More work lies ahead for PN17 Capital A, say analysts

This article first appeared in The Edge Malaysia Weekly on April 29, 2024 – May 5, 2024

AFTER much anticipation, Capital A Bhd has finally revealed its plan to exit its Practice Note 17 (PN17) status for financially distressed companies. The low-cost carrier is proposing to sell its aviation business to sister company, AirAsia X Bhd (AAX), for RM6.8 billion through a share and novation of debt deal.

Under the plan, shareholders of Capital A will see the distribution of RM3 billion worth of new shares in a new listco called AirAsia Group Bhd (AAG) at RM1.30 apiece and the transfer of RM3.8 billion debt from Capital A to AAG. No cash will be exchanged. AAX will then transfer its listing status to AAG.

But will the exercise help offset Capital A’s negative shareholder equity of RM10.47 billion (as at end-December 2023) and lift the low-cost carrier from PN17? Analysts are divided on this.

Nevertheless, the consensus is that the proposed deal is a step forward for Capital A to exit its PN17 category — which it had slipped into in January 2022 after its external auditors Ernst & Young issued an unqualified audit opinion with material uncertainty relating to going concern in respect of its audited financial statements for the financial year ended Dec 31, 2019 (FY2019), plus its shareholders’ equity on a consolidated basis was 50% or less of its share capital.

“We are overall positive on the exercise mainly on the streamlining of the aviation segments to be consolidated under AAG, in strengthening the business model for long haul-short haul integration, with a new medium-haul segment as the intermediary, by leveraging onto the new A321 fleets,” says Hong Leong Investment Bank Research in an April 26 report.

“Shareholders of Capital A will also benefit from it exiting PN17 status, its new focus on the growth of the aviation support business segments, leveraging onto AAG’s growth and new shareholdings in AAG, to ride on the expected growth of low-cost carriers globally,” the research house says.

Negative equity negated?

According to filings with Bursa Malaysia, Capital A would secure a pro forma gain of RM8.52 billion.

This entails RM4.69 billion from the sale of AirAsia Aviation Group Ltd (AAAGL), which comprises 40.71%-owned Thai AirAsia, 46.25%-owned Indonesia AirAsia, 100%-owned Philippines AirAsia and 51%-owned AirAsia Cambodia, and RM3.83 billion from AirAsia Bhd (AAB), which wholly owns Malaysia AirAsia.

Earlier this year, Capital A also revealed plans to dispose of its branding business to a US-listed special purpose acquisition company (SPAC) for US$1.15 billion, which will result in a pro forma improvement to its shareholders’ equity of RM2.49 billion.

The three exercises will add up to net pro forma gain of RM11.01 billion. This compares with Capital A’s accumulated losses of RM10.49 billion.

To sweeten the deal, 73.33% or 1.69 billion of the new shares in AAG, valued at RM2.2 billion, will be distributed to entitled shareholders of Capital A according to their respective shareholdings via a capital reduction. Including these and other components such as the deconsolidation of the RM5.5 billion merger deficit related to its acquisition of AAB, Capital A’s shareholder equity is set to be positive, all else being equal.

Its total borrowings are expected to drop to RM1.08 billion, with the bulk of its liabilities transferred along with the aviation business to AAX.

According to MIDF Research, the proposed corporate exercises will aid the group in its transition out of its PN17 status, with a deadline of June 20 to submit the plan to Bursa.

In an April 26 report, MIDF Research also says Capital A’s shareholders’ equity will turn positive at RM492.8 million through the deconsolidation of the merger deficit resulting from its previous acquisition of AAB following its disposal, assuming no conversion of its convertible securities.

“If all outstanding redeemable convertible unsecured Islamic debt securities (RCUIDs) and warrants are exercised, the projected shareholders’ equity would amount to RM1.67 billion following the proposed distribution and disposal of AAB,” the research house adds.

Capital A has 649.67 million outstanding one-for-one warrants as at end-March, with an exercise price of up to RM1 apiece. It last traded at 28.5 sen at the time of writing. It has another 942.73 million debt securities with an annual profit rate of 8% based on nominal value of 75 sen apiece, convertible to Capital A shares on a one-to-one basis. It last traded at 78.5 sen apiece.

From 4.25 billion shares, Capital A’s share base could rise to 5.85 billion shares with full conversion of the warrants and the debt securities. This means a Capital A shareholder could receive between 289 and 397 AAG shares for every 1,000 Capital A shares, calculations show.

Meanwhile, Nomura Global Markets Research points out that since Capital A’s FY2023 unaudited shareholder equity stands at a negative RM8.7 billion, it could still be tricky to simply assume it would return to positive equity from just the aviation business sale.

“As per pro forma FY2022 numbers, removing the aviation entities from the profit and loss gives an implied loss of RM352 million in FY2022 for its non-aviation businesses, and we believe it was still loss-making in FY2023, albeit narrowing,” it says in an April 26 report.

Separately, Maybank Investment Bank Research in an April 26 report estimates that Capital A’s shareholders’ equity position will turn positive, taking into account both corporate exercises and the listing of the vehicle that will own its AirAsia brand on Nasdaq.

Earnings impact

With the deal, Capital A’s earnings appear diluted due to its 18.4% stake in the merged aviation business under AAG. It currently owns 12.77% in AAX, 100% in AirAsia Malaysia, and 100% in AAAGL.

Capital A’s largest shareholders are Tan Sri Tony Fernandes and Datuk Kamarudin Meranun with a 24.1% indirect stake via Tune Live Sdn Bhd and Tune Air Sdn Bhd. Fernandes and Kamarudin also hold direct stakes of 0.04% and 0.5% respectively.

In AAX, the duo also own a 16.54% indirect stake via Tune Group Sdn Bhd. Kamarudin has an 8.29% direct stake in the company, while Fernandes has 2.5%.

After AAX completes a RM1 billion private placement, and after the deals are completed up until the distribution of AAG shares by Capital A, Fernandes and Kamarudin will own a 13.18% indirect stake in AAG via Tune Live, Tune Air and Tune Group. Capital A will hold another 18.39% in AAG.

Meanwhile, AAG could see former AAX director Datuk Lim Kian Onn subscribing up to 15% of its enlarged share base, which could entail further dilution in the aviation entity in exchange for more capital.

“Seeing that Capital A is disposing of its four airlines that have traditionally generated most, if not all, of its earnings to AAG, it goes without saying that Capital A will not be generating much earnings after the disposal,” says Maybank IB Research.

The research firm highlights that the RM3 billion in AAG shares that Capital A will receive is lower than the research house’s valuation of RM4.58 billion for the aviation business.

However, “there will be upside if AAG’s share price appreciates in the long term”, even as some argue that the disposal is value dilutive to Capital A, it adds.

Nomura Research, which has the sole “sell” call on the counter, cut its FY2025 earnings forecast after taking out the aviation unit contribution, and excluded AAX’s long-haul business contribution due to low core net profit in FY2023, pending guidance.

Based on AAX and Capital A’s aviation business in FY2023, the share of earnings before interest, taxes, depreciation and amortisation (Ebitda) to Capital A under the new structure would amount to RM214.32 million, down 63.56% from RM588.23 million, a back-of-the-envelope calculation shows.

Capital A could see a new income stream from the proposed spin-off of its brand business Capital A International (CapAI) in the US, which plans to collect royalty from revenue generated by airline operating companies (AOCs) in relation to Capital A affiliates’ aviation businesses.

The royalty fee is set at between 0.5% and 1.5%. Based on AAX and Capital A’s FY2023 aviation business top line, revenue from the royalty is estimated at RM154.4 million to CapAI, in which Capital A would hold 46.1%.

In FY2023, Capital A booked RM836.99 million in net profit on revenue of RM14.77 billion. Capital A also operates in-flight caterer Santan, super app MOVE Digital, air freighter Teleport and aircraft maintenance unit Asia Digital Engineering (ADE).

The non-aviation business had an Ebitda of RM209 million, with all segments making profit save for BigPay, which made a loss of RM70.6 million, as well as operations categorised under the “others” segment.

According to MIDF Research, Capital A intends to begin sharing profit guidance for its digital entities during the briefing of its 1QFY24 results.

Capital A shares closed at 73.5 sen last Friday, up 5% from the previous day’s close when the announcement was made. Nonetheless, Capital A shares have fallen 10% so far this year. At the close of trading last Friday, its stock was valued at RM3.1 billion. AAX shares were up 13% to RM1.37, as investors deem the medium-haul affiliate as the winner from this development.

Of the nine analysts covering Capital A, four gave a “buy” rating, four a “hold” and one a “sell”, with an average price target of 90 sen, which indicates a potential upside of 22% from last Friday’s closing price of 73.5 sen. That said, the target prices vary widely from 60 sen to as high as RM1.68.

In a news conference on April 24, Fernandes highlighted that the aviation business’ ancillary income has become “one of the biggest drivers of cash attrition, and margin growth”.

In an earlier interview with The Edge, Fernandes also revealed his vision of eventually spinning off MOVE and Teleport in the coming years. Prior to that, a fundraising round for MOVE Digital — which Fernandes says “needs the most work” due to strong competition — of about US$30 million was also under consideration.

“We have strong businesses that analysts and the market have not looked at,” he said. Teleport is the No 1 air cargo provider in Asean, says Fernandes.

“I’m most excited about [MOVE Digital] because it needs the most work, the biggest challenge is the big guys (its competitors) in the business. But I believe we will be very strong because we have a massive database … of 50 million people.”

Time will tell if Capital A’s other ventures will eventually step out of its aviation business’ shadow.

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