In 2007 shareholder newsletter, Buffett had written that “if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.”*
In 2016, Buffett eschewed his own advice and revealed a surprise bet on airlines. Years of consolidation through post-bankruptcy mega-mergers and a decline in fuel prices have helped airlines rake in record profits.
When Warren Buffett started to buy airlines, we thought we should dip our toes in as well. But we procrastinated until the pandemic hit in 2020 (that’s how good we are at procrastinating!).
In 2021, we think that the industry is on its knees and there is really no way for it to stay grounded forever and it is really the time to revisit our initial impetus to invest in the takeoff.
The way to understand our thesis on investment in carriers is more like a venture capital investment than a regular public equity investment.
Do scroll through the long list of assumptions below.
If you disagree with any, skip this thesis. This is not for you!
This flight will be gut wrenching, so hang on to anything you can grab hold of.
Travel is desired by all and enjoyed by the few (11% of the world population flew). Once they start, they can hardly stop.
As the world gets richer and populations age, people with the time and the means to take a holiday abroad will keep flying. The urge to travel is unlikely to be permanently dimmed by a pandemic, people will just fly to somewhere closer.
Domestic travel will recover more quickly than international travel. Tourism in coastal and rural locations will recover faster than cities.
Demand for short haul flight will recover first. Short haul fare prices will remain low, low cost carriers will recover faster while legacy carrier continue to lose money.
If our assumption is that travel is going to come back, then the domestic and regional travel will began before long haul international flight. We will want to be invested in short haul than long haul. We will prefer low cost carrier than legacy carrier.
Funding is like selling a portion of your soul, you lose slowly and then everything.
Legacy carrier had received bailout from their various government. These bailout are not “free” as they are structured as equity/debt support. Issuing tons of shares to government bodies only ensure that they continue to meddle with business, making legacy airlines job of returning back to profitability much harder.
Ryanair in Europe, Southwest in America and AirAsia, all low-cost carriers had raised equity/debt and are ready for a rebound in air travel. Their ability to raise money from the private sources shows that investors believe in their sound business model and balance sheet to weather the pandemic.
Lessor repayments will largely be deferred as the lessors need the low cost carriers to stay alive. The low cost carriers’ dominant market position, coupled with a subdued global aviation market ensure that the lessor has no choice but to complete the negotiations at their own cost. New repayment plans and lease payment model created will be beneficial to the low cost carriers.
As most low cost carrier choose not to receive any government bailout, they are also the one who had responded the fastest in trimming whatever fats they have. Upon exiting from the pandemic, they will operate with efficiency that the legacy airline cannot hope to compete on.
For normal businesses, the more debt or equity you issue, the worst the investment return. For a company which has a “bright future”, the main thing is to ensure that there is adequate capital to get to the future.
Low cost carrier will come out of this crisis with a much stronger business model compared to the legacy carrier. On a strategic basis, the low cost carriers are much more important than the legacy carriers. They simply carry more passengers. The government of each low cost carrier will ensure that the low cost carrier to continue to survive.
Nothing is base on reality, but perception of reality which drives possible reality.
Soros’s reflexivity theory states that investors don't base their decisions on reality, but rather on their perceptions of reality instead. The capital raise shows that the company has a higher chance getting to the “bright future” creating the possibility of more successful capital raise.
The “bright future” is a world where everyone is travelling. Funding raise both in equity and debt only help to ensure that the “bright future” is possible resulting in the rise in the share price.
Rising share prices allow for equity raise with lower share issuance, exactly at the time when the perceived risk is the lowest.
Valuation is usually base on estimating cashflow, earnings and assets. But if everything is negative, the only valuation you can depend on is the current fund raise. If the fund raise ensure that the company survive, then the valuation of the company gets higher allowing a positive reflexivity to set in.
This will form part of our leisure thesis under the statistical portfolio.
We have been thinking and reading about this company since 2015. This is the only airline which we are interested in as it is still a “start-up”. It is founder led, place in a growing region of the world and has multiple ways to grow. The founders have proven their mettle through the years and we think they will survive and do well when the pandemic recedes.
At the same time, they are also looking beyond airlines and looking at data. We do not know what that will entail, but we believe that the options that is present in this company could provide some re-rating in the future.
AirAsia is Southeast Asia’s largest low-cost carrier.
On a five year chart, it is trading at a new low. If we had invested in AirAsia in 2016, we would had made a profit exiting in 2018 - 2019. Instead we are going to invest in them when they are still trying to survive the pandemic. If you agree with our numerous assumptions above, this requires little convincing.
Key operational metrics improved in December 2020 in comparison to September 2020
31% increase in passengers carried by AirAsia Thailand,
doubling of passengers carried by AirAsia Philippines,
number of passengers carried by AirAsia Indonesia multiplied by 11 times,
AirAsia Malaysia closed the fourth quarter with 834,934 passengers carried on a healthy 72% load factor.
Debt and Equity raise
first tranche of the Placement Shares, at MYR 0.675 per placement share was completed following the listing of and quotation for 369,846,852 Placement Shares on 19 February 2021.
second tranche of the placement Shares, at MYR 0.865 per Placement Share was completed following the listing of and quotation for 100,367,362 Placement Shares on 17 March 2021.
Investors include TPG Capital founder and chairman David Bonderman, TPG Asia Partners, Head and Shoulder Financial Group chairman, Stanley Choi and investment firm Aimia Group.
Plans to raise MYR 2.5b through debt and equity
MYR 1b loan will come from three Malaysia banks, pending approval from Malaysia’s regulators - Danajamin.
Based on fund raising by the first (MYR 0.675) and second (MYR 0.865) tranche of private placement
Conversion of Aimia 20% stake in Big Life at MYR 1.20
A database of 560m annual unique visitors for its web and app
40m mobile app downloads and a wide following on social media
BigPay download of 1.2m, 700,000 cards (we just applied for one)
Organic customers growth through online payments
KYC is done through check in at airport
National ID (passport) is verified through travel arrangement
If you had not realise, we had not touch on any financial.
The way to invest in the venture capital way is not to look at the numbers for there is no numbers to see. Projecting that the revenue and margin will revert to the past (mean reversion) is just an exercise of plonking some imaginary numbers on an excel sheet and believing that the future will look like the past (we don’t think so…).
None of these are needed here. The thing to look for are
Target Addressable Market [Verified]
Business Model [Tested]
Enough capital to tie through to the “bright future” [Just Confirm?]
The two fund raising exercise had de-risk AirAsia from going to go kaput within this year. The MYR2.5b should last them for another 2 years,.
Before the pandemic, AirAsia has already start morphing into a digital play with little physical assets (but with lots of leasing liabilities). They are an operational company with the capability to grow with the least amount of operational cost.*
Some downside protection:
Malaysia government will not let AirAsia go Kaput (AirAsia is definitely more strategically important than Malaysia Airline)
Lessor cannot afford for AirAsia (their biggest customer) to go Kaput.
The best airline investor in the world David Bonderman is with us here (thou at much lower prices…)
Some upside options:
Completion of MYR 2.5b worth of fund raising
Fund raising on AirAsia Digital
Higher than expected passenger demand
We are firmly seated and let us all pray that the flight will takeoff and not crash.
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*We have conveniently avoided the question: is the industry turning profitable? Our best guess is that long haul will become horrible and short haul will be a mildly profitable. The digital route will bring the riches if AirAsia can execute effectively.