View from City Road: Fred's spanner in the gearing

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The Independent Online
FRED 3, the Accounting Standards Board's new exposure draft proposals on the correct way to account for capital instruments, convertible bonds for example, comes at an interesting time for companies such as British Airways.

The UK carrier is seeking a 25 per cent stake in Qantas, the Australian airline. Local analysts reckon the government down under has valued Qantas at pounds 1.3bn so BA may be liable to pay pounds 325m if it wins the auction. BA is also waiting to hear by Christmas Eve on the success or otherwise of its proposed dollars 750m ( pounds 500m) tie-up with USAir. If both come off, on top of the forays into the French TAT and the late Dan-Air, BA shareholders may well wonder if they will be asked to contribute to the party via a rights issue.

At the end of September, BA said it had gearing of 40 per cent. That does not sound too bad, but it was talking about the proportion of debt to total capital, not just equity. It has also been including as permanent capital pounds 320m of bonds. These are convertible from next year until 2005 into ordinary shares at the equivalent of 243p, compared with a market price of 277p (down 2p).

Fred 3 proposes that companies with convertibles should not anticipate conversion and should treat the bonds as debt, not pseudo-equity. On this basis BA's gearing, defined as debt as a proportion of equity, at end-September was 104 per cent, a figure that jumps to 138 per cent if BA's operating leases are lumped in.

This makes BA's claim that it can afford its global ambitions without a rights issue look even braver. Assuming, heroically, that all its deals go ahead, BA may be pushed to think up a new liability that escapes Fred 3's net.