This article first appeared in The Edge Malaysia Weekly on September 30, 2024 - October 6, 2024

SHAREHOLDERS of low-cost carrier Capital A Bhd (KL:CAPITALA) and AirAsia X Bhd (KL:AAX) will vote on the former’s proposed disposal of its aviation business to its medium-haul affiliate for RM6.8 billion at their extraordinary general meetings on Oct 14 and 16 respectively.

The corporate exercise is meant to facilitate Capital A’s exit from Practice Note 17 (PN17) status for financially distressed companies, and ensure access to capital for the bigger, more efficient airline group under AAX.

“From [AAX’s] standpoint, we are ready to take off, whereas Capital A is just about to get on the runway,” says Capital A CEO Tan Sri Tony Fernandes. 

In his latest interview with The Edge, he responds to the mixed views on the airline business’ valuation, dilution in the two listed companies and the prospects of the wider aviation industry.

On the potential shareholder value dilution, Fernandes says: “AAX by itself, history has shown, is going to struggle. By injecting the [short-haul] airlines [held via Capital A’s units, AirAsia Aviation Group Ltd (AAAGL) and AirAsia Bhd (AAB) into AAX], it will have a massively earnings-accretive business.”

For common shareholders of AAX and Capital A, the dilution effect will be less, as Capital A will distribute to shareholders RM2.2 billion worth of AAX shares or 73.33% of the total AAX shares it will receive from the proposed disposal.

“We [Fernandes and Capital A co-founder Datuk Kamarudin Meranun] put our money there [in Capital A and AAX], and our lives to be honest. Our stakes are not as diluted because we invested in both companies. I would hope that most minority shareholders [hold shares in both Capital A and AAX too],” he says.

AAX will issue RM3 billion worth of shares at RM1.30 apiece to acquire AAAGL, which holds AirAsia’s subsidiaries in Indonesia, Thailand, Cambodia and the Philippines. It will also raise RM1 billion through a private placement at RM1 per share.

The two exercises will see AAX issue 3.31 billion shares, which will raise its share base to 3.75 billion shares from 447.07 million shares currently. A detailed circular to its shareholders on Sept 24 shows an equity dilution of about 88% as a result.

For Malaysia AirAsia, which is held through AAB, AAX will assume RM3.83 billion worth of debt that Capital A owes AAB. To sweeten the entire deal, AAX will throw in free warrants on the basis of one warrant for every two shares held.

Based on the combined figures for AAX and Capital A’s aviation business for the first half of 2024 (1HFY2024), the dilution at the earnings before interest, taxes, depreciation and amortisation (Ebitda) level for AAX minority shareholders on a per share basis is around 13.4% (before eliminations), compared with the 88% equity holding dilution. That means, while their voting rights become much smaller, the earnings do not shrink as much after Capital A’s aviation business is combined with that of AAX.

Over at Capital A, a shareholder holding 1,000 shares in the company will receive 392 AAX shares from the proposed distribution.

Fernandes and Kamarudin, who collectively hold an indirect stake of 23.81% in Capital A, will see their indirect interest in AAX post-exercise reduce to 12.7% from 16.74% (excluding the 17.91% Capital A will keep in AAX). Kamarudin’s direct stake in AAX will fall to 1.01% (from 8.29%), while Fernandes’ equity interest will drop to 0.32% (from 2.5%).

Fernandes reiterates that the proposed deal will be enough to lift Capital A’s equity position to positive, adding that it will no longer need to rush to unlock value by listing its branding business, Capital A International.

The combined price tag of RM6.8 billion for AAB and AAAGL is higher than the RM5 billion previously projected by some analysts who cover the company.

A Capital A spokesperson explains that the gains from the disposals will be enough for it to achieve a positive equity position as the deal is now pegged on the net liabilities of AAB and AAAGL as at January 2023, instead of 2022 figures.

Capital A had initially planned to bridge the gap by listing its branding business in the US for US$1.15 billion.

As at last Thursday, the entire market capitalisation of Capital A — of which 93% of revenue and Ebitda comes from its commercial airline — stood at RM3.9 billion.

In valuing the aviation businesses, Deloitte Corporate Advisory Services Sdn Bhd used discounted cash flow (DCF) method based on projections prepared by the management for FY2024 to FY2028, with discount rates of 12% to 19%.

The discount rates are seen as on the high side as it includes the risk premium associated with Capital A’s PN17 status, even though the aviation business will exit its PN17 status after the disposal, says the Capital A spokesperson.

“With the interest rate cuts [that have started in the US], the discount rate would be lower and the valuation could be higher. It is good for AAX that we agreed at this price as of April,” the spokesperson adds.

On the other hand, some analysts see the five-year average revenue growth assumptions as optimistic — at 13% for Malaysia AirAsia, 11% for Thai AirAsia, 15% for Philippines AirAsia and 21% for Indonesia AirAsia.

For the six months ended June 30 (1HFY2024), Capital A booked a loss before tax of RM545.73 million on revenue of RM10.1 billion, dragged by foreign exchange losses of RM807.05 million and aircraft depreciation charges. AAX’s 1HFY2024 net profit came in at RM84.94 million on revenue of RM1.58 billion.

“At RM6.8 billion, AAB and AAAGL should be earning RM680 million (or 18.1 sen per AAX share post-acquisition) at 10 times PER (price-earnings ratio),” says an aviation analyst, who is less sanguine in view of Capital A’s loss-making run so far this year.

Such profitability was achievable in the past. Capital A booked strong earnings in FY2016 (RM2.04 billion), FY2017 (RM1.64 billion) and FY2018 (RM2.02 billion) on the back of an aggressive expansion and strong demand, before the industry’s overexpansion and heightened competition dragged the group into a loss in FY2019.

Other analysts The Edge spoke to point out that AirAsia still has more planes to activate. Notably, Asia-Pacific’s recovery is from a lower base due to lag effects compared with other regions, according to International Air Transport Association (IATA) data. China is another wild card, with some hopeful of a bigger tourist volume next year.

In 1H2024, Capital A and AAX’s aviation businesses flew 33.7 million passengers or 44% of the full-year forecast of 76.6 million passengers. In the latest quarter, 77% of AirAsia’s 218 aircraft were in operation. AAX, meanwhile, operated 22 planes from Thailand and Malaysia in 2Q2024.

“Excluding Cambodia, passenger numbers are nearing pre-pandemic levels, with year-to-date recovery reaching 84% of pre-Covid-19 figures, surpassing capacity recovery of 81%,” AirAsia said in a July 25 statement.

Just as critical as the non-cash airline deal is the fundraising to support AAX’s operations post-merger.

In absence of the financial support enjoyed by the many other government-linked airlines during the pandemic, AAX’s RM1 billion (US$240 million) private placement will be necessary to partly fund aircraft purchases and maintenance, as well as route expansion. AAX is also undertaking a capital reduction of almost RM4 billion to erase the aviation business’ accumulated losses.

In 2022, AAX proposed a RM166 million rights issue, but it did not proceed with the exercise.

The acquisitions of both AAB and AAAGL are conditional upon the private placement, unless the interested parties agree otherwise to vary or waive the relevant conditions precedent. “We’ll get the placement [subscribers],” assures Fernandes, who says there is interest from foreign institutional investors.

Apart from the placement, AAX is also providing subscription options to Garynma Investment Pte Ltd, a vehicle of former director Datuk Lim Kian Onn, amounting to 12% of AAX’s share base post-placement and acquisition. For illustrative purposes, this amounts to 450 million shares in the company.

If completed, the placement and subscription combined could raise up to US$350 million for AAX, in line with Fernandes’ earlier target of raising US$300 million to US$400 million in equity for the merged airline business under AAX.

There is the cyclical tailwind of lower oil prices and improving ringgit against the US dollar, which could double the aviation business’ earnings year on year in FY2025, Maybank Investment Bank Research says in a Sept 18 note.

Fernandes pointed out in February that Capital A’s passenger traffic is expected to rise to 117.5 million by 2028, from 76.6 million passengers in 2024.

All in all, the group will welcome a total of 10 new aircraft and six new leases in 2024, he says. An earlier projection for new deliveries was 11 planes in 2025, 12 in 2026, 18 in 2027 and 28 in 2028.

On top of that, Fernandes is optimistic that the fast-growing aircraft maintenance, repair and overhaul (MRO) services unit Asia Digital Engineering (ADE) will help keep costs low for the merged aviation business.

Over at Capital A, its effective share of the aviation business’ earnings (AAB, AAAGL and AAX combined) will be reduced by more than 70% post-distribution (see table).

Based on AAX’s theoretical share price of RM1.30, Capital A’s share price ex-distribution will be adjusted 51 sen lower. It will have a 17.91% stake in AAX or 672.46 million shares remaining.

AAX’s share price settled at RM1.77 last Friday, while that of Capital A, which also owns logistics unit Teleport and ADE, closed at 94 sen.

Moving on, Capital A could be expected to reveal its regularisation plan this month, says Fernandes.

On Capital A’s non-aviation businesses, save for Move Digital (which includes loss-making BigPay operations), its other operating segments are Ebitda positive.

Teleport’s parcel deliveries surpassed its FY2023 performance with 31 million parcels delivered in 1H2024, while air cargo saw 130,000 tonnes or 64% of total FY2023 tonnage during the period. It is growing its air network capacity with over 40 airlines.

For the branding business Capital A International, which currently charges fees on usage of the AirAsia brand, the group expects brand licensing agreements with non-airline businesses to take effect in 2025.

ADE launched its 14-line hangar on Sept 26, adding to its existing seven lines in operation. An additional four lines may be added adjacent to the new facility, according to reports.

“Capital A is an interim platform. I don’t believe in the conglomerate [model],” says Fernandes, adding that he sees the value of the non-aviation operating segments under Capital A potentially unlocked via separate listings in the next three to five years.

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