Sats-WFS deal: Pro forma financials in circular show lower immediate boost to earnings, EPS

SINCE announcing plans to acquire Worldwide Flight Services more than three months ago, Sats has consistently said the “transformational” deal will make it more resilient and unlock significant growth potential.

But information provided by the in-flight caterer and ground handler about the immediate financial impact of the transaction has since been updated.

When Sats unveiled the S$1.8 billion acquisition of WFS on Sep 28 last year, it said in a statement that the deal would boost its earnings per share (EPS) for the financial year to Mar 31, 2022 by 78 per cent on a pro forma basis.

The pro forma financial effects of the deal provided in the initial announcement showed its net profit for FY2022 would rise from S$20 million to S$56 million (including amortisation of intangible assets), while its EPS would rise from 1.8 Singapore cents to 3.2 Singapore cents.

This was based on the assumption that Sats raises S$1.7 billion through a rights issue of 609 million new shares at S$2.79 each – which the company quickly began insisting would not actually happen.

On Oct 3, 2022, Sats said no decision had been made on the funding structure for the WFS acquisition. Three days later, The Business Times quoted Sats chief executive Kerry Mok saying that any rights issue by the company would be much smaller than S$1.7 billion.

On Dec 1, 2022, Sats said it had finalised its funding plan. The company now plans to raise S$800 million through a rights issue some time in Q1 2023. It will raise a further S$700 million through a term loan, and put S$320 million of its existing cash balances towards the deal.

What does all this mean for investors? On Jan 3, 2023, Sats said in a circular to its shareholders that the acquisition of WFS would result in a significant “step change” in its revenue and Ebitda (earnings before interest, taxes, depreciation and amortisation).

But Sats also provided pro forma net profit and EPS numbers that are quite different from its original announcement on the deal.

The company’s FY2022 net profit now rises from S$20 million to only S$28 million (including amortisation of intangible assets); its EPS rises less than 6 per cent, from 1.8 Singapore cents to 1.9 Singapore cents.

Sats has also now included pro forma earnings numbers that include adjustments to the target group’s financial statements to bring them in line with Singapore Financial Reporting Standards (International).

Including the SFRS(I) changes, the company’s pro forma FY2022 net profit actually falls from S$20 million to minus S$16 million (including amortisation of intangible assets). Its pro forma EPS falls from 1.8 Singapore cents to minus 1.1 Singapore cents.

Interestingly, the circular includes financial numbers for WFS not disclosed in the original announcement – numbers that show WFS fell into net losses during the first three quarters of 2022. On the face of it, the pro forma earnings numbers for Sats might have been even worse if they were prepared for the six-month period to Sep 30, 2022.

Increased interest expense

When asked why the pro forma FY2022 net profit and EPS in its circular were lower than in the initial announcement, Sats replied that its finalised funding structure now includes a certain amount of debt.

“Taking on S$700 million of debt under the term loan will result in increased interest expense, thus reducing the pro forma net profit as disclosed in the circular,” it told BT.

“In view of the cash-generative nature of the businesses, Sats is confident that it will be able to deleverage and meet its debt commitments, with the potential free cash flows that will be generated from the combined businesses,” the company added.

Sats noted that the debt load will reduce the cash call on its shareholders. “This achieves a balanced mix of debt and equity, and a reasonable overall cost of capital. In addition, the reduced size of the proposed rights issue enables more minority shareholders to fully participate in funding part of the acquisition and avoid being diluted.”

Why were the SFRS(I) adjustments, which have the effect of lowering the pro forma net profit and EPS figures, not included in the original announcement? Sats said the computation was “a major and complex undertaking” that was not appropriate for presentation at the time.

Sats added that it was not required to include the SFRS(I) adjustments in the circular, but it voluntarily did so. The company also stressed that the adjustments have no bearing on the cash flow of the target group.

As for its pro forma earnings numbers not fully reflecting WFS falling into losses in the first three quarters of 2022, Sats said it was required to prepare pro forma financials based on its latest audited financial year-end – which was Mar 31, 2022. (see *Amendment note)

It also pointed out that the recent losses at WFS were largely due to unrealised foreign-exchange losses against its senior secured notes and other one-off items.

Share price slump

When Sats announced the acquisition of WFS last year, its share price promptly sank. This was attributed to a lack of clarity about the company’s fundraising plans, as well as doubts that the deal would result in as much of an EPS uplift as suggested by the pro forma estimates that were provided.

The circular published on Jan 3, 2023 now suggests that the pro forma net profit and EPS numbers in the initial announcement were indeed overly optimistic, and that the deal might even be initially dilutive for Sats’ earnings.

Moreover, it seems clear the finalised funding structure that Sats announced on Dec 1, 2022 had significant implications for its pro forma earnings numbers – which is perhaps why its stock price did not recover even after it “reduced” the size of the rights issue.

Shareholders of Sats planning to vote on the proposed acquisition of WFS at the extraordinary general meeting scheduled for Jan 18, 2023 should carefully consider all the information contained in the circular.

They should perhaps also keep in mind that the recent trajectory of Sats’ share price has been an accurate barometer of the financial implications of the deal.

*Amendment note: An earlier version of this column, in the 20th paragraph, incorrectly referred to WFS falling into losses in the first three quarters of 2023 instead of 2022.