In what is a stark reminder of the severe turbulence facing the industry, the CEO of Qatar Airways, Akbar Al Baker, recently told the press that despite actually increasing capacity from March 29 to tackle the need to operate repatriation flights, the company only has “enough cash to take [it] through a very short period of time.”
The COVID-19 pandemic is placing a cashflow strain on all operators. In order to stay solvent, most have cut capacity and grounded planes. As a business built upon the movement of people approaches an abrupt halt, the International Air Transport Association estimates the industry is expected to lose nearly $250 billion in revenue, while the Centre for Aviation warns that many airlines will go bankrupt by May.
Efforts to avert an industry crisis have begun, with global airlines raising more than $17 billion from various banks and credit lines in March 2020, according to Bloomberg estimates. Within the mix, operators have exercised all other available options. Singapore Airlines will push for a right issue from its current shareholders, Korean Air plans to raise funds via asset back securities while Japan Airlines issued bonds. In the US, a $50 billion bailout was passed to keep airlines operational until September.
The cash infusion works as a temporary solvency bridge but does not address the underline issue: demand. Without a passenger recovery, cashflows will continue to deteriorate. With more staying at home, social distancing, and going on-line, travel will remain subdued for an indefinite period. A quick rebound appears unlikely, due to concerns that prematurely lifting travel restrictions could revive a new round of virus infections.
The industry is expected to consolidate to match the new reality. In a letter to employees posted on March 27, United Airlines CEO Oscar Munoz and president Scott Kirby foreshadowed the inevitable, that “our airline and our workforce will have to be smaller than it is today."
This creates fresh uncertainty for airline operators asking for capital in a shrinking market. Among notable deals penciled for 2020, Lion Air, one of Asia’s low cost carriers (LCC), was looking to raise more than $500 million in an IPO exercises. Air India had also been discussed as a possible privatisation candidate from the Indian government to help bridge the country’s budget deficit. These now look far less likely to occur, certainly within this year.
The capital markets landscape
Despite the near shutdown, capital markets remain relatively active in Asia. InnoCare Pharma raised $300 million in a virtual IPO in Hong Kong while SBI Credit Card in India pulled off a $1.4 billion IPO in March 2020. Central Retail raised $2.5 billion last month. In total, Asia has raised $24 billion through equity sales thus far this year.
But the capital markets will be less generous to airlines. Certain investors will sit on the sidelines to find out who will be a buyer and who will be a seller. Healthier operators will likely absorb less profitable ones, but in both cases, either public taxpayers or private investors become a white knight, most likely a mixture of the two.
Nationalisation follows the 2008 bank bailouts script. China’s three biggest carriers Air China, China Southern Airlines, and China Eastern Airlines have been reported to buy out HNA Group’s aviation assets. In Malaysia, Khazanah Nasional, the country’s sovereign wealth fund, has been pushing LCC AirAsia Group to merge with loss making national carrier Malaysia Airlines, where related impairment charges weigh on the fund’s income.
Inevitably, consolidation instigates a capital misallocation as public and private investor shareholders are further intertwined. Any airline looking to raise capital will need to demonstrate that an IPO both serves the national interest (create jobs) while also working as an efficient operation (profitable), which very few demonstrate.
Before the pandemic, shareholder activists balked at companies holding excessive cash, arguing it as a barometer for inefficient investing. But given the credit crunch evident in all sectors, these calls are likely to go quiet. Amid the $50 billion bailout earmarked for airlines in US, it is not lost among the public the top operators have issues about the same amount back to shareholders in buybacks and dividends over the past ten years.
But increasing cash on book would fundamentally change the business operations for airliners, as the decision would directly impact their fleet. This matters as leasing or owning planes impacts the balance sheet. Even though depreciation is a non-cash component of operating expenses, it depletes cashflow.
Given the necessity that people movement benefits an economy, airlines are essentially ‘too big to fail.’ The challenge was highlighted in a letter written by UK Chancellor Rishi Sunak on March 24, explaining that bespoke state support would be possible “if all commercial avenues have been fully explored, including raising further capital from existing shareholders.”
Avoiding the moral hazard that meets these conditions will prove challenging. Singapore Airline’s rights issue diluted its shareholders, but counts Temasek Holdings, the government’s investment company, as its majority shareholder at 55% pre-dilution.
Though difficult to imagine, normality will resume, as airline operators will adapt for the coveted Asia market, particularly China. Overseas spending by Chinese travelers is estimated to be worth between $130 billion to $280 billion, supported by 150 million Chinese traveling overseas, according to the China Tourism Academy.
Given that only an estimated 9% of China’s population are passport holders, the potential market is quite lucrative. The question becomes, which company can wait for normal to return and will investors ever view the industry in the same way again?