This article first appeared in The Edge Malaysia Weekly on March 27, 2023 - April 2, 2023

AIRASIA X Bhd’s (AAX) share price has more than doubled year to date.

The aviation player, which is in the process of mapping out its regularisation plan for the April 28 submission deadline, saw its stock price soar to RM1.68 on March 17 — the highest since August 2019. However, it had descended to RM1.20 last Friday.

The regularisation plan is crucial as it is supposed to lift not just AAX, but also its sister company Capital A Bhd — which operates short-haul, low-cost airline AirAsia — out of Practice Note 17 status. It is widely known that the regularisation plan involves Capital A injecting its aviation business into AAX via an issue of shares.

AirAsia co-founder and Capital A CEO Tan Sri Tony Fernandes has insisted that the exercise is not a merger of the two airlines but merely putting AirAsia under AAX’s listing status.

The recent share price rally has prompted the investing fraternity to wonder about the price that AAX will pay for AirAsia.

Since the previously grounded aircraft are back in the skies, even though the number of flights is not back to pre-pandemic levels yet, analysts say Fernandes may now have more chips in hand to negotiate with.

On the other hand, AAX shares need to be fairly valued too. Otherwise, the minority shareholders will suffer excessive dilution.

The two companies have common shareholders.  The two co-founders of AirAsia, Fernandes and Datuk Kamarudin Meranun, own 24.64% of Capital A through their private vehicles, Tune Live Sdn Bhd and Tune Air Sdn Bhd. Well-known Hong Kong poker player Stanley Choi Chiu Fai holds a 7.99% stake in Capital A through Positive Boom Ltd.

Kamarudin is the largest shareholder of AAX, with a direct stake of 8.94%, while Fernandes held a direct stake of 2.69% as at Oct 11, 2021. In addition, the duo control a collective indirect stake of 31.59% in AAX through Tune Group Bhd and AirAsia Bhd.

It is learnt that goodwill is one of the main items determining the valuation of AirAsia.

“One could value it [goodwill] based on its earnings potential in the near term, say, one or two years. Since the business is getting better now and it will make some profit, then give it an arbitrary historical price-earnings ratio [PER], for example 10 times,” says a foreign fund manager.

“The true value of a business is the cash flow that it can generate, minus the debts,” he points out.

Nevertheless, he notes that the scenario has changed rather drastically after the pandemic. For instance, Capital A currently has a shareholder equity deficit of RM9.42 billion — a huge sum that will substantially affect the valuation.

So far, Capital A shareholders have yet to recapitalise the company. Meanwhile, AAX has cleaned up its balance sheet as its creditors took a massive haircut.

Some quarters say goodwill accounting is subjective, especially an amount based on estimated future earnings.

Maybank Investment Bank analyst Samuel Yin values Capital A’s short-haul business at RM4.4 billion, or 80 sen per share, based on a forward PER (FY2024) of eight times. This is higher than the company’s current market capitalisation of RM3.08 billion, based on its latest share price of 74 sen.

Yin says AirAsia group “has the recipe” to to deliver, while keeping the low-cost, long-haul model viable.

“Jet fuel may be high, but so are fares. Also, aircraft lease rates are very cheap now relative to pre-Covid. [The lease rate for] widebody aircraft is up to 70% lower. Plus, Malaysia Airlines is not aggressively rebuilding capacity. The whole dynamic for long haul has changed,” he tells The Edge.

“After the restructuring, after getting rid of the negative shareholders’ equity and delivering at least two profitable quarters, interest in the stock will return.”

However, others point out that lease rates could increase against the growing competition in the long run and the low-cost, long-haul business will be tested again.

Capital A’s 2021 annual report shows that its aviation business is booked at almost half a billion ringgit for the intangible value of its landing rights in its books. As at Dec 31, 2021, the company’s intangible assets totalled RM833.45 million, including goodwill, landing rights and developed software.

Landing rights, which relate to traffic rights and landing slots for destinations operated by Indonesian Air Asia and Philippine Air Asia, make up the bulk of its intangible assets at RM443.9 million. The shelf life of these landing rights is estimated to be indefinite.

An analyst with Endau Analytics says the methodology used to value landing rights and slots varies in different jurisdictions. While most analysts contacted by The Edge do not include intangible assets in their valuations, there are instances in other parts of the world where landing slots are sold at a premium and used as collateral.

One example was in 2015, when Virgin Atlantic Airways secured a £220 million secure note transaction using the airline’s take-off and landing slots at London’s Heathrow Airport. Virgin Atlantic managed to fetch that price simply because the slots are at Heathrow Airport — one of the busiest in the world.

“In valuing Capital A, one needs to consider not only the numbers but also the company’s influence in Malaysia, where it is key to the country’s tourism sector. Pre-pandemic, AirAsia brought the most tourists to Malaysia compared with other airlines,” says the Endau analyst.

He adds that Capital A remains the region’s dominant low-cost carrier and will stay in this position for the foreseeable future as it has the first-mover advantage, being the first discount carrier in Southeast Asia.

“The Tony Fernandes factor must be considered when valuing the company, as the airline is practically toothless without him. As are the brand, reputation, slots and its small number of, but very productive, employees,” he says.

“AirAsia X and Capital A have the same DNA and, ultimately, the same ‘conductor’ in Tony Fernandes. Capital A is undervalued as the markets have yet to fully absorb the impact of Covid-19 on airlines’ equity.

“Conversely, the recent surge in AirAsia X’s share price is interesting and does not, in our view, reflect the reality of the low-cost, long-haul airline model. Investors may need to reassess their portfolios and do a deeper dive into the fundamentals governing the airline industry.”

Capital A and AAX grounded most of their fleets during the pandemic, resulting in accumulated losses that eventually eroded their shareholders’ equity, triggering the PN17 status.

The deadline to submit a regularisation plan to rectify its status is drawing near for AAX. It has until April 28 to submit its proposed regularisation plan to exit PN17 status. Capital A’s submission deadline is in July.

It is challenging to sustain profits and positive free cash flow in the airline industry, which is vulnerable to global market dynamics ranging from wars to fuel prices, weather phenomena, natural disasters and pandemics.

Some quarters view that enterprise value (EV) to earnings before interest, taxes, depreciation and amortisation (Ebitda) is a more suitable method to value airlines post-pandemic, as many carriers have undergone restructuring during the tumultuous period.

Capital A’s EV is estimated at RM16.88 billion while its Ebitda is RM1.4 billion, implying a ratio of about 12 times. For comparison, Singapore Airlines has an EV/Ebitda of 6.75 times, while US-based Southwest Airlines and United Airlines have ratios of 14.1 times and 13.7 times respectively.

While not all airlines can take advantage of the post-Covid recovery, analysts say AirAsia stands out among its peers for having the lowest unit cost in the world for many years now, giving it room to offer the lowest fares and squeeze out its competitors with volume. AAX and Capital A’s cost per available seat kilometre (CASK) are 13 sen and 28 sen respectively.

During the announcement of its latest quarterly results, AAX officials pointed out that fare trends are hovering above pre-pandemic levels, although with some rationalisation on the back of high demand for international air travel.

Capital A’s revenue per available seat kilometre (RASK) was 21 sen in FY2022, up from 17 sen a year earlier, due to higher ancillary revenue, average fare growth and passengers carried. AAX’s RASK was 13 sen.

RASK is considered more encompassing than total revenue because it factors in all operating income in terms of capacity, rather than just passenger revenue.

While the divestment of its airline business to AAX will leave Capital A with only its digital businesses, AAX will need to absorb the liabilities of Capital A’s aviation business and upcoming operational expenditure, such as the leases for the planes.

The combination of two carriers under one entity may have few synergies, but the exercise may help to support the low-cost, long-haul model.

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