Yes, so I guess a lot of your time is spent on making sure that you can make payroll at the end of the month, where do we get the cash this month. You’ve got Treasury, the government, the shareholder, on the other side, which has got you under a microscope because I guess they are tired of having all of these bailouts go on and on and on. So you are in a difficult position, therefore, you have to spell out a road map or the business rescue practitioners have to spell out the road map before Treasury is going to release the purse strings.
DEON FREDERICKS: I agree, and I think it’s always important that an organisation with a culture needs to understand that. We’ve had a session sometime with some stakeholders where we have indicated this and indicated but everybody needs to step up because government will not continue to bail us out, and many of the people didn’t want to do that.
CIARAN RYAN: For people overseas who don’t know, just give us a quick idea of the fleet of SAA and there is a restructuring of that fleet that is going on and why is that.
DEON FREDERICKS: We’ve got around about 50 wide bodies and narrow bodies. As you have cancelled a significant number of the routes you will have to reduce that fleet now. As you know, we brought in four A350s, which is significantly more fuel efficient, so at least we’ll get efficiencies from that. As part of the business rescue process you can now renegotiate all the contracts on the table, which will give SAA then an ability to have a lower cost base and that’s critical because you need to do both, you need to do the revenue line and you need to address the cost line urgently.
Staff morale low as layoffs loom on the horizon
CIARAN RYAN: What is the staff morale like?
DEON FREDERICKS: As you can expect, suddenly if you have something like a Section 189 over your head, everybody is immediately focused on me, what will happen to me, where is my block in the structure, will I have a job, so the morale is not high. As management we need to make sure that we continue speaking with them, communicate, because that’s the only thing that you can do, and be as transparent as you can.
CIARAN RYAN: Right because it’s quite clear that there are going to be layoffs and it’s just in what sections of the organisation that these layoffs will be.
DEON FREDERICKS: Yes, it will depend on the final negotiation and consultation with the unions and based on that what the final structure and shape of the organisation will look like.
CIARAN RYAN: Just to wrap up here, we are running out of time but I think you did touch on this a little bit earlier, I think Lufthansa, Virgin and virtually every airline in the world is going to go through a similar process, are they not, Virgin doesn’t have the option of going to the government but Lufthansa could certainly go to its government and say this is force majeure, we don’t have any other option but to come to you cap in hand, please bail us out. Even looking in South Africa, your other competitor, Comair, which flies the British Airways brand, they did quite well but now their results are showing similar kinds of stresses.
DEON FREDERICKS: Everyone will have to look, and I think ultimately what I say is people say let’s wait until this abnormal situation washes out. I think there’s a different view that one needs to take in a global integrated environment, where you don’t have control over a significant number of variables, that you say this abnormal situation is the new norm, this is the new normal and you need to plan around that and manage around that, and make sure that you have contingency plans if anything happens like the coronavirus what is Plan B and what is Plan C.
CIARAN RYAN: Final question, Deon, and it’s about you, where did you grow up, where did you go to school, are you a family man, tell us a bit about yourself.
DEON FREDERICKS: I grew up in Kuils River in Cape Town, I went to Elsies River High School, which at that stage people saw it as a gangster school…
CIARAN RYAN: And was it, was it rough?
DEON FREDERICKS: It was a good school and I think it applies to education today and we see it in matric results as well. We need to focus on those schools as well because if you look at the products that came out of the schools, they are in top management positions currently with all the challenges around that. I articled at that stage at Coopers & Lybrand in Cape Town. I couldn’t find work in the apartheid era in Cape Town in the ‘80s.
CIARAN RYAN: So you were articled and you couldn’t find work?
DEON FREDERICKS: Yes, and the funny thing is I phoned for a job interview and they sounded impressed until I walked in and they realised I’m not white.
CIARAN RYAN: So that was it, really, hey.
DEON FREDERICKS: So I ended up in Bophuthatswana, in Mafikeng…
CIARAN RYAN: Which is now the North West province in South Africa.
DEON FREDERICKS: I lived in Mafikeng because I had a family at that stage and I had to look after the family, two girls and one boy. Then afterwards I wanted to come back to Cape Town and couldn’t, so I started out at internal audit in Telkom, I was then requested to go and set up an audit function in Cape Town and after that I took over all the regions of internal audit and then moved across because audit was never my first love, I moved over to finance and I became responsible for the executive in the Western Cape, later I took over the Eastern Cape as well. Then the Americans arrived and centralised everything to Pretoria. So I had the option to either stay there and have better quality of life and 25% of the job I had previously or go to Pretoria and I agreed to go to Pretoria for three years, and then it was 20 years later.
CIARAN RYAN: Is that right, so worked your way up from internal audit to CFO?
DEON FREDERICKS: Yes, when the Americans left I became what they call in the US the controller for the group, after that I was deputy CFO, then CFO and then retired when I was chief of investments, and then the opportunity or the request came to assist.
CIARAN RYAN: Right and here you are today. Okay, we are going to have to leave it there. Deon, thanks so much for coming into the studio to talk to us. Please come back again in a few months’ time for an update on what has been going on at SAA and I hope you can accommodate us.
DEON FREDERICKS: Thanks very much for the opportunity.
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Is this the end for SAA? – Accounting Weekly