By ALEX FRANGOS
June 18, 2015 12:53 a.m. ET
It is hard to see AirAsia’s turbulence problems getting better at a lower altitude.
Asia’s biggest low-cost carrier lost more than quarter of its value after Hong Kong-based GMT Research released a report June 10 questioning the airline’s reliance on associates to funnel profits to the listed parent company. Shares recovered somewhat Thursday, but remain near a five-year low.
GMT has rightly struck a nerve with investors. The crux of the argument is that heavily indebted AirAsia, listed in Malaysia, depends too much on struggling associate airlines that share its brand name, but operate semi-independently in countries around Asia, to pay it fees. These payments flatter the parent’s bottom line, while obscuring its true health.
Much of that transfer is done through airline leasing agreements between the parent, which owns or leases the planes, and the associates who operate them. The parent charges fees for leasing, maintenance, insurance and the like, and in some cases sells planes outright at a profit to the associates, according to GMT. These deals have caused related party transactions at the parent to rise to 213% of operating profit last year, from 22% a decade ago.
What’s troubling is those deals are often not resulting in cash payments to the parent, implying the associates themselves are struggling. Amounts owed by related parties have swelled to 2.8 billion ringgit ($750 million) at the end of March, equivalent to 60% of shareholder equity. The amount outstanding at the end of 2010 was just 380 million ringgit, or 10% of equity.
The associates still pay some cash to the parent—but to fund that, AirAsia has extended them significant amount of credit. That’s helped send the parent’s net-debt-to-equity ratio to 273%, according to Capital IQ. The company notes leverage was higher during the financial crisis in 2008, but it is also about double the level from two years ago.
The company and its outspoken founder, Tony Fernandes, say it isn’t hiding anything. It blames the associates’ structure on regulators in the countries it operates in for not letting AirAsia, as a foreign company, hold majority stakes in its units there.
AirAsia promises pro-forma results for the entire group, including associates, next quarter. Details on what the company earns from associate transactions will be needed to puncture fears that intercompany dealings are making profits look better than they actually are.
GMT says AirAsia has to raise about $1.9 billion in equity to right the ship, more than the company’s existing market cap of $1.1 billion. AirAsia said Thursday it will aim to have its Indonesian and Philippines associates raise $200 million in convertible bonds that will go to pay back some of what’s owed to the parent.
It is hard to see why investors would want to fund the associates just to see the cash go to pay off the parent. The company is trying to entice them with the notion that IPOs down the line will value the two units at $1.3 billion. That seems unlikely, given the parent company is currently worth less than that.
When flying AirAsia, it pays to buckle up.