Additional Thoughts on the Debt and Equity Offering
Some posters on this board have suggested that the equity portion of the recent offering was an add-on to satiate the request of debt holders, and that the debt holders are now running the show. I don’t believe this is the case. I believe there is much more at play here.
As previously discussed, Air Canada entered this crisis with the most liquidity (as a percentage of revenue) than any other NA airline. In March and April the airline further increased its liquidity/cash position. Unlike the U.S. airlines, Air Canada has begun laying off a significant portion of its workforce, further reducing its cash outflow.
In my previous post on loyalty revenue, U.S. airlines are now considering pre-selling loyalty points – United did this during previous financial difficulties. Air Canada would have this as an avenue to pursue as well, but has not yet mentioned this as an option. It seems therefore that Air Canada is currently well-positioned cash-wise to navigate safely through this crisis. So the question is, did the Airline really need to raise approximately $1 billion in debt and equity as additional cushion?
The convertible notes offering with a 4% coupon rate is considerably lower than many expected and much lower than what the U.S. airlines are paying. Delta will pay a coupon rate of 7% on its new bond issue while United abandoned its bond offering when it became clear it could be forced to pay 10% interest. True, Air Canada’s offering are convertible notes, but at the option of the Airline, not the holder of the notes. The 4% coupon rate and relatively short closing suggest Air Canada execs are confident that the offering will be successful.
With respect to the equity component, as OTB pointed out on Stocktwits, “all 30.8 million shares could be owned by foreign owners (Class A Variable), and would still maintain the foreign ownership threshold just below 49%, ensuring all Class A variable voting shares have full voting power. Note, as of April 27 there were just over 110 million Class A shares owned.”
This opens the door for specialized U.S. funds who are focused, long-term activist investors, rather than just Buffet (Vanguard, Fidelity, State Street, etc.) type investors who are common holders of many airlines’ shares. As CEO of Air Canada, Calin pushed the federal government to raise the foreign ownership rules to 49%. I believe this is what Calin had in mind when he sought this rule change: narrow ownership of the airline by focused and knowledgeable long-term investors. These funds are typically located in the United States.
Air Canada should know who is accumulating these shares since early in the year. Given that most of theunderwriters for this offering are U.S. based, it is not unreasonable to assume that it’s these U.S. investors that the Airline is targeting.
The Transat Deal – In Jeopardy?
Clearly the market dynamics have changed since COVID19. One attraction that Air Transat brought to the table last year was its fleet of A321 NEO aircraft, most of them the long-range version. As I mentioned in a previous post, these are ideal aircraft for Air Canada’s narrow-body fleet – a game changer. Until COVID19, the earliest these aircraft could be acquired from the manufacturer was 2024-2025.
Recall that Air Canada recently cancelled its order for 11-Boeing 737 Max 9 aircraft. These are Boeing’s equivalent of the A321 NEO. The original order in 2013 called for 61 aircraft, 33 Max 8s, and 28 Max 9s. The Max 9 failed to meet performance specs and did not have the range of the A321 LR version. So a few years ago, Air Canada changed the mix, increasing the number of Max 8s, and decreasing the Max 9 order to 11 and delaying delivery of these aircraft into the early 2020s. In the interim, Air Canada acquired early to mid-life A321s at opportunistic prices when other airlines experienced financial difficulties (e.g. WOW airlines sale of four A321 NEOs to Air Canada in 2019). That said, most of the acquired aircraft were not the NEO version, and there still remains a gap in the new narrow-body fleet as a result of the recent cancellation of the 11-Boeing 737 Max aircraft.
As part of Air Transat’s revamping of its fleet, it signed a leasing agreement for A321 NEOs in 2017. Most of the early delivery slots for this aircraft were acquired by leasing companies. Given that the deal with Air Transat was signed well into the business cycle, the relatively small size of the airline and its declining profit margins, a risk premium would have been built into the negotiated leasing rates. While it is possible that Air Transat is currently re-negotiating these rates, the fact remains that the leasing company still has to cover its aircraft acquisition costs plus a reasonable, albeit reduced profit margin.
Previous economic cycles closely examined revealed that most airlines began buying aircraft mid-cycle as passenger demand increased. This pushed the prices of new aircraft up as airlines competed for delivery slots, and pushed deliveries farther out; and airlines frequently resorted to leasing to obtain earlier delivery slots, paying at least 15% more for leased aircraft.
In reality, the best (opportunistic) time to buy aircraft is during economic downturns, difficult for most airlines to do, as they are typically stressed financially, and focused more on short-term challenges.
As mentioned in a previous post, the COVID19 crisis has resulted in cancelled orders/deliveries for both Airbus, Boeing and leasing companies, and an opportunity to acquire highly desirable aircraft at huge discounts (below cost), more so than in a typical economic downturn.
I believe this is an opportunity that Air Canada would want to exploit, and the purpose for the convertible debt/equity issue. They see an opportunity to complete their narrow body fleet renewal by acquiring an aircraft that will clearly serve them well over the next 10-15 years. These aircraft, known as hub-busters, would mostly be employed from Eastern Canada into secondary airports in Western Europe. Prior to the Boeing Max grounding Air Canada was using the Max 8 for some of these routes but the better narrow-body aircraft would be the A321 LR version. And given its already low operating cost, the ability to acquire these aircraft at deep discounts would gain the Airline a huge competitive advantage going forward – no other airline would be competitive on these routes. Future earnings would be increased under this scenario – no third-party leasing add-on, excellent operating economics and very low acquisition cost – and would more than offset the equity dilution.
I don’t see inconsistencies with the above-described plan and the wording in the prospectus for the use of this cash. Part of Air Canada’s ‘recovery measures in response to the COVD-19 pandemic’ would be to ensure the airline is much more competitive exiting this crisis.
I believe that given the relatively low rate on the convertible notes and the relatively short closing date of June 2nd, it is entirely possible that Air Canada already had most, if not all, of the buyers for both the debt and equity lined-up, and that these buyers are long-term players who want to become active participants in the Airline’s future.
We’ll see soon enough.