Should investors buy a ticket on Cathay Pacific’s US$5 billion rescue plan?

Open the emergency exit and jump on the slide to bail out? Or fasten your seat belt for a bumpy ride? That’s the high-stakes choice for shareholders of Cathay Pacific Airways after it unveiled a US$5 billion government-led bailout plan aimed at keeping the carrier aloft for at least another year. The recapitalisation plan to pull Hong Kong’s flagship airline’s shares out of a nosedive comes after seven months of anti-government protests and a pandemic that has left it burning through HK$2.5 billion to HK$3 billion per month since February. Under the plan, the government will purchase HK$27.3 billion worth of shares that would amount to a 6.08 per cent stake it would keep for between three to five years. In addition, 2.5 billion new shares will be offered to existing investors through a so-called rights issue programme, which aims to inject an additional HK$11.7 billion into the company. Is betting on Cathay’s plan a good deal for investors? The advice from experts following the stock is mixed. Shareholders have three options. They can purchase seven new shares for every 11 shares they already own at a price of HK$4.68 a piece, a 44 per cent discount to its closing price of HK$8.3 on Friday. But that means pouring money into huge uncertainties. They also could hold onto their original Cathay shares and not subscribe for new ones, despite the huge dilution of stake. Or, they can bail out and likely absorb a big loss, given that the price has fallen by nearly 60 per cent over the past five years and 25 per cent in the past year, as of Friday’s close. They have until July 14 to decide, after which the stock will trade in its new form. “Existing investors will have to carefully consider the options and whether they want to increase exposure to Cathay, a company with still strong fundamentals but increasingly uncertain outlook,” said Luya You, transport analyst at Bocom International. How Cathay Pacific’s wings were clipped amid Beijing’s wrath over protests Of eight analysts tracked by Bloomberg who weighed in since the announcement, three lowered their rating of the stock – including Daiwa Capital Markets and Morningstar, which reduced it from hold to sell – and a total of six dropped their target price for where they expect the stock to land over the next 12 months. Daiwa Capital lowered its target price by about 24 per cent. “We believe its share price will come under pressure due to the resultant dilution, but also see liquidity concerns removed given the airline’s HKD2.5-3 billion per month cash burn,” wrote Daiwai Capital Markets analysts Kelvin Lau and Frank Yip. The stock fell three straight days after the announcement, for a total decline of 5.8 per cent. But that isn’t a big fall, given a sour mood that overtook the overall market in which the Hang Seng Index also declined on those days. For Cathay Pacific, which occupies over half of Hong Kong airport’s seating capacity, issuing new shares to existing investors has many advantages compared to other financing means. It would lower the company’s net debt-to-equity ratio to 0.5 times from 1.3 times, which would make it easier to borrow more in the future if necessary, according to James Teo, Asia transportation and logistics analyst at Bloomberg Intelligence. Meanwhile, existing shareholders are more likely to lend a helping hand than new investors at this time of extraordinary difficulty, as the capital injection could dramatically improve the airline’s financial health, and they have confidence in the company’s future trajectory despite the short-term liquidity crunch, said Bocom International’s You. “We already know that Cathay has attempted multiple bond issuance on the wider market which met little interest,” she said. Airlines around the world have taken a similar path over the past few months, as the global aviation industry is forecast to lose up to US$84 billion this year by the International Air Transport Association in the fallout of the Covid-19 pandemic. Singapore Airlines earlier this month raised S$8.8 billion (US$6.3 billion) through a rights issue, backed by existing shareholder Temasek Holdings. Korean Air, South Korea’s largest airline, is also set to issue around 1 trillion won ($830 million) worth of new shares to relieve its financial strain. “It’s a good way to signal to their key stakeholders that it’s now or never for their investment: either provide critical funding or watch your investment potentially go down the drain completely,” said You. This gave Cathay’s major shareholders – as well as the Hong Kong government, worried over the city’s status as a global aviation hub – enough incentives to provide the much-needed cash. They include Hong Kong conglomerate Swire Group, Beijing’s unofficial flag carrier Air China and the state-owned Qatar Airways. But for Cathay’s minority shareholders, the story is less compelling. If they choose not to subscribe to the rights issue, they could face their share in the company being diluted by up to 43 per cent, as the big shareholders up their stakes, according to analysts. If they choose to subscribe, they would suffer less dilution at around 6 per cent, according to Teo. But the cost is forking out a substantial amount of money to keep their stake largely intact, while the future of Cathay remains more unclear than ever. Given the troubles of Hong Kong’s slipping economy and political storms ignited by China’s recent introduction of a national security law, the risks are apparent. “While prices are attractive and can yield handsome returns if the industry and Cathay can rebound like normal post-Covid, there is still substantial risk in this assumption,” said You. “We don’t know exactly what the global aviation industry will resemble in the immediate years following the pandemic. Few industry experts can give a reliable forecast for the industry at present, and this means much higher risk for your average investor.” Ajith Kom, analyst at UOB Kay Hian, reiterated a hold for the stock and set a post-rights issue price target for Cathay at HK$7.6, compared to a prior target of HK$9.46. He advises investors to subscribe to the shares to avoid having their stake being diluted. “Still, investors should be comforted that the Hong Kong government will be funding 70 per cent of the HK$39 billion cash infusion,” he said. While the company has made a few missteps, including a massive oil fuel hedging mistake in 2015 that cost billions of dollars in the years following, the fortune of Cathay will be closely tied to the future of Hong Kong. A potential return of street protests – which affected Cathay more than other airlines last year – as well as uncertainties in the progress of the global fight against the virus and passengers’ future demand for air travel are some of the biggest risks. “The aviation industry still offers plentiful opportunities after Covid-19, but it will be more important than ever to distinguish between the eventual winners and losers who may not survive in the end,” said Bocom International’s You. “The stakes are much higher at this critical juncture.”