Re MyTravel’s Corporate Catastrophe
This month I’ve focused on the collapse of MyTravel, formerly Airtours. It’s a great story and
opens up lots of opportunities for ratio analysis and a re-examination of window dressing.
Clearly, then, it’s A2.
To keep the accounts from looking too scary, I’ve simplified them (as is so often the case with
collapsing companies, the accounts are full of inconsistencies from year to year). I would like to
point out one simplification that is major, and questionable. In 2000 the company raised capital
through a £200m+ convertible bond. The issue is should it be treated as share capital (because
bondholders have the right to convert to equity) or loan capital. I’ve decided that this kind of
capital is equity on the upside but debt on the downside. Therefore, in MyTravel’s
circumstances, I’ve categorised it as debt rather than equity.
MyTravel’s Corporate Catastrophe
In May 1999 Peter Martin, a History teacher, read an article that talked glowingly about the
growth prospects of Airtours plc. He had recently inherited £5,000 and put it all into buying 1000
Airtours shares at £5.00 each. On October 17th 2002 Peter heard on the radio that shares in
Airtours, now renamed MyTravel Group, had collapsed to 20p. His inheritance was now worth £200.
He had lost £4,800. He wanted an explanation.
Founded in 1972, Airtours grew to become Britain’s biggest tour operator with a stock market value
of more than £2,500 million in 1999. The growth came from a combination of organic growth
(building the business from within) plus takeovers of a wide range of UK, German, Scandinavian and
American holiday companies and hotels. By 2002 it had a fleet of 42 Boeing and Airbus aircraft
which formed the basis of its packaged holiday offers.
In May 1999, were there any underlying problems that Peter might have spotted? The main one, by
far, was the rapid growth of low cost airlines. Ryanair and Easyjet were transforming the economics
of foreign travel. Traditionally, the only way to afford a couple of weeks in the sun was to buy a
packaged holiday, as scheduled flights were far too expensive. Now it could work out cheaper to get
a £50 return flight, hire a car and then book into hotels on arrival. The market size for low cost
packaged holidays was under threat. At the other end of the market, more and more travellers
were looking for exotic holidays to places like Barbados, Kenya or Thailand. This would also squeeze
the market for the traditional European sea, sand and disco resorts.
To offset against this, there were some positive signs for Airtours. It was gaining market share
compared with First Choice holidays, and the re-branding of the rival Thomas Cook holidays as
‘JMC’ was a disaster. Press coverage was favourable, stock market analysts were recommending the
shares, and its accountants and auditors (Andersen) were highly respected.
In July and September 2000, Airtours announced problems in its German subsidiary that would
damage profits. The shares dipped, then recovered during 2001 until September 11th. Inevitably,
travel company shares were hit sharply by the World Trade Centre disaster, but again they
bounced back, from 160p to 250p by the end of the year.
In May 2002 MyTravel (the name was changed from Airtours in February) warned the City that
trading in the October to March half year had been hit by September 11 th, leading to a rise in the
seasonal operating loss to £122m compared with £77m the previous year. This was accepted by
analysts as fair enough, especially as Chief Executive Tim Byrne spoke optimistically about the key
summer season, and announced the August launch of a new low cost airline called MyTravelLite, to
operate from Birmingham. The general expectation remained that the full year’s figures (to
September 30th 2002) would show profits of up to £150 million.
July and August seemed calm enough, with a further announcement by the Chief Executive that ‘the
fundamental underlying strengths of the business, and future growth prospects, remain strong’.
City analysts made little comment about the July switch in auditor from the by now discredited
Andersen to Deloitte and Touche. As shown in Table 1, the City of London’s teams of stock market
analysts remained positive. Sir Tom Farmer, a non executive director, seemed confident enough, as
he bought 200,000 shares at 129.5p on September 9 th 2002.
Table 1. Stockbroker 2002 Recommendations on MyTravel shares
Date
Share price
at the time
28/6/02
150p
1/10/02
70p
2/10/02
72p
Broker
UBS
Warburg
Williams de
Broe
ING Barings
Charterhouse
Recommendation
Strong Buy
Profit
estimate
2002
£115m
Profit
estimate
2003
£175m
Hold
£75m
£115m
Hold
£70m
£135m
Then came a series of bombshells. On September 30 th, a trading update on the last day of the
financial year was positive about the summer season, but warned that the auditors required a
change in revenue recognition* policy. This would hit 2002 profits by £15 million. With the shares
dropping by a third, furious shareholders forced out the Chief Executive, who resigned on October
8th. Then, on October 17th came another profits warning. This time it was stunning. Instead of the
£150 million profit expected for 2002, the actual operating profit might be no more than £35
million. The company announced that 2002 profits would be hit by:
 ‘overestimation of profits and underestimation of costs’ to the tune of £12 million
 an £8 million downgrade due to ‘a problem of reconciliations as we closed the 2002 accounts’
– this apparently was that the same £8 million revenue item had been counted twice, by
mistake!
 Finally there is a £15m to £30m charge related to a switch to ‘more conservative
accounting policies’
This potential £50 million black hole might turn out to be worse, as the auditors had only looked so
far at the UK operations of the business. Analysts speculated on the likelihood of further
problems, especially in the German offshoot.
For a business with a multi-billion pound turnover, £50 million should not present a huge problem.
Yet a look at MyTravel’s accounts (Table 2) shows the precarious position the business is in. Profits
have been quite weak, the liquidity is poor and gearing is substantial.
Other parts of the October 17th statement caused concern. The cancellation of the 2002 final
dividend to shareholders was inevitable, but to try to keep investors’ confidence from hitting rock
bottom, MyTravel chose to announce that bookings for Summer 2003 were 44% up on the
corresponding period last year. This led to a further problem. Rival travel companies pointed out
that these bookings were being achieved by giving free travel insurance and not taking deposits.
This led one major investor to say ‘It’s getting harder to believe in anything. It looks like they have
been fostering a culture of meeting the numbers at the expense of the long-term health of the
business’ (Financial Times 18/10/02).
Potentially the most disastrous problem for MyTravel was reported in the October 18 th issue of
The Times: ‘TUI, the German owner of Thompson Holidays and Lunn Poly, the travel agent, said that
in view of financial uncertainty, it had been decided to take MyTravel holidays “off sale in our
distribution businesses for the time being”’. If travel agents decided not to risk dealing with the
company, its trading position would soon deteriorate to the point of collapse. By the end of October
18th Peter’s shares were worth only 18p, with a clear possibility that they might soon be worthless.
He needed answers.
*Revenue recognition is the accounting procedure for identifying when to recognise a customer order as actual income within
the accounts. That’s not a problem for Tesco, which knows when a customer has paid. But it’s harder for other businesses,
where today’s booking for a holiday next year could be recorded in this year’s accounts or next year’s. The new auditors had
demanded that MyTravel should adopt more cautious, prudent accounting practices.
Table 2 Airtours/MyTravel Group plc Profit and Loss Account* to September 30 th
*simplified version
all figures in £millions
Sales turnover
1998
2753
1999
3309
2000
3949
2001
5061
Cost of sales
2350
2811
3353
4245
Gross profit
403
498
596
816
Overheads
300
386
545
744
Operating profit
103
112
51
72
Retained profit
70
76
127*
(16)
*Includes one-off profits of £150m
_______________________________________________________________________
Table 3
Airtours/MyTravel Group plc Balance Sheet* as at September 30 th
*simplified version
all figures in £millions
Fixed assets – Intangible
Fixed assets – Tangible
Fixed assets – Total
1998
393
393
1999
581
581
2000
535
569
1104
2001
540
515
1055
Stock
Debtors
Cash
17
414
375
12
575
566
17
712
793
13
838
379
Current liabilities
802
949
1274
1203
4
204
248
27
Assets employed
397
785
1352
1082
Long term liabilities
Share capital
Reserves
231
134
32
537
141
107
809
365
178
560
369
153
Capital employed
397
785
1352
1082
Net current assets
Questions (60 marks; 80 minutes)
1. At the time Peter bought his shares, the 1998 accounts were the most recent. Use ratios to help
you to analyse two features of the 1998 accounts that could have been seen as a good reason to buy
the shares.
(8)
2a) Calculate the gearing ratios for Airtours/My Travel in 2000 and 2001.
(4)
2b) Comment on your results.
(6)
2c) From the accounts, explain briefly how the company managed to lower the gearing in 2001.
(4)
3. To help Peter understand what went wrong, discuss three major weaknesses in the way
Airtours/MyTravel was managed during 2000 and 2001. Conclude by choosing and explaining the
single one you believe to have been the most significant.
(15)
4a) Explain the meaning of the term ‘profit quality’.
4b) Assess the quality of the company’s retained profit in 2000.
(3)
(5)
5. To what extent do you believe MyTravel’s share price collapse in October 2002 was due to
creative accounting?
(15)
Mark Scheme – MyTravel plc
Questions (60 marks; 80 minutes)
1. At the time Peter bought his shares, the 1998 accounts were the most recent. Use ratios
to help you to analyse two features of the 1998 accounts that could have been seen as a good
reason to buy the shares.
(8)
MARKING GRID (Out of 8)
2
CONTENT
2
2
APPLICATION
2
4
ANALYSIS
4-3
Two relevant ratios identified,
with correct formulae
Formulae applied to calculate
two ratios correctly
1
One relevant ratio identified,
with relevant formula
0
No relevant content present
1
One ratio applied correctly to
the data
0
Answer is not applied to the
context
Analysis of the potential
benefits to shareholders
within 1998 accounts
2-1
One or two points applied in a
limited way to analyse the Q.
Relevant ratios include:
1998 calculation:
No analysis of question or
theory
Comment/analysis
Return on Capital (ROC)
103/397 x 100 = 26%
Very high/v. profitable; far above
interest rates or inflation rates
Acid test
789/802 = 0.98
Very close to the ‘ideal’ of 1:1
Gearing
231/397 x 100 = 58%
High, but not worrying, given the
high liquidity & profitability
2a) Calculate the gearing ratios for Airtours/My Travel in 2000 and 2001.
Gearing
(4)
2000 = 809/1352 x 100 = 60%
2001 = 560/1082 x 100 = 52%
2b) Comment on your results.
(6)
2000 High, and only prevented from being higher by obtaining more from shareholders; sharp
deterioration in operating profit should also give cause for alarm.
2001 Falling, but only by using cash to pay off long term debts, i.e at the cost of the firm’s
liquidity
2c) From the accounts, explain briefly how the company managed to lower the gearing in
2001.
(4)
Gearing was lowered by using cash to pay back loans. That is perfectly sensible, but may be a
concern if it hits the liquidity position, or if it looks likely to recur over several years.
3. To help Peter understand what went wrong, discuss three major weaknesses in the way
Airtours/MyTravel was managed between 2000 and 2002. Conclude by choosing and explaining
the single one you believe to have been the most significant.
(15)
MARKING GRID (Out of 15)
3
CONTENT
3
3 weaknesses
identified or good
understanding shown
of the knowledge used
2-1
Shows some
understanding of the
knowledge used
3
APPLICATION
4
ANALYSIS
5
EVALUATION
3
Relevant issues applied
in detail to the case
4-3
Analysis of question set,
using relevant theory
5-3
Judgement shown in choosing
and justifying ‘the most
significant’ weakness
2-1
Relevant issues applied
to the case
2-1
One or two points applied
in a limited way to analyse
the Q.
2-1
Some judgement shown in text
or conclusions
Possible answers include:
 Failure to tackle the key underlying issue of the very rapid growth of low cost airlines such
as Easyjet, until the launch of MyTravelLite in August 2002 (too little and too late)
 Excessively aggressive accounting may help in the short term, through window dressing, but
is likely to cause problems in the future, as underlying profit or cash flow problems cannot
be masked forever; unfortunately for MyTravel, these accounting problems emerged in a
year when collapses at Enron, Worldcom and elsewhere had made the stock market very
wary of overly creative accounting
 The point made by the Financial Times on 18/10/02 was important, that the business may
have been making decisions on the basis of achieving targets ‘at the expense of the long
term health of the business’. This short-termism would have been influenced by the
inclination to window-dress the accounts, but is a far more serious issue. Window- dressing
is largely presentational, whereas allowing people to ‘book’ holidays without paying a deposit
will have a direct effect on cash flow
The most important? A case could be made for each, but my instinct is always to see underlying
issues as the most important, as they tend to be the cause of the more immediate problems. So
I’d choose the first of the above.
4a) Explain the meaning of the term ‘profit quality’.
(3)
High quality profit is produced by ongoing operations, and can therefore be expected to be
repeated in future years (it’s an ‘income stream’); low quality profit comes from one-off factors;
the worst of these would not even generate cash, such as ‘profit’ caused by a decision to lengthen
the depreciation period on fixed assets.
4b) Assess the quality of the company’s retained profit in 2000.
(5)
MARKING GRID (Out of 5)
2
CONTENT
2
Answer shows good understanding
of the term
1
Answer shows some understanding
3
APPLICATION
3
Answer applied fully to the
company’s 2000 P&L
2-1
Some application of the term to the
company
The operating profit more than halved from £112m in 1999 to £51m in 2000, showing a serious
downturn in the firm’s ongoing business (prior to September 11 th). The retained profit figure of
£127m is only £50m up on 1999, despite the inclusion of a £150m one-off gain. Therefore the
firm’s profit quality deteriorated dramatically in 2000.
5. To what extent do you believe MyTravel’s share price collapse in October 2002 was due to
creative accounting?
(15)
MARKING GRID (Out of 15)
3
CONTENT
3
APPLICATION
4
ANALYSIS
3
Good understanding of
creative accounting
3
Relevant issues applied
in detail to the case
4-3
Analysis of question set,
using relevant theory
2-1
Shows some
understanding of the
term
2-1
Relevant issues applied
to the case
2-1
One or two points applied
in a limited way to analyse
the Q.
5
EVALUATION
5-3
Judgement shown in discussing
the extent to which creative
accounting was responsible
2-1
Some judgement shown in text
or conclusions
Possible answers include:
 Clearly the creative accounting was important, because it undermined confidence in the
firm’s finances, which damaged not only the share price but also the confidence of the
travel trade; the latter might lead to serious operational problems (cancelled bookings etc)
 Another key factor was the failure to dampen down investor expectations about the likely
profits during 2002. Earlier in the year it would have been far better to say that the
business was still suffering from September 11th. This would have saved the embarrassment
of having to declare an operational profit shortfall jus after the end of the financial year
(September 30th 2002).
 The 2002 problems also may suggest a management accounting failure. Did the firm actually
not know earlier that things were going so badly?
 At the time of writing this (October 27th) it seems that the key issues relate to confidence
in the business (the operational performance is not that bad), therefore it is reasonable to
say that the extent of the share price collapse was largely due to accounting problems, of
which creative accounting was probably the single most important.