SATS will go ahead to buy Worldwide Flight Services – a global cargo handling business with presence across 18 countries in five continents.
At first glance, I thought this acquisition made much sense — SATS/WFS deal would push the combined companies to become a global cargo handling player.
In fact, SATS would eventually diversify revenues across Asia, Europe, the Middle East and Africa, and North America.
Source: SATS/WFS Prospectus 3 Jan 2023
Yet SATS shares have fallen more than 30%.
And even after the deal was approved last week, shares were still stuck in the bargain bin.
If the SATS/WFS deal had so much growth potential, why is the market still undervaluing its SATS shares?
And more importantly, will SATS still pay a dividend ever again?
WFS — struggling profits?
I went deeper into the SATS/WFS prospectus…
WFS profits soared over the last two years. But that’s not what surprised me.
What’s interesting was, if I assumed SATS had bought over WFS, SATS profits would have only improved by just $2 million.
Source: SATS/WFS Prospectus 3 Jan 2023
In fact, over the past few years, WFS struggled to produce a consistent profit.
And profit margins were much lower than I thought – mostly in the low single-digit.
Source: SATS/WFS Prospectus 3 Jan 2023
I cannot imagine a dominant cargo handler with huge presence across the world struggle to maintain a steady profit margin.
What’s more, I noticed WFS revenues weren’t that impressive too.
WFS big problem — Negative Equity
But it’s not WFS struggling profits, or razor-thin margins that concerns me the most.
What struck me the most though, was WFS’s equity – it’s negative.
Put it this way, SATS has an equity of $1.04 billion.
If SATS had already bought over WFS, the combined equity would have dropped to a -$1.13 billion.
That means, WFS has a colossal negative equity to begin with: -$2.18 billion.
Why does WFS have a negative equity?
A closer look at the footnotes tells me the negative equity is due to WFS huge goodwill balance and intangible assets — a total of $1.6 billion.
Source: SATS/WFS Prospectus 3 Jan 2023
The thing is, over the last few years, WFS buys and pays a premium on these intangible assets by acquiring other businesses – Pinnacle and Mercury were one of them.
On hand one, WFS can grow quickly by buying other businesses.
On the other, and more crucially, this also means the company cannot grow organically by developing its own intellectual properties.
You see, these goodwill and intangible assets were largely bought – customer relationships, trademarks and contracts.
And WFS paid a high price for it, which resulted in a negative equity.
WFS relies on acquisitions to fuels its growth. And this makes it a highly “capital-intensive” business.
As a long-term investor, what I want to find is capital-efficient businesses that uses as little capital to maximize profits consistently for shareholders.
This way, a company shares not only grows, but it can also reward investors with consistent dividends.
According to a brokerage firm, analysts say they expect “SATS to report higher core operations from a faster-than-expected Chinese reopening, as well as a revised proforma contribution from the acquisition of global cargo handler Worldwide Flight Services (WFS).”
They also added that “SATS’s revenue could double to $5.5 billion to $5.9 billion per annum with the acquisition of WFS… In a nutshell, we estimate WFS’s net profit contribution to SATs including intangibles amortisation to amount to about $4 million and $26 million for FY2024 and FY2025 respectively.”
I find this hard to believe.
After buying WFS, SATS revenues will double.
But WFS is probably going to weigh down SATS healthy balance sheet.
WFS has a voracious appetite for acquisitive growth, which means it needs to constantly burn cash to grow the business.
Can SATS/WFS transform from a highly-capital intensive business to a capital-efficient one overnight?
I’m not sure.
Kraft Heinz, one of the world’s largest consumer food companies was also on an acquisition binge.
In 2019, it had to write down the value of their Kraft and Oscar Mayer brands of US$15 billion, forcing the shares to crash more than 20% and had also slashed their dividends from 62.5 cents to 40 cents.
Kraft Heinz shares never recovered to its 2017 highs.
What’s more, Warren Buffett who had earlier invested in Kraft Heinz had to write down his investments in Berkshire Hathaway.
SATS/WFS highly risky debt ratio
After the acquisition, SATS/WFS “debt to equity” ratio – a measure of leverage — would have ballooned from a mere 46% to 160%.
Source: SATS/WFS Prospectus 3 Jan 2023
In my view, a leverage ratio that’s higher than 120% is a huge sign of concern.
After the deal closes, SATS still has S$300 million of debt to repay in 2025, EUR500 million and JPY7.8 billion to repay in 2026 and US$400 million and RUE590 million to repay in 2027.
This make SATS/WFS pretty risky in a high interest rate environment.
And especially if it cannot produce enough operating cash flow.
Will SATS still pay a dividend ever again?
There’s no doubt, WFS would push SATS into the global stage as a dominant cargo handler.
At first, I thought SATS would temporarily stop dividends, figure out how to complement WFS and grow both businesses across the world.
As always, the devil is always in the detail: WFS has three major problems – struggling to maintain steady profits, dealing with a colossal negative equity and a scarily high leverage after the deal is completed.
If any of these issues persist, I find it tough SATS would want to carry on paying dividends. Either it has to cut or suspend dividends.
And I don’t think the company is in a healthy position to borrow money to pay dividends.
What’s more, WFS only made $2 million net profits last year.
If I’d paid $1.8 billion to buy WFS, I need exactly 900 years to get all my money back.
That’s a long time.
Even if WFS could improve its net profits to $50 million/year, I find SATS is not paying a cheap price for this business.
It would have made more sense if a big fish bought over a smaller fish. Much of the time, smaller fish that buys over the big ones usually have trouble trying to run the business.
But that’s just my 2 cents.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan
It reminded me of NOL buying APL years eons ago. It created quite a buzz then but, in the end, NOL could not make it.
Yes! I voted against the EGM. and expect the margin of approval to be closer. Not 96.8%. Phew! Also wonder why private equities institutions holders does not issue any “for’ or ‘against’ report on the acquisition. Less Temasek ‘s Venezio holding of near 40%, the others approval is 56%. Questions is can the banks, trading houses and platform holding SATS shares for nominees who do not indicate their votes allows to vote for them.
The next step is regulatory approval. The next questions is – Who are the govts or countries that needs to approve the deal and why ? Since it is just a logistic flight forwarding and moving business.
If the people selling WFS only wants cash and not SATS shares , then what makes the SATS mgt think that top WFS people will want to stay any longer than their lock-in transition periods to ensure the successful implementation of the acquisitions.
Also geo-political risks in America and Europe is especially volatile, and can change overnight like the weather.
Another very important point for Singapore minority shareholders – which you are addressing now is, – there is no visibility of profitability and dividends going forward. Why pump in more money to take on something with no gain in sight. Might as well remain status quo and concentrate on the market that SATS knows best-ASIA.
If you are on air at Money FM89.3, please invite the SATS’ CEO and CFO to address and talk about this acquisition. Especially how much dividends and when can we see it compare with its stellar SATS dividends history before the pandemic and the WFS acquisition. If the dividends increased every year , i ‘m sure the SATS share price will also recover automatically.