Part 1 of 3 of a Treasury Staff Insights: Rangitaki article by Juston Anderson
On 18 January 2002 the New Zealand Government invested $892 million in Air New Zealand, giving the Crown an 82% ownership stake in the company. A further $149 million was invested in Air New Zealand in a rights issue in December 2004, taking the total invested by the Crown to $1,042 million.
So what financial returns has the Crown received for this investment?
Using an internal rate of return (IRR) calculation, I estimate that the Crown has received a return of 8.4% per year from its shareholding in Air New Zealand, as at 9 May 2016.
Below, I explain how I arrived at that figure.
Two subsequent blog posts will look at some implications of this analysis:
- how movements in Air New Zealand's share price affect the IRR calculation
- separating the IRR into realised and unrealised returns, and why this matters
- the impact on the IRR of the Crown's sale of some of its shares in Air New Zealand in November 2013
Is 8.4% a "good" return?
An internal rate of return can be used to compare two or more investments to each other; it doesn't tell you whether an investment was "good". And "good" is not really a term that an investment advisor would use, as it is a value judgement.
You could argue that 8.4% is greater than the Crown's cost of borrowing over the period from 2002 to today, and on that basis the investment was "good". This would not be a sound argument, for a number of reasons - for example, it ignores risk.
A better benchmark than the cost of borrowing would be to consider market estimates of Air New Zealand's cost of equity. This is the return that market analysts think that shareholders in a company would need to receive, to compensate them for the risks of investing in that company. A few years ago, market estimates of the cost of equity for Air New Zealand were between 12% and 16%, somewhat higher than the calculated IRR.
But of course the Crown is not a market investor, and the Crown's motivations for investing in Air New Zealand were not purely financial. The Crown had other reasons for investing. And the Crown did not invest on the expectation that it would sell the shares later and make a profit, as a private investor buying shares would.
Calculating the internal rate of return
To work out an internal rate of return on an investment, you need to know four things:
- how much was initially invested
- any cash returns you have received from the investment
- the current market value of the investment, and
- the dates when all of the above happened.
Returns from Air New Zealand
Since January 2002, the Crown has received around $869 million in dividends from Air New Zealand. The dividends are shown in the graph below.
The blue bars are ordinary dividends, while the red bars show special dividends. The green bars are dividends paid on Air New Zealand's redeemable preference shares, which were issued to the Crown as part of its investment in Air New Zealand in 2002. They converted to ordinary shares in January 2005.
In November 2013, the Crown reduced its shareholding in Air New Zealand by selling around 221 million shares (reducing the Crown's shareholding in the company to around 53%) for which it received $365 million of cash.
So the total cash that the Crown has received is $1,234 million.
The market value of the investment
The dates when this happened
We need to know when all of this happened so that we can take account of the time value of money. This is the principle that a dollar today is worth more than a dollar at some point in the future. You could invest that dollar now, and with the income from the investment, you would (hopefully) have more than a dollar in the future. For the same reason, a dollar that you received in the past is also worth more than a dollar received today.
Ignoring the time value of money, the Crown invested $1,042 million in Air New Zealand, has received $1,234 million of cash, and currently holds an investment in the company worth $1,341 million.
That might sound like a significant return, but it was over a fourteen year period. To put that into perspective, if you invested $1,000 in a bank term deposit that paid (say) 5% interest (after tax), and reinvested all of the interest payments, then after fourteen years you would have almost $2,000 in the bank.
The attached spreadsheet shows the details of the IRR calculation which, taking account of the time value of money, tells us the Crown's return on its investment in Air New Zealand was 8.4% a year.
- staff-insight-anz-irrcalcs-may16.xlsx (14 KB)
-  This is effectively an after-tax rate of return, as the Crown does not need to pay tax on the returns it receives from the companies it owns.
-  Documents on the Crown's decision to invest can be found here: http://www.treasury.govt.nz/publications/informationreleases/airnewzealand/recapitalisation
-  Not including dividends paid to the Crown Financial Institutions (NZ Superannuation Fund, ACC, GSF) as a result of any shares they owned in Air New Zealand.
-  The Crown has also received tax from Air New Zealand, but this is separate from its ownership of shares in the company.
-  This is a theoretical value because (a) the Crown does not intend to sell any of its shares and (b) the market share price is for small parcels of shares changing hands, with total volumes traded during a day typically being less than 1% of the shares on issue.
-  The Crown owns 582,854,593 shares in Air New Zealand, and the market price of Air New Zealand shares was $2.30 on 9 May 2016.
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Treasury Staff Insights: Rangitaki
See Treasury Staff Insights: Rangitaki for other articles in this series.