ICYMI: Sats’ acquisition target is in the red

ONE of the most interesting stories I read in The Business Times this past week was about Worldwide Flight Services (WFS) chief executive Craig Smyth expecting further, near-term softness in the global air freight sector before an eventual recovery.

Two months ago, shares in Sats sank precipitously after the company said it would acquire WFS, the largest air cargo handling firm in the world. One concern about the deal was that air cargo demand might temporarily soften as the pandemic subsides. Another was that Sats would ultimately fund the acquisition through a big, deeply-discounted rights issue of new shares.

Sats has attempted to address the market’s concerns about the looming rights issue a couple of times. This past week, Sats said it only plans to tap its shareholders for S$800 million. The rest of the S$1.8 billion acquisition of WFS will be funded through a S$700 million three-year, euro-denominated loan and internal cash of S$320 million, the company said on Dec 1.

The company’s chief financial officer Manfred Seah also said the rights issue will not be priced at a massive discount to Sats’ market price.

But what about the post-pandemic softness in the global air freight sector? Will that concern continue to weigh on investor sentiment towards the acquisition of WFS?

The BT story that grabbed my attention cited financial information contained in a report to bondholders of WFS. The report showed WFS posted a net loss of 31.1 million euros (S$44.3 million) for Q3 2022, compared with earnings of 26.2 million euros in Q3 2021. This was despite the group’s revenue increasing 44.2 per cent to 511.3 million euros.

The report also showed that WFS had been in the red for more than one quarter. The group reported a net loss of 91.3 million euros for the nine months to Sep 30, versus a net profit of 52.4 million euros for the same period the previous year. Its revenue for the nine months was up 52.7 per cent year on year (yoy) to 1,455.8 million euros.

Among the factors that contributed to reduced profitability at WFS were increased expenses and overheads related to its acquisitions in the United States and higher labour costs. WFS also benefitted from grants in 2021 under a payroll support programme in the US, but not in 2022.

On top of that, WFS saw higher costs as a result of investments in IT and business development resources. The group was also affected by provisions for unrealised foreign exchange losses and higher interest related to its senior secured notes.

Post-pandemic softness

Citing data from the International Air Transport Association, the report to bondholders of WFS noted that global air cargo volumes (measured by cargo tonne-kilometres) declined 9.3 per cent yoy in Q3 2022. For the first nine months of 2022, air cargo volumes declined 6 per cent yoy.

“The softening air cargo demand is attributable to multiple headwinds,” the report said. “As most of the world’s regions recover from the pandemic, post-pandemic consumer spending habits are likely to lean towards entertainment as opposed to home shopping via e-commerce while the lockdowns in China have impacted the manufacturing and export of goods.”

The report added: “High inflation levels and the increasing fear of an economic recession have a negative impact on the global flows of goods. In addition, the ongoing war in Ukraine still affects cargo capacity, with some important air cargo carriers directly impacted.”

WFS CEO Smyth told BT last week that he expects the current softness in global air cargo volumes to be alleviated when the war in Ukraine and the lockdowns in China are resolved. Any easing of trade tensions between the US and China would also help, Symth said.

In the meantime, the group’s broad geographical footprint is helping it weather the softness in demand, Smyth added.

The report to bondholders of WFS said global air cargo volumes in Q3 2022 were only 3.2 per cent below their pre-pandemic levels in 2019. The weakness was more pronounced in Europe and Asia-Pacific, where air cargo volumes were 13.4 per cent and 8.7 per cent down, respectively, from the corresponding period in 2019.

On the other hand, air cargo volumes in North America were 13.1 per cent higher.

The report went on to say that global air cargo capacity stabilised in Q3 2022. During the nine months to Sep 30, available cargo tonne-kilometres increased 4.6 per cent yoy. This was attributed to industry players strategically adjusting capacity around the world to gain higher cargo load factors.

Heightened risks

Sats has itself suffered reduced profitability this year. On Nov 9, the company reported a net loss of S$32.5 million for the six months to Sep 30 versus a net profit of S$13.2 million for the same period the previous year. Revenue for the half-year rose 41.3 per cent to S$804.5 million.

The currently squeezed profitability of both Sats and WFS could raise the risks of their proposed combination – especially as WFS has a significant debt load. As at Sep 30, WFS had net borrowings of 1,046.5 million euros – more than 5.2 times its shareholders’ equity.

It seems unlikely that the deal will be scuppered, though. Both Sats and WFS appear to be well-positioned to ride the long-term growth of the aviation sector, and their merger seems strategically compelling.

More to the point, Temasek – which owns 39.7 per cent of Sats – has indicated it will support the deal, making it very unlikely that it will fail to go through.

Still, many investors who have been tracking Sats and looking for a buying opportunity will probably want to digest the company’s latest statements about its fundraising plans as well as the losses both Sats and WFS have been suffering before deciding their next move.