Cyprus Air­ways through the eyes of po­ten­tial in­vestors

Financial Mirror (Cyprus) - - FRONT PAGE -

The sale process of Cyprus Air­ways (CAIR) has been put on hold wait­ing for the re­sults of the Euro­pean Com­mis­sion in­ves­ti­ga­tion on the le­gal­ity of the aid pack­age of EUR 103m, which was pro­vided by the Cyprus gov­ern­ment to the dis­tressed na­tional air­line in De­cem­ber 2012 and Jan­uary 2013. The high­est pro­file bid­ders are cur­rently Ryanair and Aegean Air­lines, who also hap­pen to be the two most prof­itable Euro­pean air­lines in the first six months of 2014. How might po­ten­tial in­vestors view Cyprus Air­ways?

HOW AT­TRAC­TIVE (OR NOT) IS CY TO AN IN­VESTOR?

Gen­er­ally speak­ing, when ac­quir­ing a company, po­ten­tial in­vestors con­duct a thor­ough in­ves­ti­ga­tion which in­cludes mar­ket re­search and fi­nan­cial due dili­gence. The three pil­lars of the fi­nan­cial eval­u­a­tion are:

For a suc­cess­ful sale, the seller should be able to of­fer a business that is promis­ing steady rev­enues and a cer­tain earn­ings stream. The make-up of rev­enues (cus­tomers, prod­ucts, re­gions, coun­tries, etc) will be con­sid­ered. “Is there growth in rev­enues and is it likely to con­tinue? Are the profit mar­gins ac­cept­able and con­sis­tent?” As Fig­ure 1 shows, CAIR has been ex­pe­ri­enc­ing a steady fall in both rev­enues and prof­its from 2009, and even dur­ing 2005-09 when rev­enues were grow­ing, the company per­formed very poorly in terms of prof­itabil­ity. Its costs of sales and op­er­at­ing ex­penses es­ca­lated to enor­mous proportions, not con­sis­tent with the in­dus­try av­er­ages. As the re­cent pro­fes­sional re­port by CAPA (Cen­tre for Avi­a­tion) com­ments, “Cyprus Air­ways has a sig­nif­i­cantly higher CASK (cost per avail­able seat kilo­me­tre) than all of its big­gest com­peti­tors: Aegean, Monarch, EasyJet and Ryanair”. Transaero is also a ma­jor com­peti­tor, but CAPA didn’t have a CASK es­ti­mate for it.

While thin profit mar­gins are common among tra­di­tional air­lines, and in fact Aegean had ex­pe­ri­enced losses in 20102012, this is usu­ally ex­plained by high de­pre­ci­a­tion charges in this cap­i­tal in­ten­sive in­dus­try. Aegean, which in 2011-2012 un­der­went re­struc­tur­ing and made mas­sive in­vest­ments in its fleet, it set out on a path of growth which has now re­sulted in

profit. The path of CAIR has been quite dif­fer­ent.

A strong Bal­ance Sheet is a much big­ger con­sid­er­a­tion than prof­its. In­vestors are not eas­ily scared by losses on the In­come State­ment. But they want to see a solid as­set base. This is what mat­ters MOST in any ac­qui­si­tion deal be­cause this de­fines the fu­ture po­ten­tial of a company to gen­er­ate rev­enue and prof­its. CAIR’s bal­ance sheet has been shrink­ing at a fast pace: the company has been sell­ing off as­sets, air­planes, air­port slots and build­ings. Al­ready in 2011, a re­port by the As­so­ci­a­tion of Euro­pean Air­lines (AEA) de­scribed our na­tional car­rier as “the fastest-shrink­ing air­line in Europe”.

The bal­ance sheet from the 2011 An­nual Re­port (the lat­est au­dited re­port) showed neg­a­tive eq­uity of EUR 16mln, which meant that to­tal li­a­bil­i­ties ex­ceeded its to­tal as­sets by EUR 16mln. Ac­cord­ing to such bal­ance sheet, even if CAIR sold all of its as­sets in 2011, it would still owe EUR 16mln to its cred­i­tors. As a re­sult of a weak­en­ing as­set base, start­ing from 2011 there has been a sig­nif­i­cant and con­tin­u­ous an­nual drop in pas­sen­ger traf­fic (Fig­ure 2).

As if this is not a scary enough pic­ture for a po­ten­tial in­vestor, there may be more bad news on the way. The Euro­pean Com­mis­sion may not ap­prove the re­struc­tur­ing plan and the state aid pack­age pro­vided to CAIR in De­cem­ber 2012 and Jan­uary 2013. As Min­is­ter of Fi­nance Har­ris Ge­or­giades warned (Cyprus Mail, 5 July 2014), if that hap­pens, the na­tional air­line will face bank­ruptcy and will close down. No in­vestor would want such a bur­den on the company’s bal­ance sheet. Yet the risk of such a decision is very high since the Com­mis­sion al­ready ap­proved re­struc­tur­ing aid for CAIR in 2007 and, ac­cord­ing to EU rules, re­struc­tur­ing or res­cue aid may only be pro­vided once in a 10 year pe­riod. into op­er­at­ing, in­vest­ing and fi­nanc­ing. Over­all, they re­sult in a cer­tain net change in cash over the ac­count­ing pe­riod. What mat­ters to po­ten­tial in­vestors is the op­er­at­ing cash flow, which should be pos­i­tive. This is a more ob­jec­tive way than prof­its to iden­tify if the company’s main business is sus­tain­able and ro­bust. The CAIR Cash Flow sum­mary for 2010-2011 showed a highly dis­tressed company which was un­able to gen­er­ate cash flow via its main business and was mas­sively sell­ing off its as­sets (Fig­ure 3). By con­trast, Aegean dur­ing the same years, be­ing also a loss-mak­ing company then, showed a highly pos­i­tive op­er­at­ing cash flow (mean­ing that its main business was healthy) and highly neg­a­tive in­vest­ing cash flow (mean­ing that they were in­creas­ing their as­set base for the fu­ture growth).

THE ONLY HOPE OF LONG TERM SUR­VIVAL

The dread­ful fi­nan­cial sit­u­a­tion and the dim fu­ture prospects of the na­tional car­rier have been in the spot­light since June this year. The sale of the last Heathrow slot, which caused CAIR to re-di­rect pas­sen­gers to Stansted, was highly crit­i­cised by the air­line pi­lots union PASYPI and the po­lit­i­cal op­po­si­tion par­ties, AKEL in par­tic­u­lar. “Sell­ing the times­lot would be cat­a­strophic for the company’s fu­ture” (Cyprus Mail, 3 June 2014). Fur­ther harsh crit­i­cism fol­lowed in July when the gov­ern­ment be­gan its ac­tive search for a strate­gic in­vestor.

Con­sid­er­ing that de­spite the whole se­ries of re­struc­tur­ing plans, CAIR has been a loss­mak­ing en­tity since 2009, with a rapidly shrink­ing as­set base, a grow­ing mount of debt, and the neg­a­tive op­er­at­ing cash flow, it is ob­vi­ous that the gov­ern­ment sim­ply has no other choice left. Con­tin­u­ing to cover the losses at the ex­pense of the tax­pay­ers is no longer an op­tion.

The re­cent pro­fes­sional re­port by CAPA (Cen­tre for Avi­a­tion), pub­lished on Septem­ber 9, and ti­tled “Cyprus Air­ways: In­vestor Needed as Mar­ket Share Evap­o­rates”, con­cluded that “The re­struc­tur­ing is not enough to sus­tain Cyprus Air­ways and the sale to a strate­gic in­vestor looks to be its only hope of longer term sur­vival. If this turns out to be ei­ther of Ryanair or Aegean, Cyprus Air­ways may face a brighter fu­ture.”

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