Commentary: SATS and WFS – short-term pain, long-term gains

Date: January 16, 2023

When a company announces a significantly large purchase that requires a rights issue to help raise the money to pay for the deal, the market’s knee-jerk reaction is usually to sell the shares, even if what is on the table holds long-term promise for the company.

The prevailing logic for selling is twofold: first, the rights issue is immediately dilutive, and second, shareholders do not like the idea of having to fork out cash for an acquisition whose benefits may take many months or even years to bear fruit.

Then, after the market has had a suitable “cooling off’’ period to digest the pros and cons of the proposal – a process that typically takes several weeks – the shares sometimes begin to creep upwards, possibly as investors with a longer-term lens replace those with a shorter-term investment horizon.

Such has been the case with many large-scale rights issues announced during the past two years – for example, those announced by Singapore Airlines and Sembcorp Marine. For both companies, their stock prices have recovered considerable ground from where they bottomed after weeks of selling.

The latest example comes from airline caterer and ground handler SATS, which on 28 September last year announced its intention to buy the world’s largest air cargo handling firm Worldwide Flight Services (WFS) for approximately €1,313 million (approximately equivalent to S$1,820 million).

On the day after the announcement, SATS’ shares dropped by as much as $0.91 or 23.5% before closing the day at $3.07 from $3.87 before the announcement. By the end of the week, the share price had crashed 22.2% or S$0.86 to S$3.01, with the slide continuing for the next six weeks. The price double dipped to S$2.54 in the last week of October and in the second week of November before rebounding by a hefty S$0.30 or almost 12% to S$2.89 now.

Even though the price is still considerably 27% below its pre-announcement levels, the interesting question to ponder is this: is the market slowly beginning to recognise the merits of the purchase? If so, should shareholders who attend the extraordinary general meeting later this month to vote on the WFS acquisition, give their approval? On the other hand, shareholders have to juxtapose the WFS acquisition and the anticipated recovery of SATS’ business in China as the country shifts away from a zero-COVID policy.

In November 2022 and January 2023, SIAS organised two hybrid dialogues between SATS shareholders and senior management to clear the air over the WFS purchase and to assist shareholders in making an informed decision when voting. What follows is an encapsulated version of these sessions that saw SATS present a scenario that can best be summarised as “short-term pain but long-term gain’’.

What if another pandemic were to strike?

The crux of the issue is this: is it good enough for a Singapore-based company with a very small domestic market to be just another player in the Asian cargo market, or should it have loftier ambitions and aim for a global footprint?

In answering this question, SATS’ management have taken into account a factor which three years ago did not exist in anyone’s minds – the possibility of another pandemic which, if it results in yet another shutdown of all countries, would once again drag SATS into a loss-making position as Covid-19 did, given its heavy reliance on airline catering and ground handling.

Yet throughout Covid, when passenger numbers dropped to zero, air cargo provided the one bright spot, continuing to generate revenue. Many airlines converted passenger aircraft to take on more cargo by removing seats to make space; Singapore Airlines for instance, was known to have even strapped parcels onto passenger seats in a bid to maximise cargo uplift.

Pandemic or not, buying WFS, expands SATS’ reach in cargo handling in one fell swoop to Europe and America, tripling its revenue.  If another pandemic were to strike, the combined entity would stand to benefit significantly by virtue of its significant presence in the major airports across Americas-Europe-APAC. To justify a major acquisition based on the possibility of another pandemic happening may be tenuous although the base case scenario of the WFS acquisition appears fundamentally sound.

With the world facing high inflation, rising interest rates and a possible recession in 2023, does the acquisition make sense?

This issue was raised at the November dialogue session and the reply from SATS’ CEO Kerry Mok was essentially that it is precisely the uncertain economic outlook that enabled the company to secure a lower price for WFS than that which was originally asked.

“We are not paying top valuation, neither are we paying the lowest’’ he said. “The price is within range’’. Despite management’s assurance, shareholders still question WFS’ profitability which was significantly boosted during the pandemic.

According to proxy advisory firm Glass Lewis which recommends shareholders approve the deal, the transaction has a last 12-month (LTM) earnings before interest, tax, depreciation and amortisation (EBITDA) multiple of 12 times and an adjusted EBITDA multiple of 11.1.

Its own assessment of 14 completed transactions announced since 2018 in the airport services or air freight industries found that the deal’s LTM EBITDA and adjusted EBITDA multiples ranked in the 55th and 52nd percentile respectively.

Will there be managerial continuity to ensure seamless integration of WFS into SATS’’ operations?

This was asked multiple times at the November’ 22 and January’ 23 sessions and the answer given was that the key members of WFS’ management team have indicated their commitment to continue working with WFS after the acquisition and appropriate retention plans will be put in place to support their retention.  SATS plans to give the integration process 12-18 months, sufficient time for both companies to learn about each other.

As stated in the original release “WFS will become a wholly owned subsidiary of SATS after the proposed acquisition and will continue to be led by Chief Executive Officer Craig Smyth, alongside other key members of the senior WFS management team’’.

It was also learnt at the session that 4 years ago, WFS approached SATS about possible collaborations, which suggests that WFS had already identified SATS as a good strategic fit.

Does the deal make financial sense?

In its 28 Sep 2022 announcement, SATS said the deal is expected to be “immediately financially accretive”, raising its earnings per share (EPS) by 78 per cent from S$0.018 to S$0.032 cents and increasing its net profit on a pro forma basis from S$20m to S$56m for the financial year ended 31 March 2022.

However, SATS in its 3 Jan 2023 circular to shareholders has since revised these figures – EPS rises only to S$0.019 whilst net profit only goes up to S$28m.

SATS has clarified that the downward revision is because the deal will now be partially funded by S$700m in borrowings, which therefore increases the interest expense and reduces the pro forma net profit.

It also noted that the debt load will reduce the cash burden on shareholders as the rights issue will not have to exceed S$800m. The remaining S$320m will come from its cash.

SATS has also disclosed that WFS incurred net losses for the first three quarters of 2022 but has clarified that this was largely due to unrealised foreign exchange losses against its senior secured notes and one-off items.

It has also said through initiatives that include cross-selling, network expansion and deeper eCommerce cargo partnerships, “the combined entity is expected to capture meaningful run-rate EBITDA (earnings before interest, tax, depreciation and amortisation) synergies in excess of S$100m’’.

To summarise, shareholders should weigh the positives surrounding the WFS purchase against the negatives created by major M&A (including a share overhang from the rights issue) when voting on the deal.

They should digest the information in the circular released on the 3 Jan and evaluate SATS’ position that ultimately boils down to having to undergo short-term pain in exchange for longer-term gains.


David Gerald
Founder, President & CEO