By Callum Magee (University of Glasgow), Chan Seomun (University of Warwick), and Chirag Gupta (NYU Stern)
Overview of the Deal
Finnair, the flagship carrier and the largest airline in Finland, issued €200 million worth capital securities. The capital securities, also known as the ‘New Capital Securities’, offer a yield of 10.25% per annum until September 3rd of 2023 - the “Step-up Date.” Thereafter, its interest rate will be fixed at 15.25% per annum. Albeit the lack of specified maturity date of the bonds, Finnair is entitled to redeem the New Capital Securities at par on any day during the three month period prior to and including the Step-up Date. Thereafter, the firm plans to offer redemptions of the bonds on each annual interest date.
Still, the firm neither has legal obligations to redeem the New Capital Securities at any time nor do the holders of the securities have rights to demand the redemption. The securities will be treated as equities in the company’s consolidated financial statements, which follows the guidelines of the IFRS. Still, the holders of the New Capital Securities will not be given the rights of a shareholder and the securities will not dilute the holdings of the current shareholders of Finnair.
Macroeconomic Trends
Starting from earlier this year, the coronavirus has devastated the global economy and is continuing to affect multiple industries. Notably, being in an enclosed environment with poor ventilation substantially increases the transmission rate. Consequently, countries started shutting down borders in March when the number of daily cases peaked. Still, a large number of governments are keeping their travel restrictions in place.
In part driven by the pandemic and the resulting decisions of authorities to stop, or at least slow down the spread of the virus, the airline industry has been one of the hardest-hit from COVID-19. Airlines had to furlough a large number of employees due to pandemic incurred dent in revenues and profit.
Finnair employs 6,700 workers, 6,200 of whom are based in Finland. The firm temporarily laid off the majority of its Finland-based employees, partly for the spring and summer when the virus peaked - the partial layoff will be in place until further notice. Apart from these ‘temporary’ reductions in the workforce, Finnair plans to permanently cut up to 1,000 jobs.
Not many experts anticipate the end of COVID-19, with some even projecting combatting the virus for years unless a vaccine is developed soon. In Finnair’s earnings call for the 2nd quarter, the company reported a €314.6 million loss during the first half of 2020, projecting far more dismal financials for the second half of the year. Furthermore, the company updated its savings target from €80 million to €100 million, underlining a bumpy road ahead awaiting the airline industry and the firm.
AstraZeneca, alongside the University of Oxford, is one of the front runners in vaccine development. Recently, however, they reported an emergence of side-effects in one of its clinical phase 3 patients, raising concerns about the drug’s stability. Even if a vaccine is developed, air-traffic is unlikely to instantly recover to pre-pandemic levels as consumer confidence may take longer than expected to be regained. Also, there is no guarantee that airlines will be able to financially cope with the long-combat with COVID-19.
Despite the implications of COVID-19 on the airline industry, Finnair’s reliance on Airbus, with all 85 of its aircraft coming from the European plane maker, they were able to avoid grounding the Boeing 737 MAX and the high-volume cash-burn that came along with it, which competitors such as Ryanair faced due to the two deadly crashes that killed all 346 people. This may give Finnair a European competitive advantage as airlines who relied on the 737 MAX model face a double hit with the pandemic. Nevertheless, Finnair's drop in air miles and lacklustre demand, which dropped 97.5%, may cause them, along with competitors, to raise prices once demand picks up again and once passengers have the confidence to start travelling within their designated travel bubbles. Extra revenue from passenger tickets could help Finnair recoup revenues lost from cancelled flights to regions such as Hong Kong, whereby travel on this route was reduced to once per day, instead of the normal twice-daily flights, and cover the costs of cleaning procedures and face mask offerings to customers by the company.
Company Details
Finnair is the flag carrier and largest airline of Finland, with its major shareholder being the government of Finland which owns 55.8% of the company. Finnair is the dominant domestic and international air travel company in Finland and is one of the world’s oldest operating airlines. Finnair is headquartered in Vantaa on the grounds of Helsinki Airport, its hub, and specialises in the transportation of passenger and cargo traffic between Europe and Asia, and also offers package tours under its Finnair Holiday and Aurinkomatkat-Suntours brands.
Founded in: 1923
Headquartered in: Vantaa, Finland
CEO: Topi Manner
Number of Employees: 6,788 (As of 2019)
Market Cap: €615.79 million (As of September 2020)
EV: €1.64 billion (As of September 2020)
LTM Revenue: €2.27 billion
LTM EBITDA: €77.3 million
LTM EV/Revenue: 0.72x
LTM EV/EBITDA: 21.22x
Debt Asset Ratio: 0.5x
Table 1: Current Capital Structure of Finnair (Capital IQ)
Table 2: Bond Structure of Finnair (Capital IQ)
Table 3: Credit Health Panel Comparable Analysis (Capital IQ)
Projections and Assumptions
Why was this deal done?
Since the outbreak of COVID-19, the airline industry has been in a huge panic. As travel restrictions limited the number of flights, banning all flights in the worst case, various companies in the sector became cash-strapped.
Furthermore, as Finnair’s hybrid bonds are in the form of an equity instrument that does not dilute the firm’s current holdings structure, issuance of the hybrid bonds would do no harm to current shareholders. By adding hybrid bonds on their current capital structure, Finnair can diversify its investor base, which the firm believes to be key to mitigating the impact of COVID-19 on its capital structure, balancing their financial strength. The firm is planning to use the proceeds of the offering to finance the redemption of its existing capital securities. This older debt carries a lower 7.875% annual interest rate, which would step up to almost 13% if it were not repaid by October. Leftover capital is likely to be used to cover up the pandemic-driven plunge in revenue, as well as paying the remaining employees of the firm.
“Refinancing of the existing hybrid bond further supports our balance sheet strength”
Mika Sitrkkinen, Finnair’s CFO
Short-term Analysis
The media reported Finnair’s issuance of hybrid bonds just two days after the airline revealed its plans to furlough at least 1,000 jobs and to extend temporary layoffs that have been in place since the outbreak of the pandemic.
Travel restrictions are imposed by governments, therefore, the degree of restrictions - for instance, the number of destinations flights can go - differ by airline. Exceptionally tight travel restrictions in Finland significantly dented the number of Finnair flights. Finnair faces a bleak outlook due to the effects of COVID-19, with passenger numbers not expecting to be back at pre-COVID levels until 2023. In August alone, Finnair carried 193,000 passengers, which is 85.8% less than in the corresponding period of 2019.
General macroeconomic developments and lacklustre demand may have a material adverse impact on the demand for Finnair’s services, including their flying routes to Asia and non-EU countries. Changes to the bilateral agreements and/or the trade relationship between EU and non-EU countries may result in limitations to Finnair’s flight routes. This coupled with nervous passengers due to the pandemic, who are expected to spend as little time in the air and in transit as they can, will severely impact demand for long-haul flights, and give rise to more short-haul and efficient aircraft to facilitate faster travel. This may cause financial and liquidity issues for Finnair in the long-run if they aren’t able to see the demand they had pre-COVID, as the amount of indebtedness that Finnair currently has and which it may incur in the future could lead to the breach of financing covenants or limited access to additional capital and liquidity.
Despite Finnairs reduced flights and incurred cash-burn, Q2 cargo flights were resilient, with 602 one-way cargo-only flights mainly to Asia, as Finnair was a strong link to supplying essential items to countries through the pandemic. Furthermore, due to COVID-19, the operational level was adjusted and thus underlying currency and fuel price exposure was non-existent, mitigating the negative external factors to Finnair's finances. Finnair has however stated that they will restore their hedging positions, with the timeframe dependant on capacity and fuel price development.
“A rapid turn for the better in the pandemic situation is unfortunately not in sight. As the timeline for aviation’s recovery is unclear, our plan is also to implement significant temporary layoffs to adjust our resources”
Topi Manner, Chief executive of Finnair
Long-term Analysis
Although Finnair’s long-term outlook is bleak due to an exogenous shock, the State of Finland holds a 55.8% stake in the company, creating a backstop for the airline company if they face severe liquidity issues. It’s unlikely the State of Finland will let their prized aviation company go bankrupt given their majority shareholding. However, future complaints and appeals concerning the state aid decision connected to the State of Finland’s participation in Finnars rights offering and other transactions involving Finnair and the State of Finland may result in additional costs for Finland and materially and adversely affect Finnair's financial and liquidity situation. As a result, on the 20th May 2020, Finnair announced that it was targeting nearly €80 million in permanent cost base reductions by 2022, compared to 2019 levels. The COVID-19 impact, such as remote working and its effect on business travel, are likely to be longer-term in nature. As such, Finnair has increased its savings target by €20 million, increasing its initial expectations for a permanent reduction in its cost base of €100 million.
Furthermore, although the aims of Finnaris Dividend Policy is to pay on average at least one-third of the earnings per share as a dividend over an economic cycle, their Board of Directors and shareholders resolved in the 2020 AGM that due to the pandemic, no dividend will be paid based on the balance sheet adopted for the year 2019. This coupled with Finnair’s prediction of a 2-3 year recovery of air traffic back at 2019 levels, and with their backing of the State of Finland, this may help them preserve a strong liquidity position and the ability to raise further capital in future, and ensure the company's long-term survival.
Financial Ratio Analysis
Table 4: Financial Ratios of Finnair (Capital IQ)
Return on Assets, Return on Capital and Return on Equity have all entered negative territory in LTM 12 months Jun-30-2020 as Finnair has been struggling from universal lockdowns and travel restrictions resulting in inefficiencies in managing the company and the environment, affecting the core operations of the company
Finnair’s EBITDA margin has managed to stay positive in the LTM 12 months Jun-30-2020, but EBITA and EBIT have turned negative, a sharp contrast from previous years, signalling higher costs incurred to survive the pandemic
Finnair’s Current Ratio has managed to stay resilient, maintaining a similar multiple to previous years. This may prove Finnair is likely to survive the current turmoil, even disregarding the Finnish Government's support
Risks and Uncertainties
One of the most common methods implemented by the government to stop the spread of the virus is social distancing. Once some countries started to ease travel restrictions, some airlines started operating their business again. Still, the airlines that resumed operations not only had to reduce the number of flights due to plunge in demand, but also had to follow the social distancing rules on planes, keeping spaces between passengers and reducing flight capacity. Until social distancing measures are completely eased, Finnair will have to confront at least a 50% decrease in revenue for a while. Nevertheless, innovative international travel bubbles which have been introduced or which are currently under development may help aid Finnair's disrupted financial recovery as they have access to previously restricted flight routes.
In the worst-case scenario, there is a possibility that Finnair may not be able to redeem the hybrid bonds. As there exist no legal obligations for the firm to redeem the newly issued hybrid bonds, and if the company's financials worsen to the point where they cannot pay back their lenders, holders of the bonds may face a tough time collecting what they have lent.
“We maintain a diversified investor base by using equity instruments, such as the hybrid bond, as we seek to mitigate the impacts of the COVID-19 pandemic on our capital structure”
Mika Stirkkinen, CFO of Finnair