Friday, November 25, 2005

PMB & MAS Need To Give Up The Domestic Routes, Among Other Things...

Up until the Widespread Asset Unbundling (WAU) exercise in November 2002, Malaysia Airlines had been booking massive losses from its domestic air services division. At one point, losses amounted to RM360m a year. Under the WAU, the ownership of the domestic operations was transferred to Penerbangan Malaysia Berhad (PMB), with Malaysia Airlines retained as the operator. Since the transfer of the domestic division to PMB, these losses are no longer reflected in the national carrier's accounts. By the financial year ended March 31, 2003, the losses had narrowed to RM150 million, but a huge financial burden for PMB to bear nonetheless. Although the domestic division is of little concern to shareholders these days, how much longer should PMB/the government subsidise the operations. Is the WAU a temporary measure or a special purpose vehicle?

Most of the losses to the rural air services in Sabah and Sarawak. MAS continues to operate these zero-profit routes as a social obligation. PMB badly needed to raise fares in these sectors, which it was not allowed to do the past 14 years. Another reason is that the fleet of aircraft flying the domestic routes is old. MAS revealed that it was awaiting response from aircraft manufacturers concerning its proposal to replace its ageing 737s and Fokker 50s with an order of up to 78 new aircraft at a catalogue price of US$3bn. Without a corresponding fare hike, making returns on that investment would be nada. Thanks to low cost carriers, the pressure on fares is downwards and not up. If we remember correctly, MAS even offered excess tickets on domestic flights at huge discounts two years ago to fend off competition from AirAsia. AirAsia will welcome the opportunity to increase its domestic frequencies. With its expertise in short-haul flying and quick turnarounds, the chances of making profits on these routes are probably higher with AirAsia. Why is PMB/MAS still holding onto the domestic routes?? Just give ALL existing and new domestic routes to Air Asia as their business model and quick turnaround should ensure a better result. Chances are, it is not that MAS/PMB fear that AirAsia will fail in the task, but rather that AirAsia will succeed in the task - slap in face guys, take it anyway you want, MAS/PMB have had a very long time trying to turn around the domestic operations, give the proven upstart a go and leave your egos at home.

If naysayers retort that AirAsia will then scrap the unprofitable domestic routes, then just make it clear in the agreement that AirAsia must service all the existing domestic routes undertaken by MAS and any new routes that they choose to add on. Then we won't have "excuses" all the time of how unprofitable rural routes in East Malaysia are.

What is in the best interests of the country? PMB, although run like a private entity, is ultimately financed by taxpayers. It has to make commercial decisions to become a viable business entity.

1 March, 2005 - MAS net profit for the nine months ended December 31 2004 rose 30 per cent to RM216.91m, but rising fuel costs hit third quarter profit which declined 75 per cent year on year. The nine-month net profit was achieved on a higher revenue of RM8.02bn against RM6.16bn previously. In the third quarter, however, net profit fell to RM57.62m from RM230.08m in the last corresponding quarter, attributing the period's less favourable performance to rising fuel prices. Fuel cost during the quarter under review had risen by about 88 per cent or RM534m.

4 March, 2005 - MAS plans to spend RM1.5bn to improve operations and make its planes more comfortable in an effort to win more business class travellers. MAS faces competition from AirAsia Bhd and other discount carriers on economy fares. It lags Singapore Airlines Ltd and Cathay Pacific Airways Ltd in attracting business and first-class travellers, who pay at least double the fare of economy-class passengers. The airline aims to boost sales by increasing the percentage of high-fare passengers. MAS carried 4.66 million passengers in the third quarter, filling 71.2% of seats on average. The airline filled one of every five first-class seats available, 60% of business seats and between 70% and 80% of economy seats.

24 March, 2005 - MAS expects up to 25 per cent return on investment from its on-going RM700m facelift on the premium seats and cabins of its 34 planes. MAS senior general manager sales, distribution and marketing Datuk Rashid Khan said the yield return would be contributed in many forms,such as higher passenger load, higher earnings and net profit or higher ticket sales. The RM700m facelift initiative, which started in the middle of last year, is expected to be completed by July next year, involving 17 units of the B747-400 and 17 units of B777-200.

31 May, 2005 - MAS has allocated RM1.0bn in capital expenditure for the nine months to December 2005, compared with RM1.0bn rgt for the past 12 months to March 2005, chief financial officer Low Chee Teng said. The capex is for engineering equipment, seat upgrade, construction of a hangar. Low said last year's capex included some RM300m in expenditure on its establishment of the Four Seasons Resort in Langkawi. MAS has hedged 50-55 pct of its fuel requirement for the nine months to December 2005 at an average jet fuel price of US$61.50 a barrel. MAS's load factor for the year to March 2005 rose to 69 pct from 67.6 pct ayear earlier. The international load factor for 2005 stood at 68.7 pct against 67.1 pct in the previous year, while domestic load factor was 71.3 pct, down slightly from 71.4 pct previously

18 June, 2005 - MAS may hand over a big chunk of its domestic flights to budget airline Air Asia Bhd under a plan that could help the Government reduce its financial burden.The Government now absorbs the costs of MAS' local services through PMB. MAS made operational losses of some RM281m for domestic flights in fiscal 2005, an almost 80 per cent increase from RM156.7m it lost a year earlier. According to sources close to the deal, MAS would probably concentrate on Malaysia's major cities, namely Penang, Langkawi, Kuching and KotaKinabalu, while AirAsia will service less profitable routes in the country.

15 August, 2005 - MAS and AirAsia Bhd are likely to post contrasting quarterly results for the period ended June 2005 despite having to operate in a similar turbulent environment.While MAS is expected to post a quarterly loss of between RM100m and RM200m, low-cost carrier AirAsia is tipped to remain in the black with an estimated profit of between RM25m and RM30m. MAS' first-quarter results are scheduled to be released on August 23 while AirAsia will release its fourth-quarter and full-year results on August 26. MAS' projected loss is due mainly to its vulnerability to fuel price increases and inability to cushion the impact due to high overhead costs. A US$1 increase in jet fuel price would erode MAS' annual earnings by 24 per cent or RM60m while a similar price increase would impact about 5 per cent of the earnings of AirAsia, Singapore Airlines (SIA) and Cathay Pacific. MAS and AirAsia are operating on different business models. AirAsia's lean cost structure is one reason why it is able to withstand the effect of high fuel prices. AirAsia has a more effective fuel price hedging strategy, while MAS fuel price hedging and fuel surcharge efforts were insufficient to offset the impact of the skyrocketing oil prices.To date, MAS has hedged around 61 per cent of its fuel requirements forthe first quarter and 65 per cent of its full-year requirements at arelatively high rate of US$62 per barrel. In addition, the fuel surcharge imposed by MAS is the lowest among the world's major carriers. MAS' overall earnings outlook for the current financial year ending December 31 2005 would remain vulnerable to the volatile fuel prices, continued increase in staff cost as well as sluggish growth inthe global cargo sector.

22 August, 2005 - MAS has booked a pre-tax loss of RM274.83m for its first quarter ended 30 June 2005 against a profit of RM22.5m for the same quarter last year due to higher fuel prices. It incurred an increase in fuel cost of RM248.1m during the current quarter. Revenue for the three months rose 16.7 per cent toRM2,846.288m from RM2,439.470m for the same period last year, it said in a filing to Bursa Malaysia.

22 August, 2005 - MAS will implement a 5-year program that aims to improve profitability during the period by up to RM1.0bn rgt, chairman Munir Majid said. The program includes restructuring the organisation to focus on key areas of business value; develop comprehensive plans to deliver the target improvement; and implement focused, short-term improvement projects to deliver immediate impact on the bottom line. "We target to save up to RM200m in cost savings in the first six months," Munir said, adding that the cost savings could come from further improvement in fuel efficiencies and yields. MAS yields currently stand at 18.5 pct while those of other airlines are in the region of 23-40 pct. Munir explained that the first-quarter loss wasdue to several factors and was not limited to high fuel prices. "This is a reality check. The company has not been making operating profits ever since the asset unbundling. The profits that have been reported are anaccounting profit attributable to gains from one-off benefits, not fromsustainable operational performance," he added.

29 August, 2005 - At every results briefing post-WAU, investors had left with the impression that the airline was finally getting its fundamentals right. It had spent good money on a financial management system, increased flights and connectivity to profitable routes such as cities in China and India, and embarked on an upgrade of its premium services.
The past nine months may have seen significant increases in fuel prices but this was believed to be manageable, with surcharges and hedging strategies. For the first time in the post-WAU era, MAS did not reveal revenue and expenditure figures that it transfers to parent PMB. The domestic air services division is believed to have netted a loss of between RM100m and RM150m during the quarter. In the financial year ended March 2004, the net PMB transfer suggests that domestic services alone incurred losses of RM280m. This quarter's domestic losses resulted in the imposition of a penalty charge of RM22.6m for under-performing in the domestic operations - which leads to the item of "other expenditure" in the airline's income statement. Analysts are also critical of MAS' fuel hedging strategies. Fuel costs jumped 58% to RM1.1bn for the quarter, accounting for 55% of losses. Jet fuel has risen 62% since the start of the year to a high of US$77.45 per barrel on Aug 17. Meanwhile, staff cost grew 17.5% and is anticipated to rise further as MAS has yet to finalise salary negotiations with its pilots.

19 September, 2005 - MAS has hedged 75pct of its fuel requirement for the second quarter to September at US$65 abarrel, as compared to 70 pct at US$62 in the first quarter.
Concluding Statements - Alright, MAS did a terrible job at hedging their fuel expenditure. The new guy Jala (from Shell) was obviously roped in to address that point specifically. If we were to take out the fuel factor from their bottom line, MAS did OK - its not good but not as bad as everyone makes it out to be. Suddenly, everyone from taxi drivers to MPs, seem to have solid "suggestions" on how to run MAS better.

The problems at MAS is not unsurmountable and not unique either. AirAsia has shown that the industry is not that bad. We, however, need to equalise the competitive landscape. Remove the ownership of domestic routes from PMB/MAS. Other issues are manageable by recruiting the "right people", issues such as "improving yields/load factors", "premium branding and service issues", "management of labour and union issues", "better management of asset and liabilities to be better matched with revenues", etc... these are issues that can be addressed by getting the "right people", any kind, no matter if they are local or foreign or otherwise.

Saturday, November 12, 2005

Lessons From The Current Oil Shock

I came across one of the smartest article in Newsweek (31/10/05) written by Ruchir Sharma (co-head of global emerging markets for Morgan Stanley Investment Management) on the present oil shock. Many are confounded by the lack of calamity owing to the recent surge in oil prices. Sharma cited some clever insights and I would like to add to them:

a) The present oil price bull market is due to demand-surge factors and supply growth that could not cope. This is very different from previous oil price rallies which were more likely due to supply shocks (e.g. wars, embargos, cartel behaviour). What this means is that a very strong global economy is pushing demand for oil, and the usage of oil is more for production of goods which has an end market demand. Hence oil consumption is largely for "productive means". The higher cost of oil is more easily absorbed or passed on along the production and consumption processes.

b) It used to be that higher oil prices meant that we are lining the pockets of OPEC nations at the expense of non-OPEC nations. Back in the mid 70s, the additional revenue from jumps in oil prices stayed mainly with OPEC nations and was not recirculated back to the global economy. Sharma cited UBS economic research as saying that back in 1974 only 27% of petrodollars was recycled back into the global economy. Now OPEC nations are more involved with the global economy by consuming as much as 83% of oil revenues. An example would be the aggressive purchasing of US Treasuries by OPEC nations which lowers the global cost of capital, thus allowing the major economies to chug along without higher interest rates cutting off economic activity.

c) The present oil shock has also magnified countries that have been subsidising the cost of oil in their country (namely Malaysia, Indonesia). These oil price surges have reinforced the growing amount of subsidy, which could have been better spent to revitalise other areas of their economies. Malaysia, correctly surmised that they should reduce the level of subsidy. In fact, one can safely say that countries engaging in subsidising oil prices are gradually lowering their subsidy from here on. It is not prudent to artificially sustain a country's competitiveness and purchasing power via the subsidy method. The political will to act on the subsidy is stronger this time around because many are recovering well from the 1997 financial implosion, and is more acutely aware of bad economic policies. It is better to reduce the subsidy from a position of strength.

d) Consumption patterns have also changed owing to the present oil price rally, but isn't that the case every time there is an oil price shock? Drops in sales of SUVs (four wheel drives) and increase in purchase of hybrid cars are evident. The only difference is that the consumer is generally pretty pissed off with the magnitude and arrogance of the oil price rally over the last 12 months. There is a growing sense of the consumer not wanting to be an idiot victim of future oil price hikes, and also a warming appreciation of global warming and conservation issues.

e) Oil companies and refineries are also taken aback by the present oil price rally. Though they are all recording supernormal profits, many felt that they were caught unawre by the rally. These companies and governments have stepped up efforts to speed up on oil exploration and refineries have charged along to increase capacity.

The above factors would indicate that the price of oil will stay stubbornly high over the next 12 months at least as demand is still genuine, and supply is still not able to catch up that fast. Extra capacity and supply will come along only after a couple of years.

What is important here is that governments have generally wised up to the need to adapt quickly, either by reducing subsidy on oil prices or change in consumption patterns or increase activity in exploration - this should reduce the price volatility in the next oil price shock, and also indicate that future oil price shocks is more likely to be determined by demand factors again rather than supply constraints.

The final lesson here is that it used to be the trade surplus countries are subsidising the ballooning US budget deficit. Though naysayers have been plenty and more vocal over the last 10 years on the need to bring down the US budget deficit (and they should), the end for the US dollar is still a bit further away as there is sufficient petrodollars providing extra support for the deficit. Hence I would only really start to worry about a collapse in the US dollar and US economy if Japan and China stops registering trade surpluses or OPEC nations NOT making real money anymore, as it is not in anyone's interest to allow the US dollar and US economy to collapse. Having said that, I would think that certain US government officials are not too perturbed by the present oil price shock. In fact, it could work out better to further sustain the US budget deficit.

Friday, November 11, 2005

Need To Quicken The PN4/PN17 Process Even More

As reported in The Star (10/11/05) a public listed company that is financially distressed and makes little effort to restructure within the new time frame set by Bursa Malaysia faces de-listing. If, in the past, Bursa has been lenient in extending time for companies to restructure, that would no longer be the case. A specific time frame, for instance eight months, will be given. If nothing is done in that time, the exchange would no longer be “generous’’ in allowing extensions.

In the past, the exchange had often been lambasted for being too slow and too lenient in its actions to penalise companies that did not conform with listing requirements, e.g. negative shareholders’ funds. Previously, companies that were financially distressed were categorised under Practice Note 4 and given a lot of time to regularise or restructure.
There were times when up to two years' grace period was granted by Bursa for companies to restructure while minority shareholders of those companies held on to their shares.

Since the 1997 Asian financial crisis, Bursa has de-listed only 27 firms but it was a long and winding process.

Under the "new" PN17, companies are give 8 months to be successful in regularising their financial situation during the time set, failing which they would be de-listed fairly quickly. Some companies that ceased to be PN4 are now in financial trouble again. If PN4 companies that are restructured get into trouble again, and if the situation is not rectified, they would then fall into the PN17 category. If still nothing is done, they would be de-listed.

When discussing the PN4/PN17 companies, we need to bear in mind the following:

a) companies are still allowed to trade even when they were on PN4, and if I remember correctly, there were "hot stocks" even within the PN4 circle, and some did attract substantial trading volume and price movements - i.e. it has been too long for companies that were classified in PN4, stayed there. If a company is in PN4, there must some urgency in restructuring its financial affairs and NOT allowed to be languishing for over 2 years - its like being held in lock-up but not locking the door at all

b) the lack of urgency (before) also helped create a false sense of security among investors. Just ask any share investor on the street and they would say that PN4,..."no difference la.." ... "can still make money if got action.."

c) USUALLY it is those companies with dubious financials that would engage "syndicates" to financially engineer their stocks (and vice versa) - a bit like.. well.. last chance to really make some money here. Specky stocks can attract big players, big syndicates and big traders because everyone thinks that there is no danger of financial calamity or that the authorities would even act on them, and even if they did the process will take such a long time anyway. If a syndicate knew that a "bad stock" could very well land itself in PN4 anytime, and that once in PN4 it would scare the bejeezus out of all investors (thus removing all volume) - I doubt very much that big syndicates would want to "play those stocks" as they could be left holding a huge chunk of a "suddenly-PN4ed" counter to the grave.

So, all in all, a bit over due but better late than never, and please stick to the proposed time frame - 8 months means 8 months, no ifs or buts... there have been just too many ifs and buts allowed in our country, just look at the application deadline for the new MYKAD, or the shifting goal posts for Universal Brokers...

Oh, btw good job Bursa...

Friday, November 04, 2005

How Not To Do A Deal - Modular & Blue-I

As reported in The Edge Daily, Modular Techcorp Holdings Bhd has obtained the approval from the majority of the shareholders to buy a major stake in telecommunications services provider, Blue-i Network Sdn Bhd for RM21.5 million cash. Some shareholders had queried Modular's board over the acquisition of the 70% stake in Blue-i. The EGM, which was held in Kuala Lumpur on Nov 2, lasted over four hours. The acquisition of Blue-i will be funded by bank borrowings of RM10 million and the balance from its internally generated funds.

Dali: Why was the deal in cash? Would it not be better to issue new shares to Blue-I vendors? Or a part cash, part shares deal?

... and why was the meeting held on the week of Deepavali/Hari Raya holidays.. isn't it more prudent to have hold the meeting during a time where the public would not be taking extended leave... or is it that the company wanted less people to attend... I believe, if the deal is solid, and the terms are fair, plus the deal is value enhancing - I would want to ensure that all shareholders get to have a say in approving the deal, especially when it is a "substantive" deal relative to the size of Modular...

Its chairman Ibrahim Hussain told reporters after the EGM that shareholders' queries ranged from the fair price to the synergies from the purchase. He said Modular would be able to leverage on its existing market of over 15 million bank card holders and university clientele to develop post-issuance applications using Blue-i’s mobile communications, computer and internet protocol solutions. Ibrahim said the exercise, expected to be completed by the fourth quarter of year, would contribute positively to the group for the financial year ending Dec 31, 2006 as Blue-i had made a profit guarantee of not less than RM6 million for FY06.

Dali: Blue-I's vendors are guaranteeing RM6 million profit for 2006... you know, you can easily list with RM6 million profit on Mesdaq... heck, even half the companies on Mesdaq don't make RM6 million a year (I am just guessing here, too lazy to do actual research, but I don't think I am wrong..). So, to give up a listing status, for what... for the client base that Modular has?? Still, there are better ways to do that, Blue-I could have a joint venture with Modular to do the same thing, and still keep its independence and still go for a listing! Why? Why? Why?

For the proposed acquisition, Modular Techcorp has inked a share sale agreement with vendors Alex Sashitharan Rajadurai and Ng Boon Choong, who held 600,000 ordinary Blue-I shares of RM1 each, representing a 50% of Blue-I’s paid up capital. Both vendors are also two of the directors of Blue-I. Under the guarantee, Blue-I must make a minimum net profit of RM6 million for the financial year ending Dec 31, 2006. In the event of a shortfall in the net profit, the retention sum of RM4.2 million would be used to make up for the shortfall and the vendors would pay any remaining difference.

Dali: ..... Tell you what, I can even give a better guarantee to Modular, I will give a profit guarantee of RM12 million (double that of Blue-I's vendors) for 2006. Since I am getting RM21.5 million, I don't care if Blue-I makes ZERO profit in 2006 as RM21.5 million minus the RM12 million that I would have to make up would still leave me with RM9.5 million cash.

For the financial year ended Dec 31, 2004, Blue-i’s net profit stood at RM1.14 million on a revenue of RM19.95 million. He said Modular would also be able to tap into Blue-i’s network of retail and corporate customers to further enhance the business of applications of bank cards for financial transactions. “Modular believes that the established network of call shops under Blue-i and its ability to deliver innovative products would give the company the competitive edge,” he added. He said the company had plans to make inroads into other countries over a year, replicating its smart card technology and also market Blue-i’s products overseas.

Some Questions That Needs To Be Answered

1) Why an all cash deal? This type of deal brings out a lot of queries. For a typical company with a limited history such as Blue-I, a more prudent deal option should have been considered. How about a deal to buy 33.3% of Blue-I now by issuance of new shares in Modular, with Blue-I vendors to guarantee profit of RM6 million for 2006, and a stipulation that the vendors cannot sell their shares till guarantee is met. If the guarantee is not met, the shares will be sold to make up for profit guarantee shortfall. Upon satisfctory completion of profit guarantee in 2006, it will trigger an option by Modular to buy another 33.3% for RM7 cash. Now isn't this a more prudent deal?!!

Don't do a deal that insults the intelligence of an average investor; or lowers the integrity of the stock exchange and its regulators; and one that tramples on the rights of the minority shareholders - we are all smarter than that, and this is not the 80s or 90s anymore!!!

2)If the deal is so good, why doesn't Blue-I vendors take Modular shares instead, cash is cash but a good scalable deal means 1 + 1 = 3 or even 7, hence taking Modular shares would be better.

3) Why is the guarantee only for one year? And as I have pointed out earlier, the guarantee does not make sense as the vendors can screw around with guarantee and still wind up taking home almost RM10 million cash. Has this deal been really well thought out? My, my, there are more holes in this deal than a block of cheese... and smellier too!

4) RM21.5 million for a 70% stake equates to valuing Blue-I at RM30.7 million. At that purchase price, Modular is paying for 26.9x historical PER. What is even more absurd is its NTA is just RM1.45 million. RM30.7 million market cap and only NTA of RM1.45 million.... hello... anybody home??? That kind of valuation is still justifiable... if you are Skype, Shanda, EBay or or if you hold a patent/technology advantage... any thing... don't be shy here... Blue-I is a simple company leveraging on technologies that are already 5-10 years old, plus much of it Redtone has already conquered... why the exorbitant premium???

5) Where are the directors? Have they been asking the right questions??? What about the independent directors?? Why does Modular go and borrow RM10 million to fund the deal?? Isn't it better to issue new shares in Modular?? The silence is deafening.

At the end of it all, anyone who has had a few years experience in investments or finance will know what the Modular/Blue-I deal is all about... the thing that makes me angry is the sheer audacity and blatantness of the proposal... come on, at least try and structure a much better deal so that our intelligence is not insulted (if you must beat your children, don't let us see the blue-black marks lah..)