A2-6 Swissair 071202v5

Group A2-6 INSEAD Sept 2002Management Accounting & Control

Management Accounting & Control

December 10th, 2002

EVATM at SwissairGroup A2-6

MBA ProgrammeSeptember 2002


Introduction

“The stability provided by SAirGroup’s structure allows us to pursue and finance an expansion

programme that ensures the Group maintains its value and its entrepreneurial independence amid a

global economy that is increasingly tending towards concentration in all sectors.”1

How did a company that embodied Switzerland’s typical image of stability and wealth, manage to

destroy billions of dollars of value and end up bankrupt, selling its activities to banks for a penny?

This paper will briefly analyse the severe trend of value destruction followed by SAirGroup before its

final demise in October 2001. It will continue to detail the enormous value destruction that took place

during the 30 days that sounded the death knell for Swissair. Finally, it will comment on how the

“stool” framework for value creation assesses the current rescue strategy and how an alternative plan

would have made it more viable and valuable for the Swiss government and Swiss people.

A dangerous trend before 9/11

SAirGroup was better known for its flagship subsidiary, Swissair. Launched in 1919, this boutique

pursued an 83-year growth story, acquiring planes, developing routes and remaining constantly

profitable. By the end of 1998, Swissair was operating a CHF5.4bn fleet (consisting of CHF2.1bn of

its own aircraft, CHF1.6bn on financial leases and CHF1.7bn operating leases), amounting to roughly

150 planes, with 44,000 staff. In addition to the airline business, the group had started investing in

related sectors thus becoming a conglomerate of air transportation-related businesses. As the direct

consequence of this ‘Hunter’ strategy, SAirGroup had a complex corporate structure (see Exhibit 1).

The fate of Swissair was sealed by a combination of this massive capital investment policy funded

through debt, the uncertain economic conditions in a traditionally sensitive sector, and hidden business

malpractices. Even though we will not perform a detailed Economic Value Added (EVATM) analysis

over the period pre-2001 as it is out of the scope in this paper, the EVATM formula can help structure

this assessment:

EVA = NOPAT – Inv. Capital x WACC

1. Roughly, we have NOPAT = operating revenue – costs. The trend during the period 1998-2001 at

SAirGroup represented a simultaneous squeeze of operating revenue and increased costs.

1 SAirGroup annual report, 1999


a. The observed revenue decrease before October 2001 (cf Exhibit 2) exceeded the

expectations of the company. Three forces combined to disappoint analysts: general trends

in the airline industry, competition, and the impact of terrorist attacks in the month of

September 2001.

i. General trends of industry: The overall economic environment surrounding Swissair

worsened in the years before the final collapse. Firstly the increase in international

seating capacity came as a direct threat to Swissair’s business model that was based on

cross-border flights. (cf Exhibit 3). Secondly, the worst accident in Swissair’s history

happened in 1998 with the death of 229 in the fatal New York – Geneva SR flight 111.

Lastly, the troubled social climate in some subsidiaries (e.g. AOM in France) limited

the exploitation of possible synergies.

ii. Competition: The development of low cost carriers stiffened the competition not only

on price but also, and more importantly, on Swissair’s distinctiveness: quality of

service (cf Exhibit 4). Secondly, deregulation of the European skies urged Swissair to

join an alliance (Qualiflyer) to face the increase in power of the larger airline alliances

such as StarAlliance and Skyteam. However the defections of both Delta and Austrian

Airlines in 1999 and 2000 respectively, left Swissair almost solely responsible for both

acquiring new customers (marketing inferiority) and retaining existing ones (stickiness

due to other loyalty programmes).

iii. Impact of 9/11: Even though the company entered a troubled period as soon as August

2001 when an audit revealed that its debt was greater than previously reported, the

terrorist attacks in the US played a critical role in the cash crisis that occurred in

October.

b. Swissair’s falling revenues were exacerbated by a latent cost increase at SAirGroup. Even

though the research of optimal synergies between the numerous entities of the holding

produced some results in the areas of purchasing, yield management and catering,

important business drivers followed a negative trend. This trend was visible on both the

direct and indirect costs side.

i. Purchases: two main components of Swissair’s purchases followed an increasing trend.

Firstly the continuous increase in jet kerosene prices as well as the rise of the US Dollar

increased their cost base. During the period 1999 to 2000, prices rose 56% in highly

volatile markets, leading to the reduction in the effectiveness of hedging strategies.

Secondly, plane leasing had reached levels of CHF8bn by the 7 th November 2001.


Such leases were accounted for as capital leases, with the main lessors being General

Electric and American International Group (AIG).

ii. Process costs: over the period 1998 – 2001, logistics, facilities, and operations costs

grew tremendously. Major burdens on Swissair were the crew salaries that were higher

than the industry standard. For instance, a comparison with Crossair, whose salaries

represented the industry norm, indicated that a Crossair pilot earned between CHF56k

and CHF135k compared to Swissair pilots who earned salaries ranging from CHF81k

to CHF290k.

iii. Sales & marketing: the declination of the “Hunter” strategy for the passenger

transportation business implied building and the consolidation of market share.

Following the method used by other major carriers, Swissair joined and contributed to

market the Qualiflyer program with limited results. For instance, from 1998 to 1999

the operating revenue of Qualiflyer group decreased by 1.4% from EUR10.8bn to

EUR10.7bn, this was matched by a decrease in the number of passengers, which fell

from 54.4 to 53.7 million over the corresponding period.

2. Invested capital at SAirGroup increased substantially during the period 1998-2001. The main

components of invested capital are fixed assets, net working capital and investment in other

companies. While the first components were strongly controlled, for instance more planes were

being operated though operating leases, as opposed to company-owned aircraft, the “Hunter”

strategy had a strong positive influence on the level of invested capital. Consequently, SAirGroup

increased its invested capital by 52% from 1998 to 2000, from CHF5.5bn to CHF8.4bn as a result

of acquisitions.

3. WACC: The evolution of WACC is difficult to compute due to the lack of data regarding the cost

of debt and the cost of equity. However, it is certain that WACC remained constant or even

increased between 1998 and 2001 for two reasons. Firstly, on the equity side, the reduction of the

equity risk gained by diversification was offset by the tough economic prospects discussed earlier.

Secondly, the impact of debt financing was subsequently reinforced by the discovery of hidden

debt in August 2001; which would have had the negative impact of increasing the WACC.

The combination of severe business prospects, the unsatisfying market results, and questionable

internal practices created a pattern of value destruction (negative EVATM, cf Exhibit 5) resulting in a


scenario ripe for the value destruction that occurred in the month preceding the announcement of

Swissair’s bankruptcy on the 1st October 2001.

Swissair’s failure -

One of the fascinating aspects of Swissair’s death is the speed at which it occurred. How could a

company that had been constantly profitably over the course of its 71-year history expire so quickly?

It will be shown that both mismanagement in the SairGroup and financial irregularities contributed to

weakening the foundations upon which Swissair was based, and in the process removed Swissair’s

ability to act for itself. Prior mismanagement eroded the ownership of Swissair’s decision-making

rights away from the company towards its creditors: the banks and the government. Now at their

mercy, it only took one liquidity crunch, that normally would not have taken down a company the size

of Swissair, to destroy the company.

The crisis that was to be the end of Swissair began innocuously at the end of 2000, with the

announcement that for the first time in its history Swissair had made a loss. The size of the loss was

not trivial; it amounted to CHF2.9Bn and consumed almost the entirety of Swissair’s capital reserves.

Managerial mismanagement has been blamed for these losses, which were generated by a series of ill-

advised acquisitions (such as the Belgian, Polish and Portuguese carriers Sabena, LOT and TAP)

fuelled by Swissair’s wish to be the centre of its Qualiflyer alliance following the withdrawal of Delta

and Austrian Airlines. However with passenger levels behind expectation and the world descending

into a global recession, the enterprise was unable to finance its ambitious plans and Swissair

accumulated a gigantic mountain of debt.

A new CEO was drafted into Swissair. Formerly the CFO of Nestle, and Harvard Business School

graduate, Mario Corti seemed to be the ideal choice to guide the company back to profitability. Corti

was immediately thrown into negotiations with UBS (Swissair’s house bank) and Credit Suisse over

further credits and the reorganisation of Swissair. Immediately the decision rights begun to move

away from Swissair’s management as it became reliant on the banks. Corti’s problems worsened at

Swissair as he begun to discover hidden liabilities in special structures in offshore accounts in the

Cayman Islands. He immediately changed the accounting standards which revealed a mountain of

unaccounted debt that spiralled from CHF6.8bn at the end of 2000 to CHF15bn at the end of

September 2001. Such an increase in the plight of Swissair only served to strengthen the position of

the banks and the government.


In an effort to reduce expenses and debt, Corti announced the dismissal of 1,200 employees, as well as

preventing the further acquisition of Sabena and TAP shares. In June of that year Corti announced

that Swissair would have to save CHF500mn if the company were to survive the year. On June 21 st

SAirGroup’s shares dropped below CHF100 for the first time (cf Exhibit 6), their lowest ever level.

The beginning of September started bad and following the events on the 11 th September got worse.

Swissair, like its competitors suffered. It asked for state aid and announced that it was facing a

liquidity crunch. Only drastic changes and a cash injection would solve Swissair’s problems. Both of

these seemed to have been met, Corti approached Berne who agreed to keep Swissair alive by agreeing

a CHF325mn injection of funds, and on September 24th Corti announced his restructuring plans for

Swissair. Swissair and its profitable regional subsidiary Crossair would join to create a new airline,

The Swiss Air Line2, while at the same time maintaining each airline’s individual brand. This merger

was to be accompanied by a 10% reduction in the workforce, up to 7,000 employees, were to be made

redundant. Representatives from Swissair and Crossair announced that Swiss Air Lines would use the

lower-cost Crossair structure, while maintaining Swissair’s high quality.

For a while it seemed that Swissair would be safe: A Swissair spokesman announced that following

the government’s promise of the cash injection, ‘a solution to the liquidity crisis is emerging’.

Swissair was safe for now – or so they thought. Interpret the events of the last three days of

September 2001 as you will, but the facts stand for themselves. Swissair went from a tenable position

to bankruptcy in the space of three days, 71 years of history were at an end and billions of Swiss

Francs in value had been erased.

Following the announcement of the government’s intervention, UBS announced that there was no

need for the government’s money, as the airline’s house bank it would put together a financial package

to ensure Swissair’s survival. After negotiations between Swissair and UBS and Credit Suisse, it was

agreed on September 29th that the banks would purchase a CHF260mn share in Crossair and give

Swissair an interim credit of CHF250mn to guarantee flights until October 3 rd. The money was to hit

Swissair’s accounts by 7pm on the 1st October – it never arrived. Frantic attempts by Berne to reach

Marcel Ospel, the CEO of UBS were met by secretaries who informed the Swiss finance minister that

Ospel was uncontactable all day, being aboard a private jet to New York. On October 2 nd, Corti was

forced to declare Swissair bankrupt, and the Swissair fleet was grounded temporarily stranding 39,000

people worldwide. On October 2nd SAirGroup’s share price dropped from around CHF50 to CHF1.27

(cf Exhibit 6) almost wiping out the company’s entire share capital. Swissair’s cash flows relating to

2 Swiss Air Lines would become the official name of Swiss, the airline that was to emerge from the Phoenix rescue plan


their debt financing stretching to 2020 collapsed saddling the company with CHF17bn worth of debt

leading to the ensuing deterioration of SAirGroup’s debt rating. The withholding of the cash

effectively killed Swissair and destroyed billions of Swiss Francs in share capital as well as resulting

in huge value destruction linked to the Swissair brand name and lost customer loyalty.

Uproar followed in Switzerland, Ospel was portrayed as public enemy number one. Harsh headlines

such as ‘UBS – United Bandits of Switzerland’3 flashed across the country. Feelings of resentment

deepened when UBS came out with its own rescue plan in the form of the Phoenix Plus plan on

October 3rd. This illustrated that UBS was perfectly aware of the consequences that its actions would

have, and had effectively been able to blackmail Swissair due to its empowered position over the

company.

Swissair was powerless to stop its death spiral. Put simply, Swissair through managerial

mismanagement and financial malfeasance had found itself in the unenviable position of having to rely

on the banks and the government for its survival. On the 3rd October UBS board member Peter Kurer

issued a statement on behalf of his harangued employer:’ it would no longer have been possible to

save Swissair this autumn.’ Kaspar Villiger responsible for finances in the Bundestrat4 told the Neue

Zuricher Zeitung that the Bundestrat had ‘underestimated the internal dynamics of such a liquidity

crisis and thus the speed with which the situation could come to a head.’ The statements of the

government and the banks can be treated with skepticism. UBS knew of the situation with Swissair

and delayed a promised payment long enough to ground the airline. UBS’s intentions for doing this

become clearer later in the paper. The government was also aware of the severity of the situation,

Corti himself has made it publicly known that he personally informed the relevant parties at the

Bundestrat of the severity of Swissair’s plight. However such complaints are irrelevant, by this stage,

Swissair had lost control of its destiny.

Rescue plans

1. Immediately following October’s collapse, two rescue plans were presented to the board of

directors and the Swiss government: Phoenix Plus and Globus. After thorough discussions, the

Phoenix Plus plan was chosen and implemented creating the new airline Swiss. The paper will

analyse in detail each plan following the architecture set out through the value objective “stool”

framework.

3 Front Page of Tribune de Geneve October 3rd 20014 Switzerland’s Upper House situated in Berne


a. As discussed above, the Phoenix Plus project was proposed by the two Swiss banks, UBS

and Credit Suisse. The plan was chiefly directed toward relieving the Swiss government

from the refinancing burden, with both UBS and Credit Suisse injecting a CHF257m to

continue operations. The immediate operational measures resulted in the immediate

transfer of flights, planes and part of the personnel from Swissair to its subsidiary Crossair.

On the corporate side, Crossair was refinanced by the banks in exchange for 70%

ownership. SAirGroup was declared bankrupt and its subsidiaries were to be sold as soon

as possible to generate cash. The existing debts towards lessors remained unpaid, the

company taking the unprecedented risk of provoke GE Capital and AIG in the courts. The

new company was to be renamed Swiss and was to be led by the capable yet inexperienced

former Crossair management team, headed by former pilot André Dosé.

Value was to be created from a decrease in operating and overhead costs, thus increasing NOPAT, this

would be complimented by a strong reduction of in debt levels decreasing WACC, and a large

decrease in invested capital since the majority of subsidiaries were to be spun off.

b. The alternative plan Globus was put together and presented by financier Pascal Najadi,

with the backing of American giant Merrill Lynch. The plan aimed at keeping the Swissair

brand alive and restructuring the group to ensure the continuation of operations with an eye

toward increased efficiency. From the financial standpoint, the company was supposed to

repackage and market its debt with the financial expertise of Merrill Lynch and the

guarantee of the Swiss government. The government were to be protected by a warrant

emission, and the lease contracts with GE Capital and AIG were to be renegotiated. On the

operational standpoint, the group was to reduce debt levels by 40% in three to four years,

divest from non-strategic subsidiaries at competitive prices, and reorganise the group

structure around a rescaled Swissair. More precisely, the company was supposed to carry

on 26 long and 26 short-haul routes including the profitable Geneva-New York route.

Accordingly, the implementation of Globus would have created value. Levels of NOPAT would have

been increased due to strong reorganization, a decrease in WACC would have arisen through debt

rescaling, and a decrease in invested capital would have resulted from the divesture of non-strategic

assets and subsidiaries.


2. Interesting conclusions can be drawn through the analysis of the rescue plans in accordance to the

“stool” framework. Overall, the Phoenix Plus has a confused definition of the overarching value

objective. The official claim is the re-launch of a viable national airline in Switzerland creating

maximum value for shareholders as well as preserving jobs and minimizing the weight on national

finances. However the timing of this proposal on October 3rd 2001 headed by UBS, who were

responsible for the late payment of the bridging loan directly leading to the grounding of Swissair

has led some commentators to suggest that an alternative motive lies behind the implementation of

the Phoenix Plus rescue package. These commentators view the real objective of the rescue

package as the acquisition of the best of Swissair by the banks at a discounted price. After a

period of restructuring, achieved by pressuring unions and the government, the banks would sell

the newly profitable airline to a major European carrier such as British Airways or Lufthansa for a

profit. The unpleasant business of the liabilities and the cost of job cuts would inevitably be left to

the Swiss government and the taxpayer.

Further criticism of the government’s choice to implement Phoenix Plus can be drawn following

analysis of the effects that it will have on decision rights and empowerment, information systems and

incentives.

a. Decision rights & empowerment: in accordance with the Phoenix Plus plan, the

management of the new airline would be headed by the former management team of

Crossair. Headed by André Dosé, a former pilot, the management team is viewed by the

industry as being young and inexperienced. Whilst this team have not yet had the

opportunity to prove their ability, they lack the experience and influence required in the

management and restructuring of an international airline and its debt schedule. Dosé,

through clearly able, lacks the training to succeed in this challenge and would have

difficulties in persuading analysts on the merits of the business plan leading to problems in

reducing the WACC. Contrary to Phoenix Plus, the Globus plan aimed at keeping the

existing senior management structure of Swissair in place. The existing CEO Mario Corti,

was recently appointed at the beginning of 2001 from his role of CFO at Nestle. It was

Corti, who had exposed the hidden debt, and demanded the changes in Swissair’s

accounting practices, and it was Corti who was widely perceived as being the man who had

the ability to take the airline forward. The Globus plan also accommodated for the existing

management team of Swissair being supported by a team of specialists (“Projekt-Team”)

from Merrill Lynch, whose responsibility was to handle the financial recovery of the

company. The Globus plan thus ensured that the decision makers would have the relevant


knowledge to make the correct value creating decisions. In addition, the pilots’ union

publicly demanded the close examination of Globus project by the authorities. The support

of this critical group of stakeholders would have been a key element in the successful

implementation of the plan, thus of value creation.

b. Information systems: in terms of architecture, the rapid changes that the Phoenix plan

proposed would lead to the blurring of the information patterns. The information system

represented the ‘leg’ of the ‘stool’ that we argue was dealt with most effectively by the

Phoenix plan. For example, the divesture from non-strategic structures would include the

eradication of the ‘grey’ areas that were the sophisticated financial systems hidden in

complex offshore structures, thus improving the line of sight relating to the companies

financing. A second benefit of the Phoenix plan in relation to information management,

related to the level of information sharing in the company being improved by the launch in

November 2001 of a website dedicated to detailing the specifics of the Phoenix plan. This

website was to be accessible to employees via intranet, and received over 200,000 ‘hits’ in

the first three weeks. This initiative aimed at sharing more information with the personnel

to decrease apprehension and re-motivate people around the value creation objective.

c. Incentives & rewards: The implementation of the Phoenix plan has led to significant

reductions in incentives and rewards. We therefore conclude that this constitutes weakest

leg of the ‘stool’. By cutting 13% of the workforce and the alignment of salaries to the

Crossair basis (as mentioned above, differences up to CHF155k a/year for pilots) left the

crucial middle management and key employees in a state of despair and un-motivation that

now constitutes a major risk for recovery. Alternatively, Globus proposed to maintain the

differences in wages for flight personnel, arguing that this reflected the cost of extra service

and extra security linked to the experience gained on long-haul flights that made Swissair’s

reputation of quality so distinctive. The Phoenix plan proposed that a major airline should

realign its values along those of a regional carrier immediately. This clearly cannot work

and would compromise levels of quality and safety on the new airline, a fact that was sadly

reflected in the loss of flight LX3597 outside Zurich with 24 lives in late November 2001.


Swiss Air Lines (Swiss)

It is briefly necessary to understand the new airline that has emerged from the Phoenix rescue package

and attempt to visualise whether its business plan has the potential to recoup some of the value that

was lost in the demise of Swissair. In a recent poll only 7% of the Swiss population thought that the

airline would survive. I think this figure speaks volumes of the attitude of the Swiss people to their

new national airline. Whereas Swissair was the pride of Switzerland, which epitomised all things

good about the country such as, service, reliability, and style. Swiss is seen to be an overgrown

Crossair trying to be something that it is not – an international airline. Swiss’s business plan relies on

using Swissair’s level of service whilst maintaining Crossair’s lower cost structure is unfeasible. In

the airline industry you pay for quality, be it an experienced pilot or airhostess. Recently industry

analysts have suggested that Swiss might struggle to fulfil these lofty ambitions. It has big shoes to

fill; Swissair’s brand name and loyal customer base were worth millions. Swiss has to turn the clock

back 71 years and start building its brand from scratch. It would be advisable to start with its domestic

market, as the Swiss people have indicated that the loyalty they showed Swissair counts for nothing

when it comes to Swiss. A slightly more sinister problem could rock Swiss’s foundations in the near

future. The unpaid leases taken out with GE Capital and AIG have not just disappeared. If Swiss are

proved to be legally obligated to take on Swissair’s debts to GE Capital and AIG, a potentially

terminal court battle awaits the new airline in the future.

Conclusion

This paper has examined in detail the extensive value destruction that has occurred at Swissair. The

speed of the company’s final demise is breathtaking. A company that made one loss in its 71-year

history was bankrupt 10 months later. The paper has detailed the value destruction at Swissair by

analysing the three main components that make up EVATM. Following the collapse of Swissair and the

emergence of the two rescue packages Phoenix and Globus, each project was analysed using the

‘stool’ approach to determine whether they possessed the necessary structure to support a feasible

overarching Value Objective. Furthermore an attempt was made to look into the feasibility of the new

airline, which emerged from the Phoenix rescue plan.


However, the value destruction witnessed at Swissair is more extensive than previously detailed. It

has been estimated in the long term that the collapse of Swissair will lead to a destruction totalling

between USD40-50bn. The destruction of Swissair runs deep. If the new airline Swiss fails,

Swissair’s collapse would have resulted in the destruction of three brands (including Crossair) in the

Swiss market. Furthermore due to SAirGroup’s inability to support its subsidiaries such as Sabena in

Belgium they too collapsed on the 7th November 2001. SAirGroup was forced to sell off many of its

assets at ridiculously low prices; the sale of GateGourmet Swissair’s international catering division is

a prime example of this. Swissair’s collapse also led to the abandonment of plans for Zurich airport to

be one of Europe’s leading hubs along with London and Amsterdam, resulting in yet more instances of

value destruction.

Value destruction is not just an economic phenomenon. It touches many other parts of society.

Switzerland’s reputation for example has been irreparably damaged, leading one commentator to

write: ‘La Suisse n’est plus la Suisse’ – Switzerland is not Switzerland anymore. Others believe that

allowing Swissair to collapse is a declaration of war of Switzerland’s previously relatively high level

of social provisions. It is possible that this will result in the Swiss ruling classes coming to the

conclusion that they should now follow the policy of cuts in social spending and wages – long the

norm in USA. The Neue Zuricher Zeitung5 noted ‘It is probably the case that with the fall of Swissair

a further, important and considerable piece of “Swiss exceptionalism” – which still exists-will be

irretrievably lost’

5 Neue Zuricher Zeitung October 7th 2001


Exhibit 1: SAirGroup structure as of 31/12/98 with major subsidiaries highlighted (source Annual

Report 1998)

Exhibit 2: financial trend of Swissair (source annual reports)

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0

500

1000

1995 1996 1997 1998 1999 2000

EBIT

Net earnings

SAirGroup

SAirLines SAirLogistics SAirServices SAirRelations SAirIntl Finance Others

•Swissair•Crossair•Balair•Sabena•Volare•Tegel•Air Littoral•Austrian Airlines•Swissair Asia•Other minority stakes

•Swisscargo•Trucking•Cargolux•Other logistics companies

•SRTechnics•Swissport Intl (techincal assistance)•Various services (taxis, hotels, cruises, photo, consulting, real estate)

•Swisshotel (and other prestigious hotels)•Gate Gourmet (catering)\•Rail Gourmet•Nuance (duty-free shops)•Others (restaurant chains, local caterers)

(based in Jersey) •Flightlease•Undefined holdings based in Guernsey


Exhibit 3: international seating capacity as a % of total capacity (source CSFB)

Exhibit 4: example of development of low-cost carriers in the UK (source BA)

15%

17%

19%

21%

23%

25%

27%

29%

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000


Exhibit 5: EVA trend at SAirGroup before the final collapse (source Annual reports, assuming WACC of 10% as per industry average)

Exhibit 6: SAirGroup stock price during the collapse (source Boursorama.com)

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0

500

1998 1999 2000

CHF M

A2-6 Swissair 071202v5

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