Bailout

Politicising Covid-19 undermines Cathay Pacific's HK$39 billion bailout

Commercial assumptions are irrelevant if Hong Kong uses the health crisis to disguise social gathering policies and extend travel restrictions.

The Hong Kong government handed Cathay Pacific a HK$39 billion package to take a 6% position into the city-state’s flagship carrier. Swire Pacific, the 200-year-old conglomerate with businesses that include property along with food and beverage divisions, remains the majority shareholder at 42%.

Under the deal, Air China’s ownership drops to 28% while Qatar Airlines sees its ownership fall to 9%. 

The bailout, a combination of preferential shares, warrants, and a bridge loan, flips the script for the industry from a few months earlier. Given the Covid-19 global pandemic, the government’s response may not necessarily meet a moral hazard, but it is not forgotten among Cathay Pacific shareholders when profits were hit due to poor fuel hedging bets between 2014 and 2018. 

Cathay Pacific’s market value has fallen by a third this year. Before the novel coronavirus brought international travel to a standstill, Cathay Pacific was already shaken as tourist arrivals dropped from last year’s summer protests. Comments over the social unrest also led to management changes, including the then CEO’s resignation.

While the HKD$39 billion bailout is slightly above the current HKD$33 billion market cap, the airline trades at 6.5x on an enterprise value to EBITDA ratio. Prior to 2020, Cathay Pacific traded at a multiple premium to Singapore Airlines, which raised S$9 billion in rights issues in early May 2020. 

Anaemic Recovery

The bailout draws two questions. The first is whether the capital injection is sufficient.

According to a press statement from Cathay Pacific Chairman Patrick Healy, “the collapse in passenger revenue to only around 1% of prior year levels has meant that we have been losing cash at a rate of approximately HK$2.5 billion to HK$3 billion per month since February.”

Fully exercised, taxpayers ensure Cathay Pacific with at least a year’s worth of operational cash to weather future uncertainty.

But many know that a return to pre-coronavirus capacity depends on the delivery of an effective and widely distributed vaccine, which is unlikely before the end of the year, according to Dr. Pui Man Hoi, an associate professor at the University of Macau and lecturer at the university’s Institute of Chinese Medical Sciences, speaking to FinanceAsia.

Even as airlines limit seat capacity, “Passengers are flying before being vaccinated, opening the potential for a future spike in infections,” says Hoi. “Halting movement again cannot be ruled out.”

The second question falls on the supply side, which is contingent when travel restrictions are eased. Despite Hong Kong flattening the infection rate and loosening engagement rules, decisions surrounding these restrictions are appearing increasingly politicised.

For those arriving in Hong Kong, a 14-day quarantine remains in place until September 17, which coincidentally follows the Legislation Council election held on September 6. Current social distancing guidelines which prohibits gathering of eight or more was extended until late June. Police cited crowd size as the reason for banning the June 4 Tiananmen vigil.

“It has become clear that demonstrations would kick off again once the full restrictions on movement, triggered by Covid-19, are lifted,” according to a note by Christopher Wood, equity strategist at Jefferies.

Demand Supply Mismatch

This creates a mismatch between the demand for travel and the supply of travel options. At a time when balance sheet strength and capital liquidity are pinnacle, the taxpayer money used for Cathay Pacific inherits additional risks the longer restrictions stay in place.

With several hard-hit European countries reopening their borders, questions surface over Hong Kong’s more conservative approach. Even with neighboring Special Administrative Region (SAR) Macau, which has not recorded a single Covid-19 fatality, Hong Kong requires a two-week quarantine upon returning. Since Macau has also implemented mandatory isolation, traveling between the two SARs entails a double quarantine.

Taxpayers are understandably frustrated, as the demand-supply mismatch risks wasting financial reserves amid a weak economic climate. Hong Kong’s economy contracted 8.9% in the first quarter of 2020.

The government is signaling confidence that visitors will return to Hong Kong, recently approving the HK$5 billion bailout for Ocean Park, with speculation that Hong Kong Disneyland will also receive aid shortly. But as Hong Kong also battles legacy social issues, confidence in the government is not openly reciprocated with the public.

“Taxpayers are sick of the lack of accountability from this administration,” according to Susan Liang, a Hong Kong-based lawyer. “It does not make sense to subsidise both Ocean Park and Disneyland at the same time.”

Hong Kong is spending a significant amount of money to offset the crisis impact. But until policies are aligned with economic realities, commercial investments like the bailout for Cathay Pacific is capped, risking another round of taxpayer-funded equity raising.

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