AirAsia-MAS share swap: The barbarians have entered the gates

Unlike the RJR Nabisco takeover where there was a fierce battle for control of the company, in the fight for control of Malaysia’s skies, AirAsia were allowed to enter the MAS gates without hindrance. The gates protecting MAS’s control of Malaysian skies were opened wider and wider for AirAsia over the past 10 years due to inconsistent government policies.

William Leong, The Malaysian Insider

SEPT 1 — In the 10-year war for control of the Malaysian skies, while a besieged MAS was desperately fighting for survival, someone opened the gates for the barbarians to enter.

Barbarians at the gates

The AirAsia-MAS share swap reminds me of the takeover saga of RJR Nabisco. The company was a merger of RJ Reynolds, the tobacco company selling “Camel”, “Winston” and “Salem” cigarettes and Nabisco, the biscuit company selling “Oreos”, “Ritz Crackers” and snacks.

The financial firm of Kohberg Kravis Roberts & Co (commonly referred to as “KKR”) made a hostile takeover bid for the company. There was a fierce battle for control of the company. The board, in protecting the company’s and shareholders’ interest, drove KKR and the other bidders to increase their bids several times until KKR won with a bid of US$31.1 billion (RM93.3 billion). It was the largest leverage buyout in history and the record stood for 17 years. RJ Reynolds was subsequently spun out of RJR Nabisco due to tobacco legislation. Nabisco is now owned by Kraft Foods. The RJR Nabisco leverage buyout was considered to be the pre-eminent example of corporate and executive greed. The events were chronicled in a book called “Barbarians at the Gate: The Fall of RJR Nabisco”.

The fight for control of the Malaysian skies has been an uneven battle from the beginning. In the end those responsible for MAS’s defence not only did not put up a fight but opened the gates to allow AirAsia into MAS’s management. The share swap has given rise to concerns on the pricing and whether it will benefit the public-funded MAS.

Pricing issues

One of the favourite sayings of corporate raiders and businessmen is “OPM”, that is to operate using “Other People’s Money”. In the case of the AirAsia-MAS share swap, it is the people’s money because MAS is funded by taxpayers.

The pricing of the share swap has raised eyebrows. The parties, in using the August 5 closing market price of both airlines as the basis for the share swap, have raised several concerns.

Datuk Seri Anwar Ibrahim, in his August 10 article “MAS-AirAsia share swap deal raises serious concerns over effective control and governance”, referred, among others, to issues of insider trading and asset stripping.

A look at the price charts of the two companies for the past six months supports Datuk Seri Anwar Ibrahim’s concerns. The MAS share price fell sharply on May 30, 2011 to RM1.34. It continued to be in the doldrums until August 5, the date of the share swap announcement. AirAsia’s share price was on a steep and sharp climb from May. It surged to a height of RM4.20 on August 4, 2011. This is on the eve of the announcement.

There may be good reasons for the share prices of the two counters moving the way they did. However, it seems improbable for this to be coincidental. AirAsia’s price was trading around its highest and MAS among its lowest when the share swap took place. AirAsia’s price fell immediately after the announcement. It could be that those who held AirAsia shares did not like the deal. It could be whoever was playing up the AirAsia shares stopped doing so. There is therefore cause for investigations to be made.

Others have raised concerns with the price. Khazanah exchanged 20 per cent of MAS at RM1.60 per share for 10 per cent of Air Asia at RM3.95 per share. They believe the price should not have been based only on the closing market price of the two counters on August 5. They point out that MAS in fact is worth more than the price traded because it is an asset-backed corporation. It has a paid-up capital of RM3.34 billion represented by fixed asset value at RM8.4 billion, net asset at RM6.92 billion. AirAsia, on the other hand, is a debt-laden company. It has borrowings of RM7.7 billion. MAS’s cash position is RM2.086 billion while AirAsia’s is RM1.7 billion. Those who approved the deal will need to justify the pricing.

One other issue on pricing is the timing of the deal. The share swap was announced on August 9. This was within 30 days before both AirAsia and MAS announced their respective 2nd quarter financial results on August 23. Under the Bursa Malaysia Listing Requirements, this is known as the “closed period”. Those in possession of the financial results during the closed period are not allowed to deal with the shares until the results are announced. This is to prevent insider trading by those with possession of price-sensitive information. Those who trade in the shares with such information will be taking unfair advantage of the public who are unaware of the situation. Paragraph 14.08 of the listing requirements allows principal officers who do not possess the information to deal during the close period by giving the requisite notification. Although the listing requirements allow such dealings, it would have been more prudent not to enter into the share swap during the closed period.

If the share swap was made after the financial results of both airlines were announced, the market price may have given a better reflection of the share price of both airlines. This may be seen from the share price of AirAsia after the results were announced on August 23. Although AirAsia announced it made a profit, it was 48 per cent less than the previous year. The AirAsia share price fell to RM3.57 at 9.04am on August 24, the day after the results were announced. Those involved will have to explain why the share swap was done before the 2nd quarter results were announced.

Opening the gates for the barbarians

Unlike the RJR Nabisco takeover where there was a fierce battle for control of the company, in the fight for control of Malaysia’s skies, AirAsia were allowed to enter the MAS gates without hindrance. The gates protecting MAS’s control of Malaysian skies were opened wider and wider for AirAsia over the past 10 years due to inconsistent government policies.

Regulation determines airlines’ fortunes

International air transport operates within the framework of the 1944 Chicago Convention for International Air Transport. Governments enter into bilateral agreements setting out the landing rights, restrictions on capacity and pricing. Sectors within a single country are normally denied to foreign airlines. This restriction is called cabotage. It is recognised that cabotage is the prerogative of the domestic carrier. The system of bilateral agreements between two governments has led to the aviation industry to be highly regulated. There has since been a change towards deregulation and liberalisation. Nevertheless, the industry remains one where regulation plays an important role.

Regulation is thus a critical determinant of an airline’s performance. It can determine how competitive the market is as well as constrain an airline in its choice of fares, capacity and frequency. Most governments impose entry controls which are usually applied to particular routes. Most governments usually permit one airline to operate a route. The government therefore plays a critical role in determining the fortunes of an airline by deciding on the routes to be given to the airlines.

Golden service takes a beating

MAS’s finance and operation problems to a significant extent are due to the government’s inconsistent and contradictory air transport policy. Such decisions gave the MAS Golden Service a beating while AirAsia became the Golden Child.

The main asset of any airline is its route networks. The government first allowed AirAsia to compete with MAS and then gave MAS’s domestic routes to AirAsia and had its route networks reduced while AirAsia increased theirs.