21.1 Etihad's Proposed Acquisition of Malaysia Airlines Shuvam Dutta his case study accompanies Chapter 21 of International Corponate Finance. A significant strategic shareholding in Malaysia Airlines (MAS) had become availa- ble in the market. The flag carrier of Malaysia with a fleet of 85 aircraft traveling to 103 destinations worldwide, the airline was trading at an equity value of US$1,316 million as of March 30, 2010 MAS was led by a strong management team with a proven track strategic business resulting in a significant positive turnaround of performance, including Malaysian ringgit (MYR) 2.3 billion in cost savings from 2006 to 2008 and steady record. Over the past few years, the management had undertaken a revenue growth from MYR 9 billion in 2006 to MYR 15 billion in 2008. Erihad Airlines was a Middle Eastern carrier looking to extend its route network beyond its hub in Dubai, and it hoped to gain access to lucrative routes to Singapore, Hong Kong, and Australia. Etihad's bankers at Standard Chartered advised them to consider a 20 to 25 percent investment stake in MAS, hand in glove with an operat- ing alliance. Erihad Airways was established as the flag carrier of the United Arab Emirates in July 2003 by royal decree with an initial paid-up capital of United Arab Emirates dirham (AED) 500 million provided by the Abu Dhabi Investment Authority. As of January 2010, the airline operated passenger and cargo services to 85 destinations around the world from its home base in Abu Dhabi Malaysia Airlines is partially privatized with Khazana Nasional, the Malaysian sovereign wealth fund, holding a residual equity stake in the airline. Malaysia Air- lines operates flights in Southeast Asia, East Asia, South Asia, Middle East, and on the Kangaroo Route between Europe and Australasia. It operates transpacific flights from Kuala Lumpur to Los Angeles via Tokyo. I flies to 87 destinations in over six agreements with American Air- continents. Malaysia Airlines has existing code share lines, Cathay Pacific, and Japan Airlines, among others. eign exchange rate fluctuations because of its foreign the As an international airline, Malaysia Airlines was exposed to the effects of for- operat- ing revenues and expenses. Its largest exposures were to the U.S. dollar, followed by y 58 per- cent of the airline's sales and almost 65 percent of the airline's costs are denominated in foreign currencies. The airline's trade receivables and trade payables balances had euro, British pound, Japanese yen, and Australian dollar. CASE STUDY similar exposures. The airline was also exposed to fuel price volatility, partially miti- gated by entering into jet fuel hedges. The bankers articulated several strategic benefits arising from the potential acqui- sition. The transaction would ensure major presences in two of the highest-growing air traffic regions in the world (Asia and the Middle East) and allow Etihad to lever- age consistently growing tourism and trade between Asia and the Middle East. The network-30 out of 56 unique MAS destinations in Asia did not overlap with Erihad's routes. Impor- acquisition would grant Erihad access to a tantly, it would give Erihad an opportunity to significantly strengthen its on the important Kangaroo Route (London/Dubai to Sydney via Kuala re). Last, it would create a politically appealing alliance between two Islamic nations' flag carriers. Erihad's management asked its bankers to value the target based on trading and transaction comparables, Based on a current share price of US$0.64, MAS was trading at an equity value of USS1,316 million, which was at the lower end of 12-month trading range between US$1,092 million and US$2,074 million-an at- tractive entry price. On the other hand, research analysts were suggesting that prices could fall further, reducing equity value to as low as US$910 million, which made the current price less attractive than it seemed initially. However, based on comparable trading multiples, the airline was undervalued relative to its Southeast Asian peers, which were trading on higher multiples based on their enterprise value/EBITDA ra- tios in 2010 and 2011. Market indicators, though, often do not serve as the best indicators for successful bid prices, as airline mergers and acquisitions (M&A) trans- actions in Asia cleared the market at significant premiums to traded value-reflect- ing high investor interest in the market, acquisition synergies, and control premiums. Thus, if precedent transactions were an indicator, the target could be valued at over twice its current market value. (See Case Exhibit 21.1.) Erihad's management now wanted to embark on a more detailed due of the airline, culminating in a discounted cash-flow valuation of the airline based on the projected financials shown in Case Exhibit 21.2. Malaysia Airlines was trading at a levered beta of 1.06, with a market risk premium of 9.38 percent above a risk rate of 3.68 percent. Its cost of debt based on outstanding bonds, loans, and leases was 3.09 percent. Etihad on the other hand was trading at a cost of equity of 10.5 and a cost of debt of 2.4 percent. Based on these assumptions and the cash-flow projec- tions provided in Case Exhibit 21.2, the deal team proceeded to value the acquisition. Current Equity Value: Last 12 Month Price Rae,0917 2.074.2 Analyst Target Prices 09.8 Southeast Asian Peers 2010E 1.8978 1,000 2,000 3,000 4,000 5,000 CASE EXHIBIT 21.1 Precedent Transactions CASE EXHIBIT 212 Historical and Projected Financials for Malaysia Airlines Historical Financials Projected Financials In Millions of MYR) Profit&Loss 2007A 2008A 2009A 2010E 2011E 2012E 2014E 14,630.215,0353 1130992,9717 14,038.55,192.1 16,439.317,787.6 15,345,5 4,763.0 1,775.8 8,806.8 4,217.9 2,442.1 1,996.7 Operation expenses -Fuel cost -Depreciation 4,031914,855.2 4,915.8 2,082.5 6 12,473.82,591.4 4,335.1 13,620.2 144428 153 4,509,8 1,588.6 4,330.0 4,619.9 1,683.7 7,521.78,139.2 3,680.1 1,996.4 1,554.2 1,890.8 1,846.7 Others EBITDA EBIT 6,950.6 2,24922,752.8 1,447.2 1,145.1 6,422.4 2,680.8 2,070.9 1,290.0 3,160,5 598.3 (556.7) 244.3 1,193.9 Balance sheer Gross debt inc ludes off- balance-sheet debt Net debt includes off 8,256.2 8,938.2 7,3902 6.081.0 7,898.5 0,157,5 10,318.9 9,681.5 4,725.4 2,664.9 4,133.5 94753236.4 6,764.98,594.8 1107.0 572.3 11440.3 4,662.1 ,774.9 4,539.2 4,382.6 2,210.0 9,984.0 9,457.7 17,458.5 7,590.8 13,598.31,983.3 15,362.0 19,264.52467.723,356.2 Total assets Shareholders' equity (excluding MI) Cash flow Cash flow from ope rating activities Cash flow from investing actiities Cash flow from financing activities 4,185.7 735.7 3.0 2058.1 2520 4,806.2 6,802.8 4,108.5 939.3 925.6 2,606.9 2951.1 3,421.6 3,973.0 2,245.22,922.6 ,3061,693.2 2,942.4 4,480.2 2,230 1,747.1) 489.6 862.5 2,675.2 205.6 (5 34.1 CASE STUDY QUESTIONS FOR DISCUSSION 1. What is a fair value for MAS as a stand-alone firm? 2. What would be the synergistic benefits for Etihad of acquiring a strategic minor- ity stake in Malaysia Airlines? 3. How much should Etihad bid for MAS shares? 21.1 Etihad's Proposed Acquisition of Malaysia Airlines Shuvam Dutta his case study accompanies Chapter 21 of International Corponate Finance. A significant strategic shareholding in Malaysia Airlines (MAS) had become availa- ble in the market. The flag carrier of Malaysia with a fleet of 85 aircraft traveling to 103 destinations worldwide, the airline was trading at an equity value of US$1,316 million as of March 30, 2010 MAS was led by a strong management team with a proven track strategic business resulting in a significant positive turnaround of performance, including Malaysian ringgit (MYR) 2.3 billion in cost savings from 2006 to 2008 and steady record. Over the past few years, the management had undertaken a revenue growth from MYR 9 billion in 2006 to MYR 15 billion in 2008. Erihad Airlines was a Middle Eastern carrier looking to extend its route network beyond its hub in Dubai, and it hoped to gain access to lucrative routes to Singapore, Hong Kong, and Australia. Etihad's bankers at Standard Chartered advised them to consider a 20 to 25 percent investment stake in MAS, hand in glove with an operat- ing alliance. Erihad Airways was established as the flag carrier of the United Arab Emirates in July 2003 by royal decree with an initial paid-up capital of United Arab Emirates dirham (AED) 500 million provided by the Abu Dhabi Investment Authority. As of January 2010, the airline operated passenger and cargo services to 85 destinations around the world from its home base in Abu Dhabi Malaysia Airlines is partially privatized with Khazana Nasional, the Malaysian sovereign wealth fund, holding a residual equity stake in the airline. Malaysia Air- lines operates flights in Southeast Asia, East Asia, South Asia, Middle East, and on the Kangaroo Route between Europe and Australasia. It operates transpacific flights from Kuala Lumpur to Los Angeles via Tokyo. I flies to 87 destinations in over six agreements with American Air- continents. Malaysia Airlines has existing code share lines, Cathay Pacific, and Japan Airlines, among others. eign exchange rate fluctuations because of its foreign the As an international airline, Malaysia Airlines was exposed to the effects of for- operat- ing revenues and expenses. Its largest exposures were to the U.S. dollar, followed by y 58 per- cent of the airline's sales and almost 65 percent of the airline's costs are denominated in foreign currencies. The airline's trade receivables and trade payables balances had euro, British pound, Japanese yen, and Australian dollar. CASE STUDY similar exposures. The airline was also exposed to fuel price volatility, partially miti- gated by entering into jet fuel hedges. The bankers articulated several strategic benefits arising from the potential acqui- sition. The transaction would ensure major presences in two of the highest-growing air traffic regions in the world (Asia and the Middle East) and allow Etihad to lever- age consistently growing tourism and trade between Asia and the Middle East. The network-30 out of 56 unique MAS destinations in Asia did not overlap with Erihad's routes. Impor- acquisition would grant Erihad access to a tantly, it would give Erihad an opportunity to significantly strengthen its on the important Kangaroo Route (London/Dubai to Sydney via Kuala re). Last, it would create a politically appealing alliance between two Islamic nations' flag carriers. Erihad's management asked its bankers to value the target based on trading and transaction comparables, Based on a current share price of US$0.64, MAS was trading at an equity value of USS1,316 million, which was at the lower end of 12-month trading range between US$1,092 million and US$2,074 million-an at- tractive entry price. On the other hand, research analysts were suggesting that prices could fall further, reducing equity value to as low as US$910 million, which made the current price less attractive than it seemed initially. However, based on comparable trading multiples, the airline was undervalued relative to its Southeast Asian peers, which were trading on higher multiples based on their enterprise value/EBITDA ra- tios in 2010 and 2011. Market indicators, though, often do not serve as the best indicators for successful bid prices, as airline mergers and acquisitions (M&A) trans- actions in Asia cleared the market at significant premiums to traded value-reflect- ing high investor interest in the market, acquisition synergies, and control premiums. Thus, if precedent transactions were an indicator, the target could be valued at over twice its current market value. (See Case Exhibit 21.1.) Erihad's management now wanted to embark on a more detailed due of the airline, culminating in a discounted cash-flow valuation of the airline based on the projected financials shown in Case Exhibit 21.2. Malaysia Airlines was trading at a levered beta of 1.06, with a market risk premium of 9.38 percent above a risk rate of 3.68 percent. Its cost of debt based on outstanding bonds, loans, and leases was 3.09 percent. Etihad on the other hand was trading at a cost of equity of 10.5 and a cost of debt of 2.4 percent. Based on these assumptions and the cash-flow projec- tions provided in Case Exhibit 21.2, the deal team proceeded to value the acquisition. Current Equity Value: Last 12 Month Price Rae,0917 2.074.2 Analyst Target Prices 09.8 Southeast Asian Peers 2010E 1.8978 1,000 2,000 3,000 4,000 5,000 CASE EXHIBIT 21.1 Precedent Transactions CASE EXHIBIT 212 Historical and Projected Financials for Malaysia Airlines Historical Financials Projected Financials In Millions of MYR) Profit&Loss 2007A 2008A 2009A 2010E 2011E 2012E 2014E 14,630.215,0353 1130992,9717 14,038.55,192.1 16,439.317,787.6 15,345,5 4,763.0 1,775.8 8,806.8 4,217.9 2,442.1 1,996.7 Operation expenses -Fuel cost -Depreciation 4,031914,855.2 4,915.8 2,082.5 6 12,473.82,591.4 4,335.1 13,620.2 144428 153 4,509,8 1,588.6 4,330.0 4,619.9 1,683.7 7,521.78,139.2 3,680.1 1,996.4 1,554.2 1,890.8 1,846.7 Others EBITDA EBIT 6,950.6 2,24922,752.8 1,447.2 1,145.1 6,422.4 2,680.8 2,070.9 1,290.0 3,160,5 598.3 (556.7) 244.3 1,193.9 Balance sheer Gross debt inc ludes off- balance-sheet debt Net debt includes off 8,256.2 8,938.2 7,3902 6.081.0 7,898.5 0,157,5 10,318.9 9,681.5 4,725.4 2,664.9 4,133.5 94753236.4 6,764.98,594.8 1107.0 572.3 11440.3 4,662.1 ,774.9 4,539.2 4,382.6 2,210.0 9,984.0 9,457.7 17,458.5 7,590.8 13,598.31,983.3 15,362.0 19,264.52467.723,356.2 Total assets Shareholders' equity (excluding MI) Cash flow Cash flow from ope rating activities Cash flow from investing actiities Cash flow from financing activities 4,185.7 735.7 3.0 2058.1 2520 4,806.2 6,802.8 4,108.5 939.3 925.6 2,606.9 2951.1 3,421.6 3,973.0 2,245.22,922.6 ,3061,693.2 2,942.4 4,480.2 2,230 1,747.1) 489.6 862.5 2,675.2 205.6 (5 34.1 CASE STUDY QUESTIONS FOR DISCUSSION 1. What is a fair value for MAS as a stand-alone firm? 2. What would be the synergistic benefits for Etihad of acquiring a strategic minor- ity stake in Malaysia Airlines? 3. How much should Etihad bid for MAS shares