Lifeline for Malaysian Airline System Bhd

Folks,

Last Friday, the Malaysian Airline System Bhd, otherwise known as Malaysia Airlines or simply MAS, made an announcement to Bursa Malaysia on its turnaround plan. Well, the plan was actually engineered by  its major shareholder Khazanah Nasional Bhd which holds 69.37% stake in MAS, while the remaining  30.63% are held by other stakeholders.

The corporate exercise, known as Selective Capital Reduction, would mean that Khazanah Nasional is working to take the airline private or de-listing from floating on Bursa Malaysia.

Khazanah Nasional has proposed to pay 27 sen per share to minority shareholders, and with this, it will be able to take MAS private. MAS was last traded at 24 sen, last week. Paying this amount would cost Khazanah Nasional some RM1.3 billion.

The letter from Khazanah Nasional to MAS can be read here. And the detail outline can be found here.

Current Shareholding Structure

At the moment, of the 30.63% that are not owned by MAS, 20.4% is free float which means that anyone can buy the share through the trading system. The remaining 10.23% are held by minority shareholders, and they are:-

• Pemodalan Nasional Bhd through Skim Amanah Saham Bumiputera (1.66%)
• Great Eastern Life Assurance (0.60%)
• Norges Bank Investment Management (0.29%)
• State Financial Secretary (0.27%)
• Mega First Housing Development (0.19%)
• Employees Provident Fund (0.18%)
• OSK Capital Paartners (0.13%)

The exercise above will require 50% in the number of minority shareholders and 75% in the value of minority shareholding. Convincing the minority shareholders is a heavy task on its own because every shareholders would want their return maximized.

Analyst Recommendations

According to investment analysts, most of them agreed that the minority shareholders should accept the offer from Khazanah Nasional.

The report from the analysts are shown below for your consumption.

#	Research House	Research Title	Recommendation	Selected Quotes
1	AllianceDBS by Alliance Investment Bank (click here to read)	Time To Say Goodbye	Accept Offer	“Khazanah intends to execute a restructuring plan for MAS post-delisting. Substantial amount of capital will need to be injected for this purpose. Hence, the entry of a strategic partner cannot be ruled out.” “As part of the restructuring, we expect MAS to realign/downsize its network and withdraw from unprofitable routes. This would remove the excess capacity within the industry, and bring yields to more sustainable levels, while benefiting the other domestic airlines (AirAsia, AAX).”
2	RHB Research by RHB Investment Bank (click here to read)	Exit The Turbulent  Flight	Accept Offer	“This gives minorities an opportunity to exit MAS at a slight premium, which is a preferred scenario vs bankruptcy.” “Khazanah believes the proposed privatisation would give it more flexibility to execute the restructuring plan and put in place an appropriate capital structure” “We expect MAS to be relisted once a sustainable turnaround is made.”
3	AmResearch by AmInvestment Bank (click here to read)	To claw back some, or to commit more?	Accept Offer	“We think there is a fair chance for the proposal’s success. Firstly, minority shareholding in MAS is well distributed.” “Secondly, the deal values MAS at a decent FY14F PBV of 1.6x.” “Thirdly, the offer is at the highest end of consensus’ fair value range of RM0.10 / share - RM0.27 / share (mean: RM0.18 / share).” “In essence, investors face the decision whether to take back some of what has been sunk into MAS, which admittedly is quite painful, or otherwise, commit more and risk losing some or all of that too, which can be equally or even more painful judging by the absence of success in the countless restructuring plans (and cash calls) at MAS over the past decade”
4	MIDF Research by MIDF Amanah Investment Bank (click here to read)	Privatisation to pave the way for restructuring	Accept Offer	“We see the SCR exercise as a good opportunity for shareholders to exit the stock. Based on our estimates, we expect MAS’ airline operations to remain loss-making over the next few years premised on the current weak yield environment and high jet fuel price.”
5	Maybank IB Research by Maybank Investment Bank (click here to read)	Khazanah Privatisation Offer	Accept Offer	“We opine that the offer price of MYR0.27 is fair and is a good exit price for shareholders. We expect MAS‟ upcoming 2Q14 results to be the weakest ever due to the triple impact of: i) a seasonally weakest quarter, for 2Q; ii) the industry continues to be plagued by very weak yields stemming from oversupply and muted demand; and iii) flight cancellations at MAS (76) to date, from China to Sabah) which will weigh on fixed overheads.” “Assuming there was no privatisation offer, our target price for MAS is MYR0.125 which is based on 1.0x FY15 P/BV. Even then, we assume a capital raising is necessary in order for MAS to sustain operations beyond 2015.”
6	HLIB Research by Hong Leong Investment Bank (click here to read)	Privatization on the Table	Accept Offer	“The outlook of MAS is of great concern, given the national airline has been suffering core losses since FY2009. The upcoming 2Q14 performance is expected be the worst, due to the after-effect of MH370 incident (March 2014) in lowering load-factor and passenger yields. The recent MH17 incident (July 2014) has further worsen passenger demand.” “MAS has undergone 3 times of restructuring and fundraising exercises since 2007, which has not yielded turnarounds due to heavy competitions (especially from LCCs), changing market demand, sub-par economy growth, ineffective management and high cost structure.” “Following the privatization, we expect MAS to cut long haul routes, (as MAS can still leverage on Oneworld Alliance) and concentrate on shorter regional and domestic networks, as well as downsize the aircraft fleet and staff number.”

Source: Research Reports

Financial Results

According to one analyst, MAS is currently burning some cash at a rate of RM5 million daily. It currently have some RM3 billion cash, and analyst predicts that it will "wither sooner than many may think".

Let us take a look at its financial performance to date:

• In the first three months of 2014 (1Q14), MAS reported a net loss of RM279 million, its biggest net loss over two years, and its fifth consecutive quarter of losses.
• Last year (FY13), MAS registered a staggering net loss of RM1.17 billion.

The following is the financial performance of MAS in the past five years:

Source: Annual Report 2013

Now, let us take a look at the route revenue and overall load factor. The route revenue is the income that MAS obtained for flying to a particular destination in a particular region, while the load factor measures the capacity utilization of the airline (the number of people it flies to a particular destination):

Source: Annual Report 2013

Many analysts have opined that MAS should cut unprofitable route, and only fly to destination that would rake significant profits. Further analysis on this need to be done in order to appreciate the issue in further depth. Percentage wise, the chart below will explain further:

Source: Annual Report 2013

As for the upcoming financial results,  which will be announced soon, Maybank IB Research Mohshin Aziz told The Star that:

the results will be awful perhaps the worst in its history. When that happens, it will definitely spook every-one and evaporate any hope for a revised offer.

Such a strong-worded statement from an analyst must not be taken with a pinch of salt, let alone a belacan, but it must be treated with the highest amount of care and concern!

My Opinion

I do not have any shares in MAS, therefore my opinion is free from being biased.

However, I do want to see MAS return to the black (meaning, return to profitability). There will be hurdles, and yes, it will take some time for them to achieve the results that they so desire.

But along the way, I suggest the following (basic and drastic!) steps to be taken:-

1. Remove and replace all senior management team, including the CEO, SVP and VP. With all due respect, the time has come for them to either retire or find another job, and let a fresh team to execute a plan. Especially for the post of a CEO. You have to find the person with necessary experiences in the airline industry. Managing airline is not the same as managing some factory, utility or a bank. It requires deeper understanding of the aviation industry. And the senior leadership team should be given a contract of 5-years as returning to profitability for a company of the size of MAS, in my opinion, will not be able to achieve profitability in the next one or two years. It will take time, and five years is a good time.
2. Reduce manpower. That being said, it is inevitable that manpower must be reduced. As at Dec 31, 2013, MAS has some 19,577 employees. Compare this with AirAsia, they have around 10,000 employees. It was also reported that currently, human resources chalk about 14% to 15% of MAS's total costs. That is quite a significant value. And furthermore, it was reported that MAS intend to cut its employee salaries by 30%. I think that is the right thing to do, besides reducing their manpower. If a company is profitable, then it can be translated into fat bonuses, and should be run to the red, then some sort of measures must be taken–the last which, if ever necessary, is to cut the salary of the employees, with the CEO's remuneration to be slashed the highest. I understand that the unison will totally disagree with this, but in order to be healthy, you need to go through some pain. Likewise, in order to see colourful rainbow, you need to face the rain, and in order for a mother to see a beautiful baby, it must go through the period of conceive. The reduction of manpower should be given via separation scheme, and not simply through random firing. 
3. Come up with a 5-year transformation plan. The new team must engage consultants or establish their own "lab program", much like PEMANDU, and draw a 5-year strategic plan. The plan, if deem fit, can be presented to the media. Hopefully, with this plan, MAS would return to profitability.

With all the arguments presented above, I urge all minority shareholders to accept the offer from Khazanah Nasional amounting to 27 sen per share.

And to Khazanah Nasional, I wish you all the best in your endeavor to bring the prestigious airline back to its former glory days!