These are heady times for Richard Lark, CFO of Brazil’s GOL Linhas Aereas Inteligentes S.A., which is shaping up as the airline equivalent of The Little Engine That Could. A former investment banker, Lark, 41, is presiding over the company’s transformation from a local, low-cost carrier into an international power following its purchase of the much larger Varig Brazilian Airlines last April.
That wing-spreading came three years after GOL listed its stock simultaneously on the Brazil and New York stock exchanges and became one of the first foreign-listed companies to complete a Sarbanes-Oxley section 404 certification. Now GOL, with a 40 percent market share of the air traffic within, into, and out of Brazil, is nipping at the heels of TAM Airlines, whose lead has dwindled to just a few points. In fact, GOL’s market capitalization, about $5.4 billion, is larger than TAM’s. CFO.com caught up with Lark to get his take on growth, listing on a foreign exchange, Sarbox, accounting standards and more.
What metrics do the CFO of a low-cost airline watch every day?
We’re most focused on load factor, which is the percentage of seats filled; yield, or revenue per seat kilometer; and cash flow. We also look at the external variables that affect our costs, such as oil prices, exchange rates, and interest rates. On a monthly basis our main focus is cost per seat kilometer and what goes into that. In Brazil the majority of the operating costs of our business, almost 70 percent, are derived from the aircraft — fuel, leasing, maintenance. And since aircraft are used for a long period of time, what’s happening in our cost structure today is a function of decisions made long ago. In the United States, labor is a much bigger component of the cost structure.
How else do you differ from U.S. airlines?
We also have more pricing power. What that means is that in Brazil we have a maximum 10 million consumers of air travel, and 60 percent are business travelers, so demand is relatively inelastic. That gives us a fair amount of ability to do yield management on a daily basis to maximize revenues. In the U.S. market you have a much smaller business component of travel and a much larger leisure component — about 70 percent — and airlines have a much harder time adjusting fares on a daily basis. So we probably spend a lot more time focused on the revenue side of the equation.
GOL’s Richard Lark is taking the low-cost airline to new heights following the company’s acquisition of Brazil’s former state-owned carrier Varig, and its foray into Europe, and soon the U.S.
It seems that the price of oil has gone up about 40 percent at the same time that the real, Brazil’s currency, increased in value. Does that mean you’re not paying a lot more for oil?
The real has appreciated 20 or 25 percent, so yes, that has offset a portion of the increase in oil prices. But it’s not just oil. About half of our cost structure is dollar denominated or dollar linked. We’ve got a big benefit from the stronger real versus the dollar, which is something that’s here to stay. The strong real is not a temporary phenomenon. It’s a function of a combination of economic stability and economic fundamentals in Brazil. U.S. investors who have invested in our business have gotten a free ride on the exchange-rate appreciation.
That’s a nice selling point at a time when you’re taking your stock overseas.
The big risk for foreign investors was always that you invested in reals but eventually you had to get your return in dollars. That’s turned out to be not so much of a risk for the last couple of years. It’s difficult to imagine that the real is going to appreciate much more, but it should show a high degree of stability.
You said the aircraft is your greatest cost. Is fuel the biggest part of that?
Fuel is the single largest component. It represents about 40 percent of our total cost structure. We are actually more fuel-heavy than most airlines, because in Brazil we have a value-added tax that adds about one-third onto the price of fuel. We do short-term hedging to mitigate the effects. But the other parts of our cost structure are very lean.
There’s a report out that says cheap funding has allowed GOL to grow rapidly with very little debt. Did you have access to inexpensive capital at the time you acquired Varig?
Over the past two years debt financing has been more competitive for financing aircraft and growth in general, given the development of the Brazilian market. Brazilian companies have had increasing access to lower-cost, long-term debt, which has been very helpful in building a solid capital structure, but equity funding is still very expensive. Our strategy has always been to go out and raise money before we needed it. We raised around $250 million in equity over the company’s first three years of operations. And then over the last three years we raised $600 million in debt financing.
Is there a particular debt-to-equity ratio that you want to maintain?
We use a couple of ratios. In terms of leverage, we use one that’s typical for the airline business, which is adjusted debt to EBITDA(R) — the R is for aircraft rent. That ratio is in the five-to-six-times range. As a capital-structure measure, we use adjusted total debt to total capital, which is in the 65 percent area. We’ve been raising debt over the past couple of years to leverage the company a bit more and lower the cost of capital, so we think those numbers are appropriate.
When Gol did its simultaneous IPOs in Brazil and the United States in 2004, did Sarbanes-Oxley enter into the decision? Did you and your management team think it might be a headache listing here?
The quick answer is no. I think being an airline is conducive to the implementation of the Sarbanes-Oxley rules. We already have a culture of documenting all the policies and procedures and controls for things such as flight safety and the technical aspects. An airline is managed like a military operation — there’s a chain of command and pilots and mechanics following written government-approved procedures. So it was very easy culturally to get everybody to embrace the concept of internal financial controls.
We were the first foreign private issuer to do the section 404 certification, and it has only generated benefits for us. Because we were a new company, it forced us to develop and document our internal controls, and that has helped us identify problems and correct them quickly. It also helped us gain credibility, not just with investors but with partners in general.
Do you remember how much compliance cost the first year?
The total cost was about $1.5 million. We had a lot of consultants help us build and install a methodology, do the first tests on the controls, and prepare the first certification. Today the maintenance to keep it going each year is probably $400,000 to $500,000.
What made you decide to list on both exchanges? Did you come here for access to capital?
Yes. We got access to an investor base that had a lot more experience investing in airlines and was better able to evaluate a low-cost carrier such as Gol. We had to get them comfortable with the Brazilian environment, but they understood the business very well. That got us a better valuation than we would have just by listing in Brazil. At that time there was only one listed Latin American airline, which was LAN Chile, and it was very undervalued. There was a lack of knowledge within the investor base about what an airline was. Today there are four listed Latin American airlines, so now you don’t need to go to the New York Stock Exchange to get access to investors who have experience with the sector.
What accounting standard are you using?
Our local [Securities and Exchange Commission] requires us to publish in Brazilian GAAP, and we provide U.S. GAAP to the American SEC. But Brazil is evolving toward adopting [international financial reporting standards]. By 2009 it probably will be a requirement for Brazilian companies to have IFRS in addition to Brazilian GAAP. At the same time, Brazilian GAAP is evolving to align itself with IFRS. That will take a little bit longer, but probably by 2011 they will substantially aligned.
Is Brazilian GAAP more principles-based than U.S. GAAP?
Actually the contrary. In Brazil we don’t have a FASB equivalent, so the Brazilian courts and SEC get more involved in issuing guidance that companies have to interpret. Brazil has a lot of difficulty finding accounting principles on which to base transactions. Sometimes we have had to look to U.S. GAAP to find a principal and apply it to Brazilian GAAP, but without necessarily having clear guidance on the Brazilian side. Now U.S. GAAP is moving toward fair-value accounting, and that’s going to complicate people’s lives. It is much more difficult. You can argue whether it’s more accurate.
Can you remember one of the issues that you looked to U.S. GAAP to help you with?
One example is hedge accounting. We used FAS 133, which allows you to match your future hedges with future operating expenses. In Brazilian GAAP there’s no FAS 133 equivalent. We got questioned by our local SEC, which was unsure of it and said they’d have to study it more.
Let me ask you about the subprime crisis. It doesn’t seem to have affected Latin America, is that right?
No, it hasn’t. Liquidity is flowing into Latin America and we didn’t really see a credit crunch in Brazil at all. There’s a lot of anticipation of Brazil being upgraded to an investment grade [sovereign] credit rating. That will have an effect on increasing asset prices in general. And we still have nominal interest rates of around 12 percent. But for smaller companies, dollar financing got a lot more expensive after the crisis.
What does it take to be a successful CFO?
You have to learn the operations side of the equation — what things cost, how to negotiate with suppliers, how to motivate employees when they don’t have that big year-end bonus hanging out there. It’s not just about raising money and tweaking around with the capital structure. CFOs that have a lot of experience in investment banking know very well how to build and manage the right side of the balance sheet. The problem is the left side.