AFA - Aerospace Forum Asia

Canadian Chamber of Commerce Dinner
Tuesday, 17 January 2006
Speech by Mr. Robert Milton, Chairman, President & CEO ACE Aviation Holdings, Inc.

A Restructured Air Canada - How an Aviation Company Can Succeed in a High Fuel Environment

Good evening ladies and gentlemen.

Guest speakers will often tell you how glad they are to be someplace whenever they open their speech. Well, tonight, I truly am.

As a three-year-old who moved here, in 1963 with my parents and sister, and lived here for five terrific years, Hong Kong back then looked a wee bit different than the Hong Kong of today. In fact, our family also looked different then, as my youngest sister had not yet been born . . . here in HK.

And for that matter, my wife who was also born here in Hong Kong also hadn't been born yet, but that is an entirely different story!

So as you can imagine, Hong Kong is truly a special place for me and my family and it always will be.

I remember vividly, as a child riding on the car deck of the Star Ferry over to Kowloon, to my favourite place, even then, Kai Tak! In fact, in those days of no tunnels, or MTR, as I remember it, about the only reason to go over to Kowloon was to get to Kai Tak.

But even in those days, my parents and I begin to realize I had a small programming deficiency between my ears because even at that young age, little else interested me more than airplanes and airlines. In fact, my parents tell the story until today of how I would pack a small bag as a child and walk towards the door of our flat at Carolina Gardens on the Peak and proclaim: I am leaving - I am leaving on Garuda Indonesian Airways!

Who knows why, and who was to know that I would never deviate from my airline obsession, or that one day I'd run one of the world's great airlines, or that I would be so genuinely pleased to be back in Hong Kong to give a speech on my favourite subject.

My deep attachment for Asia, its culture, and its people was born during those early years in Hong Kong and I can well understand why you, both Hong Kongers and expats alike are proud to call this exciting, hectic and absolutely amazing metropolis your home.
And of course my ties to Hong Kong took another small twist two years ago when Victor Li’s Trinity Time Investments came close to making a major investment in Air Canada as part of our restructuring.

We were excited at the opportunities that an agreement with the Li family would open up for the airline - especially in China, the fastest growing market for virtually everything. As most of you would know, the agreement did not proceed - but for all of us, life has moved happily along.

This evening, instead of regaling you with election talk, I’d like to tell you about the transformation of Air Canada and the debut of this new aviation services company we call ACE Aviation, which celebrated its first anniversary last September and is now embarking on year two of its evolution.

Although the Air Canada transformation is a story which takes place in Canada, it really isn’t just a Canadian story but rather an international one because many of the key issues and challenges facing airlines like Air Canada, transcend borders and because many of the opportunities our industry has are global.

When I talk about the rise of low-cost carriers, high fuel prices, financial restructuring and the burden of airport fees, I could easily be talking about any part of the globe except Hong Kong - for now.

But the way things are shaping up, 2006 could well become the year of the low cost airline right here in Hong Kong.

Today, we already see Hong Kong Express and CR Airways on short haul routes and soon, we may be seeing aircraft from Golden Dragon joining the mix, and Oasis Hong Kong Airlines on long haul routes like Hong Kong-London.

Whether we like it or not, this is the environment in which traditional airlines - like Air Canada and now even Cathay Pacific - must operate.

But there are some important differences between the airline situation in the Asia-Pacific versus the rest of the world and that is that there is such powerful underlying economic growth in this part of the world - something we, in North America, don't generally enjoy.

I am reminded of bumping into Rod Eddington, the former senior executive of Cathay Pacific shortly after he became the CEO of British Airways some years ago. I congratulated him on being able to run one of the worlds' great airlines, and being able to live in London - another one of my favourite cities. He laughed and naturally replied that it was great, and then he added that it was a lot easier looking smart at Cathay Pacific where the underlying market growth was 15% per year!

I also remember, years ago, talking to the then head of Cathay’s scheduling department, a brilliant fellow who became a friend, and who today remains in a senior Swire position, and we were discussing our relative situations.
I gamely teased him that it was easy being a genius working at Cathay, because all you had to do was aim a 747 at any big city on the planet and it would fill up profitably with little effort. I then asked him how he would like to try and make money scheduling DC-9's to Regina, Saskatchewan in January.

For those of you unfamiliar with Regina, the average morning temperature in that city in January is -22.1 degrees according to the Canadian Weather Almanac.

By the way, I should add, I view Cathay as another one of the world's few truly great airlines.

But rapid growth is not the case in most other parts of the world and certainly not in North America.

So while the majority of North American carriers are on life support and many international carriers are struggling to reduce their legacy cost structures, Air Canada emerged from its restructuring 15 months ago as a strong viable carrier able to compete effectively and profitably both at home and on the international stage.

As a result, we are now able to withstand $70 a barrel oil prices.

But getting here wasn’t easy.
Let’s look back for a moment at what has taken place at Air Canada.

Despite a huge amount of hard work and restructuring since 1999, Air Canada could not fix its problems fast enough to deal with economic and geopolitical adversity. Shortly after defying the odds and winning a hostile takeover battle orchestrated by American Airlines with the support of the Canadian government, we were faced with an unplanned merger with a collapsing Canadian Airlines, followed shortly by the burst of the high tech bubble and the accompanying dramatic drop off in traffic and yield particularly in North America.

Then came the terrorist attacks of 9/11 which had a significant impact on Air Canada as we operated 650 flights a day to the U.S. ?more than the rest of the world’s carriers combined. While our competitors in the U.S. received billions of dollars in government assistance, we received about $60 million ?and that’s in Canadian dollars.
Despite these challenges we were the only North American carrier to get back to two quarters of profitability in 2002.
The final straw, however, was the arrival of SARS in Toronto which dried up revenues at our most important hub almost overnight. By the end of 2003, Air Canada qualified as the world’s only international airline that had suffered both its home airspace being shutdown after 9/11 and its home hub being impacted by SARS.
That was the end of the old Air Canada.
The airline went into formal restructuring ?or CCAA - in April 2003 and the most significant business transformation in Canadian history began.
In our view, the key to a successful restructuring is understanding how the rules of the game have changed, and opting to embrace, rather than resist, that change. One thing we know for sure is that the old way of running an airline is over.
Faced with growing domestic competition and high operating and fuel costs, Air Canada simply had to change the way it did business. The changes we made included a redesign of our corporate structure and a refocusing of our network.
When we emerged from our restructuring, everything changed.
On the corporate side, we created ACE Aviation Holdings Inc. ACE is an umbrella company for all our airline-related businesses including:
Jazz: Canada’s second largest airline;
Aeroplan: Canada’s premier loyalty program;
Air Canada Technical Services: our full service maintenance repair and overhaul operation;
Air Canada Cargo: Our air cargo business unit which manages our cargo activities worlwide;
And of course,
Air Canada: Canada’s largest domestic and international airline.
ACE was created to reposition the old Air Canada for sustained profitability under a new corporate structure, to break out the various units that made up the old Air Canada and allow each one of them to focus on their core competencies and their profitability.
This structure highlights each of ACE’s businesses and allows them to operate independently and at the same time allows ACE to better insulate itself from the “boom and bust?fluctuations inherent in the airline industry. It is a vision which we have been working towards well before 9/11 and we are now seeing that vision become reality.
In June 2005, ACE successfully completed the first-ever monetization of an airline frequent flyer loyalty program - Aeroplan.
Market response to the IPO resulted in equity valuation in excess of $2 billion for Aeroplan and ACE raised almost $300 million for its divestiture of just under 15% of a company which started out just 10 years ago as a handful of individuals working in Air Canada’s Marketing Department.
It’s an encouraging start and we intend to grow our other business units to maximize the value of all our business units for the benefit of its shareholders.
Now, we’re taking steps to do more of the same with an initial public offering of units of Jazz Air Income Fund, which will hold a minority interest in Jazz, our regional airline.
Of course, a shift in corporate structure is only part of a larger equation. Our entire strategy is not only about rearranging reporting lines and changing the corporate structure. Our team also decided that we had to permanently compete not just against the restructured legacy carriers, but more importantly, against the low cost carriers.
To compete effectively against low-cost carriers, we needed to move much further than other restructured carriers and change the very underpinnings of our business model ?in other words, we needed to transform Air Canada from a traditional airline to a low cost airline.
Today, Air Canada is an airline that has the cost structure to compete with a low cost carrier on price, while offering services and products which discount carriers simply can’t match. In this way, we are leveraging our new competitive cost structure while highlighting the strengths we have built up as a longstanding, high quality carrier including a frequent flier program, an extensive worldwide network, two classes of service, and more.
This is a key part of our longer term strategy. Restructuring gave us a fresh financial start. We have reduced unit costs by nearly 20 per cent and we continue to look at ways to take unnecessary cost from our system.
Today, we distribute over 60% of our domestic sales via the Internet. No other old line carrier comes even close to that. Of course, to make it work, we had to simplify our product line. We’ve rebuilt the trust of our customers in buying directly from us with full transparency through easy to understand conditions. Our lowest fares are available at all times, you pay only for the desired one-way ticket type you want, starting from the lowest fare and paying consecutively higher prices for premiums such as priority seating, Aeroplan points or return-date flexibility that you chose to add on. We started in Canada and the U.S. and now we are doing it internationally.
Air Canada's simplified fares are now available for the first time for flights to and from London Heathrow and Manchester. And, the airline plans to convert more international destinations to its simplified fare structure in the near future ?including Hong Kong.
In addition, we're renewing our North American fleet with new small but comfortable jet aircraft such as the Embraer 190 and the Bombardier 705 - next-generation aircraft that offer industry-leading space and comfort which allows us to focus on lucrative U.S. - Canada transborder markets - especially city pairs that today do not have non-stop service.

And, just two months ago, we concluded an agreement with Boeing for the acquisition of up to 36 Boeing 777s and up to 60 Boeing 787 Dreamliners. This is a defining decision for the airline and sets the stage for significant international expansion in the years ahead. At the same time, it is a prudent financial step which allows us to move forward on a sound economic basis with the modernization of our international widebody fleet.

In terms of international destinations, we have a great window of opportunity to take our competitive cost structure to new destinations and new markets. That’s exactly what we are doing, in particular, by boosting links between Canada and the Asia Pacific region.

Between its Toronto and Vancouver gateways, Air Canada has one of the most extensive transpacific networks in operation, with up to 14 non-stop flights per day in each direction between Canada and seven destinations in Asia. From our main hub of Toronto, we operate the only daily non-stop flights to Hong Kong, Tokyo, Beijing and Seoul as well as a flight to Delhi via Zurich.

From our Asia Pacific gateway in Vancouver, we serve Hong Kong, Shanghai, Beijing, Tokyo, Osaka, Nagoya and Seoul as well as Sydney via Honolulu daily.
But let’s zero in on the Canada-China marketplace for a moment as an example of the new Air Canada in action.
In 2005, Canada and China signed a new Bilateral Air Services Agreement which allows for significant growth in passenger and freight transportation. The new bilateral air agreement allows for a threefold increase in capacity as well as the addition of more points in China that can be served directly.

With the unveiling of this new agreement, Air Canada quickly announced extensive new passenger and shared cargo services which include:

- New Toronto-Beijing non-stop service. This first-ever non-stop service between eastern Canada and mainland China was launched in summer 2005 and will be increased to daily flights by 2006;

- Just last week we announced Toronto-Shanghai three times weekly non-stop service to begin this summer;

- Vancouver-Guangzhou non-stop service is scheduled to begin summer 2007, and;

- of particular interest to this audience, is the fact that we plan on introducing the brand new Boeing 777-200LR with an all new lay-flat horizontal sleeper seat in Executive First Class on the high-demand Toronto Hong Kong route in 2007.

On the cargo side, we know that there is pent-up demand for air cargo services and that the market has been underserved. To that end, Air Canada has introduced cargo operations between Toronto and Shanghai using an MD-11 freighter with a total cargo capacity of 80 tonnes. The service has proved to be extremely successful and we are currently operating five weekly frequencies.

In addition, Air Canada plans to expand its dedicated cargo operations to China increasing operations to three per day.

With the introduction of non-stop service to Shanghai and Beijing from our main hub in Toronto, together with the only daily non-stop service to Hong Kong, we will provide eastern North America and Latin America with unprecedented ease of access to mainland China and Hong Kong. Moreover, now that Canada has been granted Approved Destination Status, Air Canada is well positioned to meet the significant growth that is expected in tourism between China and Canada in the years to come.

Approved Destination Status (ADS) which will allow Chinese residents to travel to Canada using a tourist exit visa is expected to have a dramatic impact on the number of tourists from China to Canada. In 2004, Canada received 77,000 overnight visitors from China, and the World Tourism Organization estimates that by 2020, there will be 100 million Chinese tourists annually.

But as I told you before, ACE is no longer just about Air Canada - our vision is to be a global player in the air transportation business and that means seeking out new opportunities and new areas in which to participate.

Here in Asia, that obviously means watching such dynamic markets as China and India.

Just yesterday, I visited Shanghai where I continue to be amazed and impressed by the dynamism of the market and the tremendous opportunities that are possible. In a country where forecasts call for air passenger traffic growth at 15 percent and air freight growth at 10 percent for the coming year, ACE sees especially interesting opportunities.
That’s a snapshot of our expansion in this region, but I assure you we are as busy in other global markets.

With all these initiatives underway, there’s no doubt that ACE and Air Canada are changing to meet the reality of today’s international air transportation market.

In the past few years, Air Canada has forged alliances with other airlines as a means of better exploiting global market opportunities. We are a founding member of the STAR Alliance and we’re very proud of STAR’s strong presence throughout Asia and particularly in Hong Kong.

Having emphasized the importance of Air Canada’s effort to reposition itself as a major global carrier, it should come as no surprise that we see the need for open market access and regulatory flexibility as a key piece of that strategy. There’s no doubt that as carriers restructure and reinvent themselves, they need the vision and support of governments to create the maximum opportunities for competition, expansion and new products and services.
I am happy to report that we are finally seeing positive momentum from the Canadian government in this regard after years and years of watching the world pass us by due to the government’s stagnant air policy mindset.

Last year’s Canada China Bilateral Agreement is an excellent example. As well, negotiations between Canada and the U.S. last November resulted in a welcome expansion of the 1995 Open Skies agreement between the two countries. The new agreement will provide greater access for Canadian passenger and cargo carriers to a much larger U.S. market as a platform from which to serve third countries and increased pricing flexibility for Canadian and U.S. carriers.

Along with a supportive bilateral environment, the environment in which airlines operate must provide an incentive to grow rather than represent a burden to bear. This is a challenge which extends to airports, air traffic control and government. There has to be clarity and fairness throughout the system in the way airports are managed and in the levels of fees and taxes levied on airlines.

So if you’ll permit me, I’d like to go back to that small matter of Canada’s federal election.

Unfortunately, Canada has now become a world leader in charging some of the highest airport fees, security fees and other government-inspired fees and charges on the planet. Imagine that ?low cost Canada has become the home of the world’s highest airport and security fees.

Does that make sense to you? Frankly, it doesn’t and during this federal election, I’d hope that the politicians will recognize how much of a drag these ridiculous fees are, not only on the airline industry but also on the economic growth of our country and our competitiveness worldwide. Forget about free trade agreements, the WTO or any other economic initiative. While countries such as Hong Kong, Singapore, China and Dubai invest millions, if not billions, building their air transportation infrastructures because they recognize them as tools for economic growth and competitiveness, Canada continues its quest to become the most expensive place on that planet in which to land an airplane.

You can be sure that I will continue to work with the industry and groups like IATA to get these issues addressed but as a group of Canadian travellers and a group travellers to Canada, you too, must make your voices heard with the decision makers ?many of whom come to Hong Kong on government missions.

These are indeed exciting times for ACE Aviation and Air Canada and we have already reached a number of important milestones in our short history as a new aviation services company.

In 2005, ACE posted strong results despite a climate of high fuel prices and financial uncertainty in the North American airline sector. Our third quarter results, released last November, are a testament to the progress we are making. For the third quarter of 2005, ACE Aviation Holdings Inc. reported operating income of $320 million. Net income for the quarter was $270 million. These results reflect our ability to now achieve North American industry leading levels of profitability versus low cost carriers, as well as legacy carriers.
By any measure - share price, financial results, cost control, productivity, market share or balance sheet strength - we are on the right track and improving each day.

Most of all, we’re looking forward to what lies ahead and tackling the challenges of this business with renewed vigour and creativity.

I’m very proud of what our people have been able to achieve through restructuring and I am convinced that we have built a solid foundation for growth and success in the years to come. I am delighted to have the chance to share the ACE story with you this evening and, on behalf of the ACE and Air Canada team, I thank you and your businesses for your ongoing support and loyalty to Canada’s airline.