This article first appeared in The Edge Malaysia Weekly on January 15, 2024 - January 21, 2024

LOW-cost carrier Capital A Bhd and its medium-haul affiliate AirAsia X Bhd (AAX) are a step closer to merging their short and medium-haul airlines under the AirAsia brand name, after they signed a non-binding letter of offer last week. The two parties had been negotiating the deal since November 2022.

Capital A’s non-aviation businesses such as airasia Superapp, Teleport, Santan, BigPay and Asia Digital Engineering Sdn Bhd will remain separate and are not part of the deal.

The valuation of Capital A’s aviation business is yet to be determined, but the announcement by Capital A did indicate that the acquisition of AirAsia Bhd (AAB), which wholly owns Malaysia AirAsia, and AirAsia Aviation Group Ltd (comprising 45%-owned Thai AirAsia, 49%-owned Indonesia ­AirAsia, 100%-owned AirAsia Philippines and 51%-owned AirAsia Cambodia) will involve cash and new AAX shares. On its part, AAX owns AAX Malaysia and AAX Thailand.

Following the Jan 8 announcement, Capital A’s share price tumbled 13% to close at 73.5 sen last Thursday while the price of AAX shares inched up initially to as high as RM1.96 before pulling back to end at RM1.91 on Thursday, down 3%.

“The announcement is in contrast to our earlier understanding that this restructuring would be through share swaps with no cash exchange, but that is not the case,” Nomura Global Markets Research transport analyst Ahmad Maghfur Usman says in a Jan 8 note.

Assuming the deal will involve a combination of share swap and cash, AAX may need to raise external funding based on its relatively low cash level of RM119.63 million as at end-September 2023.

Given that the valuation of its aviation business is yet to be determined, Ahmad observes that the announcement offers little visibility on how Capital A intends to exit its Practice Note 17 (PN17) status. Capital A had sought Bursa Securities’ approval for an extension of another six months until June 30, 2024, to submit its regularisation plan.

“We await further details of the announcement that should clear the air on valuation, which we believe is particularly important,” Ahmad says. “We consider Capital A’s current valuation to be demanding amid uncertainties surrounding its PN17 regularisation plan and restructuring, coupled with high oil prices against the backdrop of the depreciating ringgit.”

According to sources, Capital A is seeking a valuation of around RM5 billion for its aviation assets, which is a 61% premium to its market capitalisation of RM3.1 billion as at last Thursday. However, it is a 12% discount to its market value of RM5.7 billion as at end-2019, before it was hit hard by the Covid-19 pandemic.

“That said, it does not mean that AAX will issue RM5 billion of shares to buy the five airlines [from Capital A]. We understand it will be a lot less due to intercompany balances needing to be set off,” says an analyst at a bank-backed research firm.

Another analyst who declined to be named says the RM5 billion valuation is fair from a long-term valuation perspective, adding that factors such as the AirAsia brand name rights and landing slots could be a valuation boost.

Nomura’s Ahmad points out that Capital A’s stock is currently trading at 11.6 times the group’s forward price-to-earnings ratio (PER) for the financial year ending Dec 31, 2024 (FY2024) versus its pre-Covid-19 average PER of 7.4 times. He has a “reduce” rating on Capital A with a target price of 80 sen, which is based on a FY2024 PER of 11 times (earnings per share of 7.3 sen).

In a Dec 12, 2023 report, Maybank Investment Bank aviation analyst Samuel Yin Shao Yang ascribes a valuation of RM5.47 billion, or 91 sen per share, to Capital A’s aviation business and a forward PER of eight times based on his FY2024 net profit forecast of RM683.9 million.

In a Jan 9 report, Kenanga Research aviation analyst Raymond Choo Ping Khoon says based on his FY2024 net profit forecast of RM250 million and applying low-cost carrier peers’ one-year forward PER of between seven times and 14 times, the indicative valuation works out to between RM1.8 billion and RM3.5 billion for Capital A’s aviation business. “Based on an indicative valuation of RM3.5 billion, our sum-of-parts-based target price is expected to be raised by 28% from 84 sen per share to RM1.08 per share.”

“However, based on Capital A’s FY2024 consensus net profit forecast of RM446 million (assuming consensus forecast a bottom line breakeven for its digital business), the indicative airlines business valuation works out to between RM3.1 billion and RM6.2 billion,” he notes.

Choo points out that Ryanair Holdings plc is trading at a consensus one-year forward PER of 11 times, Spring Airline Co Ltd (14 times), Easyjet plc (eight times), Air Arabia (nine times) and Wizz Air Holdings plc (seven times).

The analyst at a bank-backed research firm says Capital A is selling its aviation business to AAX, which had its PN17 classification lifted in November last year, in order to generate a large enough gain on disposal for it to exit its own PN17 classification.

“AAX is buying over the five airlines, which are less cyclical than its own business. Recall that AAX generated losses in 2Q2023 and 3Q2023. Thus, both sides have something to gain from the merger,” he adds.

“At this point in time, we are unable to comment on who this transaction favours more due to the lack of relative valuations,” the analyst says.

The transaction is subject to the negotiation of a definitive share sale and purchase agreement and its completion. Capital A group CEO Tan Sri Tony Fernandes was reported as saying last week that full details of the deal would be announced in the next two weeks.

Capital A posted a net loss of RM2.48 billion on revenue of RM6.61 billion in FY2022, according to regulatory filings. Analyst consensus expectations are for the group to post a smaller net loss of RM71.58 million for FY2023 and make its first annual net profit since 2019 — of RM446.43 million in FY2024. This comes after the group posted a net loss of RM178.82 million in 3QFY2023, which brought 9MFY2023 net profit to RM996.55 million as the first-half performance was lifted by a lumpy gain of RM1.37 billion arising from remeasurement of previously held interest in an associate.

Still, its current liabilities exceeded its current assets by RM12.53 billion as at end-September 2023. In addition, the group reported a shareholders’ equity deficit of RM8.43 billion.

AAX, in its most recent quarter ended Sept 30, 2023 (3QFY2023), posted a net profit of RM5.56 million, generating five consecutive quarters of profits. The airline posted a net profit of RM5.54 million for 2QFY2023, RM328 million in 1QFY2023, RM153.48 million in 4Q2022 and RM25.09 million in 3Q2022. AAX changed its financial year end from June 30 to Dec 31 in August last year.

AAX has seen its share price surge 171% over the past one year to close at RM1.91 last Thursday, giving it a market capitalisation of RM853.9 million.

Capital A initially aimed to reach a decision on the merger last year, but discussions have dragged on as the two companies tried to iron out details. One factor complicating the discussions is goodwill, which is subjective, especially an amount based on estimated future earnings.

Both Capital A and AAX share common shareholders — Capital A co-founders Tan Sri Tony Fernandes and Datuk Kamarudin Meranun. The top shareholders of AAX are Kamarudin and Fernandes, who hold 8.94% and 2.69% direct stakes respectively, as well as indirect stakes totalling 29.3% through Tune Group Sdn Bhd (16.54%) and AAB (12.76%).

Both Kamarudin and Fernandes also hold indirect stakes totalling 24.61% in Capital A through Tune Live Sdn Bhd (12.23%) and Tune Air Sdn Bhd (12.4%). 

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