Simons Trading Research

Author: simonsg   |   Latest post: Tue, 13 Dec 2022, 10:52 AM


SATS - More Palatable Risk-Reward Profile After Share Price Decline

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  • In the investor meeting during UOB Kay Hian’s Asian Gem Conference, SATS' management shared insights and clarified investors’ queries about the WFS deal.
  • Following the sharp drop in SATS share price after the acquisition announcement, SATS’ risk-reward profile is more attractive in our view and suits investors with a longer-term horizon.
  • We upgrade SATS to BUY, with a lower target price based on an SOTP-based valuation, factoring in very conservative valuation metrics for WFS.

SATS Management's Clarification on the WFS Deal

  • We attended an investor meeting with SATS (SGX:S58) during our Asian Gem Conference on 18 Oct 22. 19 institutional investors attended the meeting. During the meeting, SATS' management shared more insights about the Worldwide Flight Services (WFS) deal and clarified investors’ questions which were focused on the deal background, the due diligence process, potential synergy realisation and the updated financing plan.
  • Through private negotiation, not public tendering. Management shared that, before formally approaching WFS in Nov 21, SATS has been tracking WFS for three years as a potential target. We are glad to know that this WFS acquisition was not through some competitive public tendering process but it was SATS who voluntarily engaged WFS to solicit for a deal. This is important as in a public tendering, bidders face more competitive pressure and have to comply with strict deal timeline; as such there is a higher chance that the winner may end up with an unfavourable valuation or insufficient due diligence.
  • Rigorous due diligence. Management noted that SATS has run a rigorous due diligence process covering the commercial, financial, tax, HR and operation aspects of WFS, involving both internal teams and external consultants and industry experts. The whole process took about five months, which is longer than a typical M&A due diligence duration (usually 2-3 months).
  • The project team has also carefully studied WFS’ synergy potential with SATS’ existing businesses and concluded that there is scope for SATS, as an industry player, to create and to realise synergistic value from this deal, while noting that WFS has changed hands three times (owned by three private equity firms) since 2006.
  • According to management, up to 40% of estimated S$100m p.a. (EBITDA level) synergy can be realised in the near term (two years horizon).
  • Financing plan. Recognising the unfavourable market sentiment towards equity raising, management sounds more firm that SATS is inclined to reduce the portion of straight equity financing to below 50% and to make up the rest with hybrid instruments such as (convertible) perpetual securities. This makes sense as these hybrid instruments are treated as equity by financial institutions (lenders) and hence would not weaken SATS’ credit profile (which may lead to higher cost of debt).
  • Management also confirmed that any equity offering would be limited to existing SATS shareholders, so as not to dilute the value of existing shareholders after the major decline of SATS share price.

After the Sharp Share Price Decline, Risk-reward Profile of SATS Is More Attractive

  • Since SATS’ first trading halt (on 21 September) related to the WFS deal, SATS share price has declined 33% from S$4.06 before the trading halt to S$2.72 (the closing price on 18 October); this is likely due to the market’s unfavourable view towards the deal and the weak sentiment towards the equity raising plan. During this period, S$1.5b worth of SATS’ market cap has been evaporated; this is equivalent to about 45% of WFS’ acquisition enterprise value of S$3.1b.
  • Assuming SATS’ existing business is still worth the value as it was and attributing all market cap drop to the deal of WFS, the market is now effectively valuing WFS at an enterprise value of S$1.6b (being transaction enterprise value of S$3.1b less SATS’ market cap drop of S$1.5b).
  • This means, if one buys SATS at the current price, he is effectively paying only 4.9x EBTIDA (based on WFS’ 12- month EBITDA ended Mar 22) for the WFS deal, instead of the original transaction EV/EBITDA multiple of 9.7x. The effective 4.9x EV/EBITDA looks attractive, considering that:
    1. this is pre synergy, and
    2. WFS is the top global air cargo handler.
  • In the context of past peer transactions, the implied 4.9x EV/EBITDA valuation of WFS is also very cheap. While SATS’ original acquisition EV/EBITDA of 9.7x for WFS was already not excessive against past peer transactions, the effective 4.9x EV/EBITDA for WFS implied by the current SATS share price is much lower than the historical peer transaction range, usually between 10.1x-10.7x.
  • One special case to note is HNA Group’s previous transaction of Swissport, a Swiss aviation service company of similar size to WFS but focuses more on the ground handling services (which SATS does not want to acquire; instead SATS likes the more scalable cargo handling businesses which forms 80% of WFS’ revenue) – HNA Group acquired Swissport back at 2016 at 10.2x EBTIDA but sought for a fire sale a few years later (but failed) after HNA ran into financial distress. HNA’s fire sale valuation for Swissport was at about 7x EBITDA by our estimate.

SATS – Earnings Forecast Revision and Recommendation

  • No change on our earnings forecast for SATS. We have yet to incorporate WFS into our financial projection for SATS.
  • Refer to the summary table in the report attached below, to derive the fair valuation for SATS, We first get the standalone valuation for SATS’ existing businesses by DCF (8.0% WACC) and then add the valuation impact of the WFS deal, which in turn is determined by our conservative valuation for WFS (based on 7x EBITDA, very conservatively pegging to the fire sale valuation multiple of Swissport) less the WFS acquisition cost (based on 9.7x EBITDA).
  • We prefer to be conservative in the valuation of WFS, due to:
    • the higher risk-free rates today (compared with when SATS negotiated the deal valuation),
    • weakening global air cargo outlook in the near term (as highlighted by a few leading air cargo operators including FedEx and DHL), and
    • the lack of financial details of WFS.
  • We will review our valuation for SATS pending more clarity on the WFS deal.

No strong near-term catalyst for SATS.

  • The uncertainties related to the WFS deal may remain an overhang on SATS share price in the near term. Investors in SATS need to adopt a medium-to-long term view.
  • Medium-term catalysts could include:
    • SATS successfully integrating WFS and delivering the forecasted synergies and
    • improving global air cargo outlook.

Source: UOB Kay Hian Research - 19 Oct 2022

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