TAP - Scaling the challenge
All,
Please find our all-new analysis here.
As we calculate through Portugal’s restructuring plan for TAP, we conclude that the amount of external capital required to satisfy the EC should be no more than €0.5bn. We think this is a scaleable challenge and retain our long position, despite last week’s events.
The Plan:
- On top of the €1.2bn of Rescue Aid injected in 2020, Portugal’s plan seems to envision the injection of Restructuring Aid of €1.5bn, resulting in a total of €2.7bn in State Aid. The plan seems to balance this figure with Own Contribution in the form of cost reductions and contract renegotiations (leases and labour) of €1.5bn, which amounts to 36% of the total €4.2bn.
- Portugal also proposed a Buffer injection of €0.5bn next year, in case TAP is unable to access capital markets and has injected a near €0.5bn in compensation for pandemic-related damages, which are not part of the plan.
The EC’s response:
- The EC can accept Own contributions of less than 50% in exceptional circumstances, however, it has a number of issues with the plan, which as of July have put the ball back into Portugal’s court:
1) The Own Contribution is too low.
2) Own Contribution is meant to be “Real and Actual”, meaning it's supposed to be equivalent to cash and not a discounted value of future cash flows, or worse: cost savings.
3) The EC dismisses Portugal’s argument that the Own Contribution rises to near 50% if taking into account the Buffer and the injection for Damages. According to the EC the access to cap. markets next year is uncertain and if anything the Buffer would be more state aid if such access fails. Moreover, the injection for Damages is excluded from the plan altogether as an exception from State aid.
4) The EC contends that in other cases, such as Air France, third-party capital has been found to validate their plans. The EC implicitly wishes to see either some external capital (outside the state and not state g’teed) or a very good explanation why this is not possible at TAP.
What now:
- The brand new CFO and head of capital markets relations among other things just resigned. He joined the board this summer (along with most others) around the time when the impending response of the EC must have been reasonably clear. That he is leaving now (for unforeseen personal reasons) does not immediately suggest that he has found that capital. However, with only about one month under his belt, he may not have exhausted all possibilities (if that is even the reason for his departure).
- We estimate that fresh capital (debt or equity) of around €500m would bring the Own Contribution ratio to nearly 50%. If it's debt, it is not to be state-guaranteed, but under Portuguese law, the parent entity has implicit responsibility for subsidiary debt. So depending on how it is structured, such debt could benefit from an implicit guarantee.
- The contribution could be split in debt and equity.
Portugal’s chances:
- The cost savings that Portugal has been advertising as Own contribution are for the most part with leasing suppliers. Those and others are external parties and the documents are allegedly signed. There is a reasonable chance that the EC will accept those renegotiations after all. Alternatively, there could be a financing solution that mirrors this as a real and actual contribution, a trickery the EC should not insist on.
- There will be €250m in Portugal that will accept an implicit govt. g’tee for an acceptable yield.
- There is Lufthansa. The German flag carrier is looking for ways to engage in the trans-Atlantic segment, but is held back by its unfavourable geo location - further away than London, Madrid or Paris. LH have been looking to take a stake in TAP even before the pandemic and the current RI should return them the freedom to do so. The transaction would be dilutive, but it would also be strategic. Portugal can size the equity to Lufthansa’s liking by deciding how much of the €1.2bn rescue aid to equitise vs. Deeply subordinate. We think €250m should buy LH at least 10% of the equity, possibly with the option of taking more down the line.
-> The above measures together should be sufficient to the EC in our opinion. So we think Portugal’s chances are relatively good. The EC after all is not looking to rock the boat unnecessarily and TAP is of immense strategic importance to Portugal.
Positioning:
We remain long TAP 24s (NY Law) for some 3% of NAV on the thesis that the bonds will not be touched and that their chances of actually being refinanced in 2024 will rise substantially in the coming months.
Happy to discuss,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk