SATS could become the world's largest air cargo handler. Why is its share price down?

TL;DR

• SATS has announced the proposed acquisition of Worldwide Flight Services (WFS) for a purchase price of €1.177 billion (about S$1.6 billion).
• WFS is the world’s largest air cargo handler with its footprint largely focused on America and Europe. SATS believes that the acquisition would be complementary to its current exposure largely in Asia, and create a global leader in the aviation sector. 
• The transaction is expected to be immediately financially accretive, raising SATS’ earnings per share by 78%. However, it will have to be funded by an equity fundraising of S$1.7 billion, including a rights issue to shareholders. 
• Investors have not taken well to the transaction, likely due to the equity raising as well as timing of the acquisition with a recession looming in Europe. 

What happened?

Last week, Bloomberg reported that SATS was in talks to acquire air cargo handler Worldwide Flight Services in a deal that could be worth as much as US$3 billion.

SATS had put out an announcement then that it is constantly on the look out for acquisition opportunities. However, there is no certainty that a deal could be struck.

One week later on 28 September, SATS went on a trading halt and announced that it would be acquiring Worldwide Flight Services for a purchase price of €1.177 billion (about S$1.6 billion).

The acquisition could potentially transform SATS into a global leader in the aviation sector. Let’s take a further look at this transaction to see if it could be a game changer for SATS. 

4 things you need to know about the acquisition

#1 - WFS is world’s largest air cargo handler

If you have never heard of WFS, it is the largest air cargo handler in the world.

With 6.3 million tonnes of cargo handled, WFS generated EUR 1.72 billion (S$2.6 billion) of revenue for the 12 months ended 31 March 2022. 

Its network of cargo stations is largely in North America, which represents 59% of its footprint. Europe, Middle East & Africa (EMEA) would make up another 34% of its footprint. 

WFS operates in five of the top 10 cargo airports in North America and EMEA, including Los Angeles, Chicago, Miami, Frankfurt and Paris.

Its exposure to Asia is relatively small at about 3%. However, it has set up foundation positions in new growth markets in Latin America and India.  

#2 - Acquisition would propel SATS to be world’s largest baggage handler

SATS is currently present in four of the top 10 cargo airports in Asia, including Hong Kong, Taipei, Singapore and Beijing. 

Combining this with WFS’ complementary footprint across Americas and Europe, SATS believes that it will have an unmatched ability to service customers on a global scale. 

SATS also believes that the acquisition would lead to more resilience in its earnings, as it is more diversified across geographies. 

From having 85% of its revenue generated from Singapore currently, SATS is targeting that Americas and EMEA would make up the bulk of its revenue (55%) in the mid term.

Asia would still be fair sizeable, making up 45% of target revenue mix.  

#3 Transaction is financially accretive

One thing that really stood out, is that WFS is currently much larger than SATS based on its scale and revenue. 

With the acquisition, SATS revenue could see a step change in its revenue from S$1.2 billion to S$3.8 billion based on FY2022 figures. 

Likewise, its EBITDA could increase 5x from S$94 million to S$445 million on an adjusted basis. 

As a result, the transaction is expected to be immediately financially accretive, raising SATS’ earnings per share by 78% from 1.8 Singapore cents as reported in FY2022 to 3.2 cents on a pro forma basis. 

Through various initiatives such as cross selling and network expansion, the combined entity could generate further synergies amounting to more than S$100 million of earnings before interest, depreciation and amortization (EBITDA) in the medium term. 

Also, a continued strong recovery in travel related businesses could also drive additional earnings upside from the transaction. 

#4 Large equity offering to fund the acquisition

The transaction would be funded through S$1.7 billion of equity fundraising and S$120 million of cash. 

The S$1.7 billion of equity fundraising would comprise of a rights issue to shareholders, as well as a private placement of common or hybrid equity to institutional and/or strategic investors. 

With this funding plan, SATS gearing ratio as measured by debt to equity would increase from 46% to 71%. 

Management of SATS has mentioned that they remain committed to prudent balance sheet management. 

The transaction requires shareholder approval, and SATS will convene an extraordinary general meeting by early 2023.

Temasek, which owns about 40% of SATS, has agreed to vote in favour of the proposed acquisition. 

There are other conditions that would need to be met, including clearing the regulators. 

If all goes well, the transaction is expected to close by end-March 2023. 

What would Beansprout do?

SATS’ share price has not recovered much this year despite the significant rebound in global air travel and increasing tourist arrivals into Singapore. 

One of the reasons is due to the higher costs it is incurring that is eating into its margins. 

It seems that investors do not really like the proposed acquisition of WFS as well. Since news of the potential transaction was reported by Bloomberg, its share price has fallen by more than 5%. 

Part of the reason might be concerns of the large equity raising exercise it has to undertake to fund the acquisition. 

There will probably also be questions about the timing of the acquisition, given the worries about a global recession and slowing activity particularly in Europe.  

On a more positive note, the transaction could potentially be a game changer for SATS if it is able to execute well and deliver on the synergies. 

Over the long term, investors of SATS might not just be buying into a gateway into Asia’s aviation services, but a global leader in air cargo handling. 

If you are looking for stocks that will benefit from the global travel recovery, do find out more about the companies that could gain from Hong Kong's re-opening.