TAP - Why bother with the EC
All,
Please refer to our unchanged analysis here.
If the Portuguese government wanted to exploit the Portuguese Law angle of the bonds in the context of a restructuring (which would have to be an insolvency / asset deal), then why would it bother talking to the EC? Buying assets out of insolvency surely does not require approval (at these valuations they’ll be the only bidders in a fair market process). But be it as it may, Portugal are all over the EC and the latter have opened an in-depth enquiry, which invites comments from everyone - including Michael O’Leary and TAP - and will last at least until September.
EC Decision on Rescue Aid:
- The EC has upheld its June 2020 decision to approve the initial €1.2bn bailout following its rejection by Luxembourg’s General Court. This was widely expected, but means that the funds injected then do not have to be repaid, which would result in imminent insolvency.
EC Decision on Restructuring Aid:
- The EC has launched an “in-depth enquiry” into TAP’s plan - resubmitted on the 10th of June 21.
- The €3.2bn Plan (not public) is described as containing
- € 512m of market loans backed by a government guarantee
- €2,730m of equity and quasi equity measures, of which:
- €1,200m equitisation of the Rescue Loan provided in 2020
- €1,530m unknown… - and could include bonds, even if we think that’s unlikely. A however forced equitisation of the bonds would hardly fit that description.
Some deliberations:
- Of the €3.2bn up to 60% could come from the Portuguese state (Parpublica) “aid", so approx. €1.9bn, of which €1.2bn are made up of the rescue facility. Another element in the aid package is the proposed guaranteed market loans of €512m. We think Portugal - like most other states - will go to the full 60% to rescue its carrier. So we are expecting another €200m contribution, which could be a write-down of the existing equity in SGPS.
- So the 40% = €1.3bn “own contribution” (see below) would have to entirely consist of “equity and quasi equity” measures. The convertible is owned by the shareholders, so could be equitised, and in any event bonds last year were asked to waive a covenant allowing the state to hold TAP SA outright - without SGPS in between. So the current share capital could go altogether, leaving approx. €1bn.
- The EC definition of “own contribution” includes write-offs. We note that TAP SA has a giant upstream intercompany loan to its own parent of €875m that is likely worthless. If eligible, a write-off against the equity would dramatically reduce the CASH required for Lufthansa to buy their stake. The entry of the German flag carrier would put the transaction beyond complaints from Mr. O’Leary but would need to be made for real tangible value (see R&R guide lines).
- We concede that all the above steps considered, the acquisition would be dilutive for Lufthansa and even if Lufthansa are planing on re-paying their state aid, cash remains a precious commodity in Frankfurt. But the deal is strategic. It's a rare opportunity and it is not large for LH.
Constraint - R&R Guidelines:
- General guidelines require an “own contribution” of at least 40% from the company and involved parties (shareholders / creditors). https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52014XC0731(01)#ntr35-C_2014249EN.01000101-E0035
Constraint - Novobanco:
- We think it unlikely that Lufthansa would want to take the reputational risk of driving a deal reminiscent of Novobanco. As widely reported, the Portuguese government and TAP had been in advanced negotiations with Lufthansa for a stake in the Portuguese flag carrier, brokered by David Neeleman until the outbreak of the pandemic put the transaction on hold. For Lufthansa to step in now, it would have to first repay its own state aid, but CEO Spohr already indicated he was looking to do so ahead of Germany’s federal elections in September. Lufthansa, who neither confirmed, nor denied latest rumours, is well positioned in Europe and into the Middle East. TAP’s routes would be complementary and would give it further strength on routes to South America and Africa. We estimate a 20% stake in TAP would be representative and help boost the “own contribution” quota.
- Novobanco has also been a very different situation. Portugal at the time had a short window in which it could act before an EC directive was coming into force. The same technicals are not in place today. But more importantly, TAP is a very important employer in the country and still a going concern. The damage to Portugal that would arise from trying to better their position by E500m through another foul manoeuvre would be disproportionately larger.
Positioning:
- We continue to hold the 24s for 3% of NAV with a view to benefiting from a large-scale equity restructuring beneath the bonds. While bonds may be asked to amend and extend, the recapitalisation of the airline should be a major positive driver.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003