Resumption of travel: What beckons for Singapore Airlines?

[Disclosure: As at time of writing, I do not currently hold any position in SIA, and have no intention to establish a position in the same. I do, however, hold a position in SIA Engineering Company (SIAEC), which is a majority-owned subsidiary of SIA.]

With Singapore announcing reopening of borders with minimal restrictions for vaccinated travellers starting 31 Mar 2022, things are finally looking meaningfully better for travel, including air travel and SIA.

An article in ST on 1 April 2022 discussing SIA, SIAEC and SATS [link; subscription required] compelled me to dust off my thinking cap/analytical lenses, to revisit my previous views regarding holding SIA stock. I last wrote about SIA in May 2021 [link], building on two earlier posts from May 2020 [1] [2].

In a nutshell, my earlier view remains unchanged: the long-term outlook for SIA shareholders is dismal. Shareholders may think that the upcoming resurgence of SIA as a company necessarily bodes well for them as a shareholder; I detail below how this is a dangerous belief. A sizeable proportion of  SIA shareholders may not fully understand the implications of the 2020 and 2021 MCBs.

Recap: 2020 and 2021 Rights Issues

To briefly recap:

• In 2020, SIA raised a combined S$8.8b, from a concurrent issue of Rights Shares ($5.3b) and issue of Rights MCBs ($3.5b). 
• In 2021, SIA raised a further S$6.2b from an additional issue of Rights MCBs.
• More information on both rights issues, including regulatory documentation, can be found on SIA's investor relations website [link]. 

The 2020 Rights Shares issue is done and dusted, having already resulted in the increase of total shares outstanding, from 1.185 billion pre-Covid to 2.963 billion post-issue. In the rest of this post, I focus on the MCBs issued in 2020 and 2021.

[extra detail: If we take the average SIA closing price from 1 Jan 2019 to 31 Dec 2019 as a proxy for SIA's pre-Covid market cap, we get $9.38 * 1.185 billion shares outstanding = S$11.12 billion. Based on the 1 Apr 2022 SIA closing price of $5.49 * 2.963 billion shares outstanding = S$16.27 billion. Perplexed? Don't be. Bear in mind that SIA raised $9.7b from the 2020 and 2021 MCBs.]

As mentioned in my May 2021 post:

• If the 2020 MCBs are converted in 2030, this will lead to 1.3 billion more shares outstanding (total 4.26 bil shares)
• If the 2021 MCBs are converted in 2031, this will lead to 2.3 billion more shares outstanding (total 6.56 bil shares)

Basically, if SIA does not redeem the two tranches of MCB early, all existing shareholders will see their shareholdings dilute by half when 2031 comes around. This is spelled out very clearly in SIA's 3QFY2021/22 financial results [link], where NAV per share is $7.45 while adjusted NAV per share, which assumes the conversion of all MCBs and convertible bonds, is $3.35. 

In Search of (more than) Ten Billion Dollars

The ST article quotes UOBKH analyst Roy Chen as follows: "We believe MCBs have to be redeemed (and better early than late), before the earnings recovery can deliver meaningful value accretion to SIA's shareholders." Read the quoted sentence very carefully. Notably, the analyst did not weigh in on whether he thinks the MCBs could be redeemed early, only stating that the MCBs ideally should be redeemed early. 

To redeem the MCBs early, i.e. before 2030/2031, SIA needs to find $9.7 billion plus some more spare change for coupon payments it would owe the bondholders. For simplicity sake, let's just say SIA needs to find $10 billion by 2030 (it's actually more, though the precise amount will depend on the effective date on which SIA redeems the MCBs, if it does so). Where could this $10 billion come from?

Let's look at past operating profit and net income (figures from SIA financial statements):

• FY2017/18 net income of $1.345 bil, on operating profit of $1.593 bil 
• FY2018/19 net income of $0.722 bil, on operating profit of $1.067 bil 
• FY2019/20 net loss of $0.169 bil, on operating profit of $0.059 bil 
• FY2020/21 net loss of $4.283 bil, on operating loss of $2.513 bil

FY2021/22 results should be out shortly, given that 4Q just ended on 31 March 2022. I have not been following the 1Q-3Q financial results very closely, so I'm just going to make some broad-brush estimates for net income/loss going forward:

• (following expected ranges are my ballpark personal estimates, if I have time I might do a thorough analysis and refine this figures in a follow-up post. UPDATE: I've created an analysis model on Google Sheets here)
• FY2021/22 net loss of between $0.75 to $1.25 bil 
• FY2022/23 net loss of between $0.00 to $0.50 bil 
• FY2023/24 net income of between $0.00 to $0.50 bil
• Thereafter, for each of the seven FYs from FY2024/25 to FY2030/31 net income in the range of $1 to $1.25 bil per FY (i.e., similar to pre-Covid or better)

Work out the sums, and you'll see that even under a best-case scenario, SIA won't generate $10b of cumulative net income by the end of FY2030/31. Assuming that SIA management makes financially rational decisions and channels earnings towards reducing the MCB burden before any dividends are paid, this means that SIA shareholders should have zero expectations of receiving any dividends until 2031, or whenever the MCBs are redeemed, whichever is earlier.

Possible out-of-the-box options

Having seen that net income alone is almost certainly unable to make up for the $10 billion needed, I tried to brainstorm out-of-the-box ideas that might allow SIA to redeem the MCBs prior to the conversion date of the two MCB tranches.

Option A - Divest SIAEC to raise money. SIA is a majority shareholder of SIAEC, owning around 77% of the latter. If SIA can find a suitable buyer for SIAEC who is willing to pay a premium, say 20% to SIAEC's closing price on 1 Apr 2022 ($2.56 * 120% = $3.072), it may raise around $2.65 bil. The trade-off is that, if SIAEC is net income positive, then such a divestment would reduce the net income of SIA Group by the amount attributable to SIAEC. Divestment may be attractive if the offer price were rich enough, though it remains to be seen whether such a decision would be strategically sound.

Option B - Further issuance of bonds before 2030/2031. In Jan 2022, SIA raised US$600 mil via a USD bond issue with 3.493% yield. If SIA is able to raise funds via further bond issues, it may be able to pay off the MCBs before the MCBs are due for conversion. This would only make sense for SIA if the new bonds are issued with a lower coupon than the MCBs. Given that the MCBs were issued with 4% p.a. (first four years), 5% p.a. (fifth to seventh year), and 6%  p.a. (eighth year onwards) coupons, I believe it is highly unlikely that this option will prove feasible. We are entering into a rising interest rate environment, so any new bonds are going to have to yield higher than the 3.493% of the Jan 2022 issue.

So far, these are the only two options I can think of. For now, I would rate likelihoods as follows (although in reality, these 3 are not necessary mutually-exclusive, so I may refine this at some point):

• Conversion of MCBs come 2030/2031: 80% likelihood
• Option A - Divest SIAEC before 2030/2031: 15% likelihood
• Option B - Issue bonds specifically intended to redeem MCBs: 5% likelihood

If I come across more possibilities that could allow for SIA to redeem the MCBs early, I might update this accordingly. At this time, these are all I can think of that could be on the table, and things do not look rosy for SIA shareholders come 2030/2031.

In Summary

The MCBs issued in 2020 and 2021 continue to loom over SIA shareholders. The financial numbers paint a bleak picture for anyone hoping for early redemption of those MCBs in order to avert massive shareholder dilution come 2030/2031. 

Arguably, the only SIA shareholder who would emerge unscathed from conversion of the MCBs would be Temasek, given that it mopped up all unsubscribed Rights MCBs for both tranches, and is thus immunized against the dilution by virtue of possessing a disproportionately large amount of MCBs. 

Minority SIA shareholders who remain sanguine about their positions in the longer-term likely assume that SIA's forward prospects as a company - certainly improved given the reopening and gradual resumption of travel - correlate directly with their future returns as a shareholder. These shareholders likely either fail to recognise how the complex financialization introduced with the MCBs will very likely translate into significant dilution of their shareholdings in less than a decade, or fail to appreciate that the remaining time window until 2030/2031 provides SIA with insufficient runway to generate sufficient earnings to fully redeem the $9.7b worth of MCB principal, plus accrued coupons. 

Existing SIA shareholders might do well to take time to fully comprehend the implications of the MCBs and to assess against their own investment thesis, lest they unintentionally find themselves holding the bag if (or, in my view, when) the MCBs are converted come 2030/2031.