Can Rolls en­gi­neer a way out of the £8bn hole it finds it­self in?

The Daily Telegraph - Business - - Business - By Alan Tovey

In nor­mal times, Au­gust should be a boom time for Rolls-Royce. It fol­lows the tra­di­tional Farn­bor­ough and Paris air shows, staged in al­ter­nat­ing sum­mers, when the avi­a­tion in­dus­try shows off fu­tur­is­tic new tech­nol­ogy, seals deals and gen­er­ally schmoozes. Rolls typ­i­cally en­ter­tains clients on the bal­cony of its mul­ti­storey chalet, al­low­ing the flight dis­plays to steal at­ten­tion away from the com­pany’s pre-ex­ist­ing prob­lems.

Not this year, how­ever. Covid-19 saw the aerospace jamboree can­celled, re­placed by on­line sem­i­nars that did lit­tle to draw fo­cus away from the cat­a­strophic col­lapse in air trans­port.

Even the more op­ti­mistic pre­dic­tions for the re­cov­ery of the air­line in­dus­try ex­pect it will be at least two years be­fore there is a re­turn to pre-pan­demic lev­els, and that’s just for short-haul flights.

With its large en­gines for wide-body jets Rolls is par­tic­u­larly fo­cused on long haul; ex­perts reckon this area of the civil aerospace mar­ket could take five years to get back to nor­mal.

To give an idea of the scale of the cri­sis fac­ing Rolls, be­fore Covid-19 struck about half of the com­pany’s £15bn an­nual rev­enues came from sell­ing and ser­vic­ing air­liner en­gines, much of it on “power by the hour” deals whereby cus­tomers paid only for what they used.

Ac­cord­ing to anal­y­sis by con­sul­tancy Cir­ium, in Jan­uary wide-body air­lin­ers pow­ered by Rolls en­gines recorded about 22,000 fly­ing hours per day. This plunged as low as 3,000 hours per day in early April, and is cur­rently at about only 30pc of nor­mal lev­els.

It’s no won­der that in the past few weeks Rolls shares have hit lows not seen in more than a decade, fall­ing al­most 70pc in a year.

War­ren East, chief ex­ec­u­tive of the Derby-based gi­ant, is do­ing ev­ery­thing he can to save the busi­ness in the face of what he has called an “his­toric shock to avi­a­tion”.

So far this has in­cluded mak­ing 9,000 staff re­dun­dant, some 15pc of the global work­force, as part of a tough cost-sav­ing plan that fol­lows on from ear­lier ef­fi­ciency drives and dis­pos­als he has in­sti­gated since tak­ing the con­trols five years ago. At a trad­ing up­date in July, Mr East re­vealed Rolls had burned through £3bn of cash in the pre­ced­ing six months, a level ex­pect to rise by an­other £1bn in the full year, while rev­enues fell by £1.1bn.

Coro­n­avirus is only one of the prob­lems Rolls is fac­ing. Shortly be­fore the pan­demic hit, Rolls fi­nally seemed to have got a grip on prob­lems with its Trent 1000 en­gine used to power the Boe­ing 787 Dream­liner.

First re­vealed by Rolls as a mi­nor is­sue in 2016 as parts wore out ear­lier than ex­pected, this snow­balled into a £2.4bn bill with Dream­lin­ers grounded be­cause of fears of en­gines sud­denly shut­ting down. This racked up com­pen­sa­tion bills, ex­pen­sive in­spec­tions, re­pairs and re­designs for what even­tu­ally turned out to be nine dif­fer­ent prob­lems.

Now there’s a fear that his­tory could re­peat it­self with Rolls’s flag­ship Trent XWB en­gine. Ear­lier this week the com­pany said rou­tine in­spec­tions of XWB en­gines used to power Air­bus’s A350 air­liner had dis­cov­ered cracks in some of the fan blades.

Rolls ex­am­ined 100 early XWB en­gines – it has built about 800 so far – and said only a fifth of them had the is­sue, which does not re­quire air­lin­ers to be grounded.

The com­pany also noted that, in part be­cause of the col­lapse in air travel, it had the com­po­nents and ca­pac­ity to re­pair them, and costs would not be ma­te­rial. But JP

Mor­gan an­a­lyst

David Perry, a noted bear when it comes to

Rolls, warned “there are a num­ber of a rea­sons to be wary: the Trent 1000 prob­lems were ini­tially con­sid­ered mi­nor but then es­ca­lated from a prob­lem that cost £25m to be­tween £2.4bn and £3bn”. He added: “Rolls does not yet know the cause of the cracks.”

It’s not that Rolls hasn’t got the money to sur­vive in the short term – and prob­a­bly the medium term, too. The trad­ing up­date an­nounced £8.1bn of liq­uid­ity, in­clud­ing £2bn of credit from banks un­der­writ­ten by state­backed UK Ex­port Fi­nance. Since the pan­demic hit Rolls has raised £3.9bn in new fi­nanc­ing and £300m from the Covid Cor­po­rate Fi­nance Fa­cil­ity.

The prob­lem is that this is not free money: it has to be paid back. And that’s go­ing to be an is­sue with Rolls likely to ex­pe­ri­ence five years in the dol­drums be­fore get­ting back to where it was. In a pe­riod of lower rev­enue, find­ing the money to re­pay the sup­port could strain the com­pany even fur­ther.

Many see Rolls as a can­di­date for Project Birch, the Trea­sury task force set up to save Bri­tain’s most im­por­tant firms and whose fail­ure could struc­turally harm the UK econ­omy. With more than 20,000 staff in the UK, many work­ing on vi­tal de­fence projects, fail­ure is not an op­tion. How­ever, the state tak­ing a stake is seen as an anath­ema to Rolls. Even be­fore state aid is­sues are con­sid­ered, the com­pany’s abil­ity to op­er­ate would be slowed by gov­ern­ment bu­reau­cracy. In any case, Rolls still bears the scars of a pre­vi­ous na­tion­al­i­sa­tion, when it had to be res­cued in 1971 af­ter costs of de­vel­op­ing its ad­vanced RB211 en­gine span out of con­trol.

The legacy of that episode means the Gov­ern­ment holds a “golden share” in Rolls, which pre­vents any sin­gle for­eign in­vestor from hold­ing more than 15pc, and lim­its over­seas own­er­ship to 25pc in to­tal. Still, des­per­ate times may call for des­per­ate mea­sures.

More likely is sell­ing the fam­ily sil­ver. Last month The Tele­graph re­vealed Rolls is in talks about a sale of Span­ish en­gine com­po­nent maker

ITP. A year ago a sim­i­lar deal that val­ued the busi­ness at about £1.5bn fell through, and in the cur­rent de­pressed mar­ket ITP might be worth only half that.

The lat­est Trent XWB is­sues might push that down fur­ther, or even make it im­pos­si­ble, as ITP has a sig­nif­i­cant stake in parts for the newly trou­bled en­gine. It would take brave buyer to ig­nore the risks of a re­peat of the Trent 1000 de­ba­cle

There are other dis­posal op­tions. Chunks of the power sys­tems di­vi­sion, which makes en­gines used to gen­er­ate power for the oil, gas and ma­rine in­dus­tries, as well as en­gines for yachts and trains un­der the MTU brand could be hived off. This could be a dif­fi­cult sale; it is one of the best per­form­ing di­vi­sions and is help­ing prop up civil aerospace.

Rolls’ de­fence di­vi­sion could also be looked at, though this would come with huge se­cu­rity com­pli­ca­tions. The most likely out­come is an eq­uity raise. Rolls has con­firmed it is “look­ing at all op­tions” and there have been re­ports of a £1.5bn rights is­sue, a sum equal to just un­der a third of the cur­rent mar­ket cap.

Whether this will be enough to sup­port Rolls with­out a sud­den pick-up in de­mand for air travel re­mains to be seen. Ac­cord­ing to JP Mor­gan’s Mr Perry, Rolls has “an £8bn hole and will need much more than a £1.5bn rights is­sue”, cal­cu­lat­ing the com­pany needs to raise £6bn through dis­pos­als and other fundrais­ing.

Mr East’s cri­sis days are from over.

Long-haul air­lines like Bri­tish Air­ways have been hit hard by the cri­sis and this paired with en­gine is­sues has left Rolls strug­gling

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