By Emmanuel Samarathisa

ALL it takes is a single RM3.5 bil bullet to put an end to Malaysia Airlines Bhd (MAB). That is how much sovereign wealth fund Khazanah Nasional Bhd needs to shut down the flailing national carrier, excluding additional debt obligations of between RM8 bil and RM10 bil.

This was among the contingencies that MAB owner Khazanah and the Malaysian government had been considering in determining the fate of the country’s flag-carrier should the search for a strategic partner fail to pass muster.

To be sure, the hunt for a suitor is on. Prime Minister Tun Dr Mahathir Mohamad on Jan 20 said there are five proposals that Khazanah, of which he is chairman, is considering. Economic Affairs Minister Datuk Seri Mohamed Azmin Ali, who also sits on the fund’s board, seconded Mahathir’s statement.

According to documents sighted by FocusM, four of the bidders were: AirAsia Group Bhd (AAGB), Japan Airlines Co Ltd (JAL), Air France-KLM SA and Malindo Airways Sdn Bhd.

AAGB and JAL were picked as frontrunners by the Khazanah management team while Air France-KLM SA told Reuters on Jan 21 it had dropped out of the race. There is neither word on Malindo nor has there been a confirmation on the fifth bidder at the time of writing.

A three-way merger

But, from the documents, the Khazanah team highlighted that AAGB and JAL had been the best bets. Preference, however, went to AAGB, despite acknowledging that the move came with “high execution risks” such as bridging corporate cultures of MAB and AAGB and regulatory hurdles, especially antitrust laws. (See table below for summary of AAGB and JAL proposals as well as synergy estimates and costs.)

But Khazanah wanted to bet on Tan Sri Tony Fernandes and his armada to get MAB off its balance sheet. MAB had been dragging Khazanah’s balance sheet to the point that the sovereign fund swung into the red for the financial year ended Dec 31, 2018, with a pre-tax loss of RM6.27 bil, its first in a decade.

The losses were pinned on global market headwinds with half of its impairments coming from MAB. Khazanah registered an impairment of RM7.3 bil for 2018 or RM5 bil more than in the previous year.

Why Khazanah managing director Shahril Ridza Ridzuan sees Fernandes as a saviour boils down to Team Shahril’s belief that a merger with the AirAsia group would solve domestic overcapacity, thus putting MAB on a more financially sustainable footing.

To achieve this, there has to be a three-way merger between MAB, AAGB and its long-haul comrade AirAsia X Bhd (AAX).

Khazanah wagered this could be realised through “meaningful merger synergies” which the fund projects would bring in RM1.45 bil per year, a quantum set by a third-party consultant, presumably Morgan Stanley. Khazanah hired Morgan Stanley on July 23 last year to explore strategic options for MAB.

Further, Khazanah wanted to push for a merger between the two AirAsias and MAB which would, in turn, be a listed entity. The caveat: Khazanah becomes a minority shareholder of a larger and listed airlines group. Essentially, this means that MAB will be sold and managed under AAGB’s fleet of aircraft.

The fund believed that such a union would create not only a Malaysian champion but an Asean champion. More importantly, there is the opportunity to repair MAB and the market’s overcapacity situation and achieve economies of scale, the document said.

But the Khazanah board found the proposal to be unfavourable, therefore marking a clash of opinions between the fund’s management and the board over what would be the solution to nurse MAB back to financial health.

Certainly the board’s rejection had its merits. According to the documents, Shahril and his team were pushing for a merger without AAGB providing a detailed proposal on the valuation of AAGB’s stake. Also missing from the proposal was any mention of revenue management which is a crucial element of any airline.

AAGB’s proposal would also leave Khazanah with a bill north of RM8 bil as the former’s proposal includes key exemptions such as an RM5.4 bil financing gap for MAB’s six A380s, the exclusion of an RM2.5 bil sukuk, costs of staff layoffs, and the cost of cancellation of 25 Boeing 737 MAX 8 orders as well as other fleet rationalisation. All these total up to well over RM8 bil that Khazanah will have to bear even if MAB is acquired by AAGB.

Conservative but unsatisfactory

JAL, on the other hand, proposed a more realistic solution. The Japanese airline was willing to commit RM1.12 bil cash injection for a 25% stake in MAB, offer revenue management and turnaround expertise and turn Kuala Lumpur International Airport (KLIA) into an international hub to compete with the likes of Bangkok and Singapore.

But the proposal was deemed to be off the mark in Khazanah’s books as estimated synergies would only amount to RM138-359 mil a year – not enough to cover MAB’s losses.

However, this does not appear to have taken into account any positive impact from revenue management and improvement in service levels which can garner higher fares and hence revenues.

JAL’s own turnaround after the company went bankrupt in 2010 was premised on better revenue management and higher service levels even as costs were kept down. In just two years, the airline recovered and made an initial public offering as a prelude to a listing, worth US$8.5 bil then, the second largest after Facebook Inc.

According to documents, Khazanah believed AAGB would fetch the fund RM1.4 bil a year in synergies but did not outline how they would accrue. There were no hard figures on valuations. But this quantum is expected to keep MAB operational, according to the fund’s estimates.

Fresh capital aside, JAL wanted Khazanah to remain MAB’s major shareholder with a 75% stake. The Malaysian government would also retain its golden share in the airline.

An attractive feature of the JAL proposal is that it expressed interest in transforming KLIA into a hub competing against Bangkok and Singapore, where it will direct traffic from Japan to India, Indonesia and Australia through Thailand and Singapore to KLIA. It also improves connectivity between Kuala Lumpur and the US through Tokyo.

Mooted also is the creation of a new mid- to long-haul low-cost carrier with a network integration which could open up new routes to the US and Europe, and a cross-secondment of MAB and JAL staff for exchange of best practices.

Despite the ease of execution, JAL turned off Khazanah due to the Japanese airline not taking a lead in the restructuring of MAB and the inability to solve domestic overcapacity. And despite JAL’s expertise and strong cultural alignment, Khazanah remained apprehensive of  the fact that the partnership would not solve “competitive rivalry.”

Race against time

But the clock is ticking as, according to Khazanah’s own timeline, the fund is expected to decide on a strategic investor including the execution of a term sheet by April. And, by June, the fund and strategic partner is expected to carry out the definitive agreements.

Failing to do so means a financial band-aid from the government, not the first for MAB. While Shahril’s past estimates requires the government to pump RM1 bil a year to keep MAB afloat, that only covers operations.

A “high level estimate” sees Malaysian taxpayers contributing up to RM21 bil to keep MAB afloat from 2019 to 2025. That would mean the fund would need to pump in roughly (and coincidentally) RM3.5 bil a year with RM1 bil to RM1.6 bil going to operations and the rest going to debt repayments and aircraft purchases.

As things stand, MAB is already on a collision course to default on its loan for six Airbus A380 jets to Turus Pesawat Sdn Bhd, a special purpose vehicle owned by Ministry of Finance Inc (MoF Inc).

Further, bondholder Kumpulan Wang Persaraan (Diperbadankan), the civil servants’ pension fund, would need to take a haircut after subscribing to its portion of MAB’s perpetual sukuk in 2012 for RM1.5 bil.

In a delusional state

And MAB seems to be in denial over the state of its finances so much so that Khazanah had panned the airline’s business proposal for the years under review. MAB’s “overly optimistic” business plan projected revenue growth of 4% a year with a focus on, among others, “driving revenue” and “managing costs” while maintaining “the premium customer experience.” Also, MAB projected that it would break even in 2022 and achieve financial stability in 2024.

The Khazanah team, however, believed there were no “clear” differentiating business models with what MAB had been doing previously. The fund said the 4%-a-year revenue jump would be “unlikely” given the average growth rate of MAB had been 1% a year between 2016 and 2018.

Khazanah added that even if MAB’s estimates were accepted, barring unforeseen circumstances, the fund still needed to pump in an additional RM10.3 bil to pay off the RM5.6 bil loan from Turus Pesawat and finance operations.

The fund deduced that any likelihood of MAB turning around based on the airline’s business plan was unlikely due to the flag-carrier’s weak track record and execution capacity as well as its inability to address declining revenue yields, basically unit revenue.

More importantly, if MAB continued to grow at its historical rate of 1%, the airline would never break even, the memo said. According to the company’s filing, MAB made RM8.73 bil in revenue but a net loss of RM791.71 mil for the financial year ended Dec 31, 2018.

Out of luck

The last time MAB basked in decent profits was when Datuk Seri Idris Jala took over the helm as chief executive officer. But his departure to serve as a Minister in the Prime Minister’s Department and as CEO of the Performance Management and Delivery Unit (Pemandu) meant there was a huge talent gap that had yet to be filled: two years after Idris vacated his post, MAB had to nurse a RM2.5 bil loss in 2011, one of the highest in the industry.

And MAB’s fortunes dove further south when in 2014, it lost two planes: firstly, on March 8, Flight MH370 vanished en route to Beijing from Kuala Lumpur. The plane has yet to be found. Secondly, Flight MH17, from Kuala Lumpur to Amsterdam, was gunned down by a ground-to-air missile while flying over a conflict zone in the Ukraine. None of its passengers or flight crew survived.

To be fair, Shahril understands the mess at MAB. His session with the Public Accounts Committee, which is publicly available, provides insight into some of the clashes between business and national interests, not only for MAB but other companies in Khazanah’s commercial and strategic investment baskets.

On MAB, he admitted that MAB’s restructuring had been rough. The corporate exercise failed to achieve its intended target of turning around the loss-making company.

“The (Malaysian aviation) industry is experiencing overcapacity involving four airlines namely Malaysia Airlines, AirAsia, AirAsia X and Malindo for a 30 million-people market, which translates into about 1.7 seats for one passenger.

“Malaysia Airlines was supposed to break even in 2018 and start reporting profit in 2019. But it registered billions of ringgit in losses which resulted in the company’s fair value not being able to support its investment,” he told the PAC last Oct 23.

The Malaysian government, according to Shahril, had been injecting funds into MAB to ensure the airline remains a going concern as the government expects to reap overall economic returns from the restructuring.

But he warned that “the government needs to limit the amount of funds which Khazanah needs to inject into Malaysia Airlines.”

Maybe Mahathir’s government is cognisant of this too, hence its apprehension in coming to a decision quickly over a strategic partner for MAS.

But if it is economic benefits, then surely the JAL proposal sounds more of a sane course of action, especially as part of the promise means turning KLIA into a competitive aviation hub. But promises do not factor in the socio-political implications of partnering with MAB.

The biggest question is, can MAB stomach the Japanese way of doing things? Maybe if that does not pan out, then Khazanah and the Malaysian government should do the right thing – take that RM3.5 bil bullet and put MAB out of its misery permanently. – Feb 3, 2020

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