The TLDR (i.e. executive summary) version is found here.

SATS has for the longest time been seen as a safe and stable blue-chip stock, especially with its market dominance locally. Even such a profile could see a c.20% plummet in share price over just 2 days resulting from a single decision. Did the market overly punish SATS? Is this an opportune time to buy into SATS?

1. Background

1.1. Business Overview

SATS Limited (“SATS”) provides gateway services and food solutions across the world. It is best known to be the chief ground-handling and in-flight catering service provider at Singapore’s Changi Airport, with c.80% market share [Source]. SATS operated as a subsidiary of Singapore Airlines until September 2009.

Gateway Services include passenger services, apron services, air cargo, security services, and even cruise terminal services. If you have ever travelled through Changi Airport, chances are you were served by SATS. With covid-19, SATS has been attempting to capture the growth of pharma & cold chain logistics as well as e-commerce in this space.

Food Solutions include aviation catering, institutional catering, and commercial catering. etc. If you have served national service in Singapore, you would recall that some cookhouses are run by SATS. SATS has been actively looking into ready-to-eat meals, and alternative proteins, building central kitchens and extending shelf-life through technology.

1.2. Important Backdrop: Key Events and Implications on Share Price Performance

Pre-covid, SATS was trading at an average of S$5.07 (2018 to 2019). Share prices remained stable as growth was relatively slow stemming from its market maturity and leadership. SATS was seen more as a stable dividend play (with a 70% to 80% dividend payout ratio).

Being closely tied to aviation and travel, its share price was significantly affected by covid, trading at c.S$3.2 (-37.2% from pre-pandemic) across 2Q-4Q of 2020. Recovery was on track especially as vaccination rates rose and Singapore gradually transitioned into endemic. In fact, the share price was hovering around S$4 to S$4.6 during 1H22, slowly inching towards its pre-pandemic average.

However, before it could completely recover, SATS’ share price unexpectedly tumbled down to less than S$3 after the announcement of its acquisition of Worldwide Flight Services(“WFS”). The market viewed the deal unfavourably and had especially weak sentiments toward its fundraising plans. Despite having just a market cap of S$3.41b (as of 13-Dec-22), SATS was attempting to buy WFS for S$1.64b [Source]. Is SATS trying to bite more than it can chew? The rights issue announced to finance the acquisition, which would cause investors the need to cough out more capital to remain undiluted, was clearly not well received in the current macro climate where the Fed is constantly hiking, and investors are waiting for cheaper valuations before buying. This led to significant sell-offs, such as Fullerton Fund Management which disposed of 1.8m SATS shares for S$5.4m [Source].

With the above backdrop in mind, our analysis and theses will revolve around these 3 simple questions:

1. Are worries over the WFS deal overblown?
2. Is there still value to extract from covid-19 recovery?  
3. Will SATS be able to stay relevant and capture future tailwinds despite historically slower growth?

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2. Are worries over SATS' proposed acquisition of WFS overblown? 

2.1. Background of the Acquisition

A brief timeline of the deal thus far, with the closing expected to be 13-Mar-23 [Source].

2.2. Delving into the key acquisition rationales

Key Rationale #1: Acquisition delivers a strong and positive financial impact to investors immediately

SATS is forecasting the acquisition to translate into extremely favourable financial impact, with c.3x revenue growth, c.5x EBITDA growth, and c.2x EPS accretion. Prima facie, these figures look impressive.

Evaluation: While financial impacts are unlikely to be as rosy as SATS claim, they are still highly impressive overall  

However, using FY22 figures as a base might not provide a true representation of the financial impact of the acquisition. Pre-covid or normalized/adjusted figures might have been more apt.  

1. The bar chart in pink used SATS’ FY22 figures, which were severely depressed due to covid-19 --> This means that an unusually low starting reference point was used, which made it seem like the increase is significant.
2. WFS benefited greatly from covid-19 as the bulk of its business is in air cargo handling, which saw a boom from e-commerce and pharma demand. It is unclear if such high revenues/EBITDA can be sustained especially with a looming global recession. --> An unusually good/bumper year of revenue and profits of the acquiree was used (Figure 3.2.b) to add to the merged entity.

Hence, painting an overly rosy picture that is applicable only for an exceptional year.

At the end of the day, SATS is trying to sell investors the acquisition story. Naturally, rosier numbers are used.

In SATS’ defence, overall, the deal is still nevertheless very likely to bring a highly positive financial impact. I say so because of the following:

1. High confidence in EPS accretion: The merged entity derived an impressive 78% EPS accretion with the assumption that the deal was almost fully funded via equity (hence increased in no. shares). With the deal now funded via more cash and debt, this will likely enhance EPS accretion. [Read more about EPS accretion here]
2. Using FY22A figures does not capture the value of synergies: The full financial benefits can only be reaped in the long term if SATS can execute well and reap the full potential of the synergies present. Historical year Pro-forma financials will not capture this important factor.

Speaking of synergies...

Key Rationale #2: Highly complementary acquisition bringing significant potential synergies with expected EBITDA run rate in excess of $100m over the medium term

Given that this was a horizontal acquisition, there are many revenue and cost synergies to be reaped. SATS has identified 5 key areas of synergies in the near to medium term highlighted below:

SATS and WFS are highly complementary especially since there are minimal overlaps in coverage. Out of the 164 locations WFS operates from, only 4 overlaps with SATS’ existing locations. While SATS is strong in Asia, WFS’s strength lies in Europe and North America [Source]. One of the key impediments of SATS’ growth was securing licenses to operate abroad. After all, the number of licenses given out is controlled and regulators often renew existing handlers. This acquisition is a game changer for SATS, transforming it from a regional-focused player to a global giant – a goal that SATS has been facing difficulties in reaching for the longest time, given the nature of the industry.

Evaluation: Actual synergies realized can be heavily impacted by execution/integration risks  

Synergies are extremely difficult to quantify. The stated $100m is likely to be based on multiple assumptions (which are undisclosed) and hence making it a slightly reliable figure at best.

Given that SATS has no prior experience in M&A integration at such a large scale, there is a high risk of unexpected integration costs, which might in turn result in the full value of synergies not being captured. To illustrate how severe this risk is: A 2016 analysis of 2500 deals by LEK Consulting found that 60% of transactions destroyed value. Studies cited in the Harvard Business Review and elsewhere place the failure rate between 70% to 80% [Source]. There is also no clear value creation or integration plan laid out by SATS in the communications thus far and hence making it difficult for us to conduct any analysis. 

Only time will tell whether the integration will be a success. Nevertheless, a few points are giving us comfort on the deal:  

1. Temasek does have a ton of experience dealing with M&A integration. Hopefully, there will be some knowledge transfer that will help smoothen the learning curve for SATS. 
2. Additionally, WFS has changed hands 3 times since 2006 (Once in 2006, second in 2015, and third in 2018), meaning that it is likely no stranger to relatively big changes within. Ideally, this translates to less resistance to change when post-acquisition integration plans are executed. 
3. A new management role was created, likely to oversee the WFS acquisition. Veronique Cremades-Mathis was appointed “Chief Strategy and Commercial Officer” in October 2022 [Source]. It is unclear whether she has prior experience in M&A integration, but she was the CEO of Nestle New Zealand and Global Head of Dairy, Food, and Confectionary at Nestle. Nestle is a pretty acquisitive company and so, I won’t be surprised if she has some experience on this front. The former Chief Strategy and Sustainability Officer (now Chief Data and Sustainability Officer), Spencer Low, also had prior experience with post-merger integration during his time at Agoda [Source]. 

2.3. Common Concerns over the Acquisition

Is SATS overpaying for WFS? 

Sure, there might be significant synergies and upsides to being captured from this deal. But the acquisition will still underperform (from an ROI perspective) if SATS overpays for the deal. 

While researching, I have read multiple commentaries opining that SATS is likely overpaying for this acquisition, mainly citing 2 reasons: 

1. WFS has an exceptionally lower valuation multiple this year stemming from covid-19 induced demand, possibly making WFS look cheaper than it actually is. 

2. SATS is buying WFS from a private equity firm, which typically has pretty high hurdle rates. 

Quantitative Perspective

To verify this, let’s look at the numbers. How much is SATS paying for WFS and how much did its current owner buy WFS for? Cerberus Capital Management (current owner of WFS) bought WFS in 2018 in a deal worth €1.2b [Source 1, Source 2, Source 3], with €660m funded via senior secured notes from various banks [Source: Debtwire]. It is unclear from public disclosures whether this €1.2b refers to enterprise or equity value.

• ‍If the €1.2b deal value refers to enterprise value, Cerberus is selling WFS to SATS at a significantly higher EV/Revenue multiple of 1.31x (LTM Mar-22 Revenues) or 1.64x (Normalized Revenues; average of 2019 and 2019) compared to the 0.91x it paid when it bought WFS from Platinum Equity. 
• From an EV/EBITDA perspective, if we use LTM Mar-22 EBITDA, SATS looks like it is buying WFS at a reasonable price of 9.7x multiple compared to what Cerberus paid at 10.17x multiple. Furthermore, precedent transactions provided by CGS-CIMB has a median EV/EBITDA multiple of 9.8x [Source]. SATS’ financial advisors also provided peer transactions revealing EV/EBITDA multiples between 10.2x to 10.7x [Source]. However, if we use normalized EBITDA (average of 2018 and 2019), SATS will be paying at a significantly higher multiple of 23.32x compared to both what Cerberus paid for and other comparable transactions. Hence, the takeaway here is that SATS will likely be overpaying from a valuation multiple perspective if after considering synergies, WFS is unable to maintain its current financial performance going forward. ‍
• If the €1.2b was however referring to purchase price or equity value, then SATS would be looking at a bargain since P/S multiple will be 0.69x (LTM Revenue) or 0.87x (Normalized Revenue) compared to Cerberus’ 0.91x. This scenario is less likely since it would mean Cerberus selling WFS at a margin contraction. 

Qualitative Perspective

Apart from numbers, there are a few qualitative factors to consider, which suggest that SATS is after all not overpaying for WFS.   

1. Management shared that the WFS acquisition was not through a competitive public tendering process, but it was SATS who voluntarily engaged WFS to solicit for a deal. Public tendering involves greater competitive pressure and hence, may result in over-bidding at an unjustified premium. Timeline is also tighter and may result in less due diligence. SATS has been tracking WFS for 3 years as a potential target before formally approaching in November 2021. ‍
2. SATS is not new to M&A and has an army analysing the deal. Apart from SATS’ own M&A team (Figure below), there were also Temasek, Bank of America, and DBS [Source] looking to advise the transaction. Management noted that a rigorous due diligence process covering commercial, financial, HR, operational was conducted over the course of 5 months. Having personally worked at M&A advisory in an investment bank and Big 4 transaction advisory, I am quite certain that a comprehensive valuation exercise was conducted. Using normalized figures as part of the comparable analysis was likely taken into consideration given that it is a relatively basic SOP. Furthermore, SATS has experience with closing multiple transactions in the past (Figure below), albeit being much smaller in scale as compared to WFS. Hence, this process is not entirely new to SATS. 
3. It is common for strategic buyers (like SATS) to pay a premium on the market/fair value as potential synergies are often factored in. The purchase price should not be seen by valuing WFS as a standalone entity, otherwise, it ignores the whole point of making this acquisition in the first place. A study by the Copenhagen Business School analysed European buyouts and noted that strategic buyers paid an average premium of 28% vis-à-vis financial buyers at 22% [Source].  

Given that WFS is a private company, it makes it significantly harder to conduct an accurate independent opinion and analysis balancing the returns (synergies) and cost (purchase price) of the deal. As such, at the end of the day, we are still somewhat making a bet on the calculations of SATS’ management. SATS’ CFO (Manfred Seah) has 25+ years of investment banking, direct investments, and financial management experience. Alongside deep industry experience from the likes of Bob Chi (CEO, Gateway Services), it does provide investors with some confidence in the transaction.

Will SATS be overleveraged post-acquisition?

Merged Entity Debt Computation

Assuming negligible non-controlling interest and preferred stock, WFS is likely to have a net debt of roughly (Enterprise Value – Equity Value = S$3.107b - S$1.639b) S$1.4131b. Currently, SATS’ balance sheet has approximately S$854m of debt. SATS will also need to take on additional S$700m of term loan to fund the acquisition. Hence, the merged entity will have a total of S$2.967b of debt. This represents a 3.5x increase in debt from its current balance sheet. This does sound like an alarming figure and is perhaps why SATS initially wanted to fund the deal fully via rights issue.

Assuming that SATS offer S$800m in rights issue at a 20% discounted price (S$2.89*80%), SATS will issue an additional 346m in shares (S$800m/S$2.31). Hence, the total outstanding shares will be 1.468b. If the share price remains constant at S$2.89 (Note that TERP is S$2.75), the market capitalization of the merged entity will be S$4.243b. D/E ratio will then be 0.70x. 

Comparable companies in gateway services have a median/mean D/E ratio of 0.68/0.79 while comparable companies in food solutions have a median/mean D/E ratio of 0.36/0.36 (Refer to valuation section for list of names). This means that post-acquisition, SATS will be relatively highly leveraged compared to industry norms. However, it is possible that SATS may engage in divesting some of its investments and assets to repay off debt in an effort to deleverage and bring down its debt position. 

Implications

Since SATS is unrated by credit agencies, there is no impact on that front. Nevertheless, the cost of debt in future will still likely be significantly higher given its much higher leverage position. While unlikely, it might also cause SATS to have issues refinancing loans in the future, in turn causing severe repercussions like the need to liquidate assets.

Furthermore, earnings will be affected significantly given the higher interest expense, especially in the current high-interest rate environment where the Fed continues to be hawkish. 

Because the financials for WFS are not disclosed publicly, it is difficult to model out the cash flow to evaluate if SATS will have liquidity issues pertaining to the high financing cost it needs to shoulder. What we do know is that SATS has 2 notes payable worth S$300m due early April. It is unclear if there are further repayments needed from SATS’ term loans and WFS’ debts in the near term. 

What gives us comfort is SATS’ strong cash generating abilities. Pre-covid, operating cash flow margin was hovering around 12 to 17% (much higher than dnata), a key reason why SATS was able to provide a 5 to 6% dividend yield for years. LTM figures show that SATS is already cashflow positive despite significantly less government reliefs. SATS also has a large cash war chest of S$369m (S$689m - S$320m) that is likely able to sustain itself for awhile. 

Again, without full disclosures, we are somewhat betting on the calculations of SATS’ management that the amount of leverage is non-threatening. 

Concerns over use of rights issue as a fundraising tool 

CEO Kerry Mok mentioned during an interview with the Business Time that “I just want to reassure people that I don’t need to do a rights issue to complete this transaction” [Source]. Indeed, there are multiple other ways to fund the deal. It could have sought a private placement (which would require a lower discount than rights issue), issued convertible bonds, conducted a share exchange with WFS or even a mix of all. SATS could have also used more of its large cash reserve, which would be the cheapest in financing cost compared to debt and equity. Not to mention, the numerous types of debt instruments available. It could be possible that SATS went ahead with a rights issue nevertheless because they were looking after investors’ interest and wanted to limit the offering to existing shareholders.

The large selloffs did seem a bit extreme. If it remain as a renounceable rights issue (as illustrated in their indicative financing plan), an entitled shareholder who does not wish to exercise his rights can choose to sell the rights on the exchange or transfer them to a third party. Value can still be extracted from the rights issue and it does not necessarily equate to a definite cash call. 

Will WFS be able to perform amidst a looming recession? 

The global economy is on the brink of recession as policy rates shoot higher. Much of Europe is already in recession and many analysts expect one to begin in the US in the 2^nd half of 2023. Air cargo demand may start decreasing significantly, heavily impacting WFS. IATA predicts 4% drop in air cargo volume next year [Source]. According to DHL, global air freight demand had declined 10% y-o-y in Aug-22 [Source]. FedEx Express (leading cargo airline) reported that its air cargo business saw a US$500m shortfall in revenue against its prior forecast for the first quarter ended 31-Aug [Source]. 

Nonetheless, SATS is investing in WFS for the long-term. From historical data seen below, air cargo is likely to grow in the long-term, alongside global GDP, especially as it rides on the e-commerce boom.  

2.4. Overall thoughts on the Acquisition  

M&A is one of the few remaining viable ways for SATS to really move the needle in the fairly saturated business environment they play in. For companies like SATS which have hit a market maturity/leadership position in its dominant market, going abroad is a natural next step. Yet, regulatory barriers especially in this industry can be difficult to overcome. Growing organically is too slow. Acquiring an already well-established company abroad becomes one of the few viable ways left for SATS to truly move the needle. While this is a relatively risky play, it does make a lot of commercial sense overall. Personally, I do believe that this is the right move forward especially since deal opportunities like these do not come by easily. 

SATS’ stock price was severely punished partly by investors’ sentiments towards its proposed equity rights issue. Yet, the fundamentals of the business is not impacted by their fundraising activities. The business did not change and is still going on as per usual. Hence, this suggests a rare opportunity to buy SATS (and effectively, WFS as well) at a deep discount. 

3. Is there value to extract from covid-19 recovery? 

A prime beneficiary of aviation travel recovery with upside yet to be priced in by the markets 

Despite being more diversified than most other SGX-listed travel-related companies and having almost equal revenue recovery, SATS seem to be lagging in terms of covid-19 share price recovery. In fact, even Singapore Airlines seem to be recovering at a better pace. Albeit small, there is likely some value to capture from covid-19 recovery upside yet to be priced in. 

Note that the comparison below is just a simple estimation. Many factors affect stock prices. Using VWAP instead of a specific price point might also increase accuracy if you are planning to recreate this on your own.

Much room for recovery, possibly catalysed by China’s zero-covid U-turn  

Singapore has already more or less transitioned from pandemic to endemic. Everyone I know is travelling and social distancing rules are non-existent at this point. However, that is not the case for the world. Only recently did China finally ease covid-19 restrictions due to massive protests [Source]. While mass infections are to be expected in the short run, SATS will likely benefit in the medium term as Singapore is a top Chinese travel destination and is SATS’ 2^nd largest market after Singapore. 

How much room left for recovery? 

Using Changi Airport’s traffic movements below as a proxy, we can see that there is still immense recovery yet to be captured. CGS-CIMB expects Changi aviation volume to reach 80% by end-FY23. 

4. Will SATS be able to stay relevant and capture future tailwinds despite historically slower growth 

4.1. A strong base for growth, protected by a widening moat

High Barriers to Entry 

• Economies of Scale: New entrants are unlikely to be able to achieve the same level of scale as SATS especially as SATS continue to deploy technology to scale and enhance connectivity. In 2005, the Civil Aviation Authority of Singapore (CAAS) awarded a third ground-handling license to Swissport International. However, due to the lack of market share and scale, Swissport was unprofitable and pulled out of Changi Airport in 2009.  
• Significant infrastructure investments/CAPEX: SATS has invested S$79.2m in FY2021-22 alone. This figure adds up to S$966.1m over the past 15 financial years and S$713.7m over the past 10 financial years. SATS has been doubling down on capex, especially since FY2017 on the likes of building central kitchens and other automation systems. Playing catchup on such significant investments is not easy. 
• Switching Costs Involved: There are limited operators, especially for ground handling since government licenses are required to operate. In Singapore, there is only SATS and dnata. Carriers are also locked into long-term contracts. For example, Singapore Airlines inked a 5-year commitment with SATS in 2019 with an option to extend for a further 5 years. Having said that, the decision to add new players is still ultimately dependent on Changi Airport Group, which SATS has no control over. In 2005, when Swissport International was awarded a ground handling license, feedback from CAAS suggested that ground handling charges were reduced by 15%, heavily affecting the profitability of SATS. 
• Relationship network: Highly difficult to replicate SATS’ government links, such as contracts with the military bases to run their cookhouses. 

Other Barriers 

• Deep industry know-how: Requires good working knowledge of airlines’ demands, especially for the food aviation business. 
• Strong Reputation: Services required of SATS are mission-critical for the customers’ operations and thus, strong branding is typically demanded. 
• Arguably, these 2 barriers are not as strong as the above 4 given that most new entrants will likely be renowned international brands with similarly deep industry know-how. 

These barriers will only continue to become stronger as SATS scale its operations.

4.2. Strong focus on the future, but yet to yield significant benefits    

Consistent narrative of investing for the future… 

During SATS’ Capital Markets Day back in Nov-21, SATS announced FY25 target revenue to be at S$3b, up from S$1.8b in FY19. Slightly more than half of the increase came from new investments. SATS also committed to a S$1b target capex and investments within 3 years, which translates to a 3x higher yearly average in capital investments. One of the key objectives for the capital deployment was also to reduce concentration risk in travel, as SATS had learnt the hard way via the pandemic. During SATS Annual General Meeting (AGM) held this July, CEO Kerry Mok reiterated management’s focus on diversification through growing overseas and broadening revenue streams. True enough, the announcement of the WFS acquisition came shortly after. 

In addition, Kerry Mok hinted that enhancing productivity through investing in technology was also another key focus, especially given escalating costs. In fact, SATS has continuously been investing in productivity. For example, the employment of smart augmented reality glasses for its ground handling operations and central kitchens and frozen food technologies for its food solutions operations. 

The sentiments above were in line with what was conveyed in 2021’s AGM, where ex-CEO Alex Hungate mentioned that SATS will ringfence capex investments for transformational projects that will increase the company’s efficiency and productivity. During 2017’s AGM, productivity was also highlighted by Hungate as a key challenge. 

…But have yet to bear fruit 

Despite significant investment efforts, productivity has yet to change significantly, even pre-covid from FY14 to FY20. Productivity is also at a historic low due to covid-19 implications. 

Interestingly, as of late, SATS has also been trying to address cost pressure from an ESG angle. ESG does create shareholder value and in the case of SATS, there is a fairly obvious linkage to its P&L. 

Harnessing ESG (Environment): Enhancing profitability through wastage reduction 

If you have ever been to any of the cookhouses in the military bases in Singapore, you would be surprised by the sheer volume of food waste generated every day. SATS has announced long-term plans to halve food wastage in all operations by 2028 and to introduce 100% sustainable food packaging by 2030. While this is non-binding, it does show management’s commitment. Furthermore, work has been in progress, such as implementing an AI-enabled system to track food waste generated in kitchens and initiating a proof-of-concept trial for an anaerobic digestion system at catering facilities in Singapore – which would convert waste to different forms of energy. Ultimately, reducing wastage will help SATS reduce cost and improve margins. This is still something relatively new, and it is best to continue monitoring SATS’ progress on this front to verify how serious they are on this front. 

Harnessing ESG (Social): Enhancing productivity through its commitment to nurturing the future 

SATS is one of the few companies with a training arm, SATS Academy (established in 2018), which aims to upskill individuals to embrace the new economy. Over the past c.2 years, more than 74,000 training seats were filled by more than 12,000 trainees in the aviation sector. After all, manpower cost is the single highest expense item faced by SATS. Having a more productive and multi-skilled workforce will no doubt yield long-term benefits for SATS.

Overall Thoughts 

Overall, SATS does appear to be a company with great foresight. Staff cost is the highest while raw material costs are the second highest expense item in SATS’ P&L. Given the numerous new initiatives ongoing to address their most pressing issues, it does reflect well on management. However, none of these investments has yet to reap significant returns. While long-term benefits are to be expected, escalating costs will remain to be an issue.

4.3. Changi Airport Terminal 5, a long-term growth driver

SATS’ growth in Singapore has always been limited by the capacity of Changi Airport. During the National Day Rally in late July, PM Lee announced that T5 will add capacity for about 50m passengers per year. Note that the 4 current passenger terminals can handle only about 82m passengers a year. In PM Lee’s words, “We are building one more new Changi Airport, it’s huge”. What this means for SATS is that the total addressable market will essentially double. Given that construction for T5 was delayed due to covid-19 and it is only expected to be operational in the mid-2030s, this event is unlikely to have been priced in by the markets. For really long-term investors, this could be another impetus to buy into SATS before the market price in T5 in the nearer future. 

5. Valuation

5.1. Overview   

We first calculate the standalone valuation for SATS’ existing business by using both income (DCF) and market (Comps) approach. This yielded a roughly S$3.50 to S$3.70 per share range. Thereafter, we account for the valuation impact of WFS. Ideally, if WFS was listed, we would be able to build a merger model, factor in synergies and arrive at a post-merger indicative valuation via DCF/Comps separately. However, since this is not possible, we will simply account for the rights issue (assuming S$800m at 20% discount), which gives us a Theoretical Ex-Rights Price of S$3.22 to S$3.37 per share. Note that fair value is likely higher given synergies and profitability of WFS is not accounted for. 

5.2. Relative Valuation   

Given that not many comparable companies operate in both gateway services and food solutions, valuing SATS’ business units separately using a sum-of-the-parts approach is more ideal. Using this method, we arrive at a standalone valuation for SATS’ gateway services and food solutions businesses at roughly S$4.66. 

Selection of Comps: We first screened for comparable companies using S&P Capital IQ with the following criteria: (1) Company Type: Public Companies (2) Company Status: Operating and Operating Subs (3) Industry Classifications: Airport Services/Restaurants. Next, we conducted a filtering process by looking through each companies’ annual report while keeping in mind (1) Similarity in revenue, business model, and industries served (2) Market Capitalization (3) Geographical segments and (4) Whether brokers such as OCBC, CGS-CIMB, DBS also used the company as trading comparable. Overall, this resulted in 13 trading comparables (6 for Food Solutions and 7 for Gateway Services). 

‍Selection of Multiples: We relied on Forward EV/FY+1 Revenue multiple due to the difficulty in splitting SATS’ expenses across the 2 business segments and hence the unsuitability of using a bottom-line denominator like EPS, NI or EBITDA. Moreover, bottom-line tends to be negative or extremely low for any meaningful multiples to be derived for many of the comparable companies. Book Value denominated multiples were also not suitable as companies in this sector tend to have a large number of fixed assets, which often do not reflect market value. Furthermore, a pro of using a sales multiple is that, unlike earnings, it is unlikely to be subjected to accounting distortions. Net income for example includes a lot of noise from investments in associates/joint ventures and others. A forward-looking multiple was also used to reflect the forward-looking nature of valuation.

Gateway Services Peers

The closest peer to SATS would be dnata, a subsidiary of Emirates Group. However, insufficient publicly available information was disclosed for an analysis to be done since it is not listed. 

Food Solutions Peers

Precedent Transaction Analysis 

Less emphasis is placed on precedent transaction analysis since no transactions involving a company like SATS with both gateway services and food solution business was found. Also, benchmarking against comparable transactions, which typically account for control premiums may cause us to overly inflate SATS’ valuation.

5.3. Intrinsic Valuation   

Our DCF (both Gordon growth and exit multiple methods) uses the Free Cash Flow to Firm methodology to arrive at the intrinsic value of SATS. Using this method, we arrive at a standalone valuation of SATS’ existing business at roughly S$3.51 to S$3.57 per share. 

Key Financial Statement Assumptions: We employed a bottom-up approach to forecast gateway services and food solutions revenues separately. A conservative forecast below analyst consensus was used. Slight margin expansion to be expected primarily driven by enhanced productivity leading to lower staff cost. Capital expenditures were projected on a % to revenue basis and forecasted to rise over the years, in line with management’s intention of deploying more capital.  

Cost of Equity: Derived based on an adjusted Capital Asset Pricing Model (Ke = β(Rm - Rf) + Rf + CRP + Size Premium). Risk free rate of 3.01% was derived by using Singapore 10 Year Treasury Yield as of valuation date. Professor Damodaran’s Equity Risk Premium was used as a proxy to derive a 4.24% market risk premium. We chose to rely on regression beta (5 year monthly against STI total return) to arrive at a beta of 1.04. The bottom-up approach was used as sanity check given that there is a limitation of close comparables offering both gateway services and food solutions like SATS. Weighted average country risk premium of 0.14 was derived from Professor Damodaran’s Research and Size Premium of 0.78% is calculated based on size premia in Kroll’s CRSP Deciles Size Study, using the Absolute Method by decile category. With that, we arrive at cost of equity of 8.34%.  

Cost of Debt: By analysing SATS’ financial health and in conjunction with guidelines from Moody’s, we were able to derive an implied synthetic credit rating for SATS. Cost of debt of 5.01% was then calculated by adding a default spread from Professor Damodaran’s research to Singapore’s Risk-Free Rate. This is also in line with the cost of borrowing of existing debt. YTM of existing issued bonds are around 5%, unsecured floating term loans are at 4.45%, unsecured fixed term loans are at 0.76% to 5.00% and secured fixed term loans are between 0.5% to 5.60%. 

Terminal Growth/Exit Multiple: Terminal growth rate was assumed to be at 2.5%, benchmarked to Singapore’s 30 Year Government Bond Yield and a slight premium to the 2% core inflation rate that MAS sees as generally reflective of “overall price stability”. A conservative blended exit multiple of 9.8x EV/EBITDA was derived from comparable companies, much lower than the average 14.49x EV/EBITDA multiple that SATS was trading at pre-covid in 2019.  

5.4. Street Consensus    

While 11 analysts are covering SATS, only the 5 below were publicly accessible. Out of these 5, we place less reliance on DBS as it was published before the WFS acquisition announcement, hence the higher target price. We place more reliance on CGS-CIMB and Philip Securities (boxed in green dotted lines below) since they were updated in December and hence reflect the most recent news. Overall, the street consensus seems to indicate a target price slightly north of S$3, representing a slight potential upside below 10% (SATS closed at S$2.89 on 13-Dec-12).     

Street consensus (in terms of the proportion of buy/hold/sell recommendations) did not change significantly despite the WFS deal. It seems that despite some apprehensiveness, analysts overall still hold confidence in SATS.  

6. Downside Analysis  

6.1. Corporate Governance 

In light of the recent FTX case, we thought it would be meaningful to take a quick look at SATS from a corporate governance perspective. After all, even other big Temasek-linked companies like Keppel and ST Marine were not spared from corporate governance issues historically.  

In general, SATS has a pretty high corporate governance standard, with significant disclosures every year [Source]. In fact, SATS was the top scorer out of 100 Singapore companies in the 2020 ASEAN Governance Scorecard published by NUS Business School [Source]. Hence, corporate governance concerns are unlikely to be material. However, there are still several points to be aware of as potential investors. 

Board Structure 

Firstly, given the separation of the CEO and Chairman roles, there is a clear division of responsibilities between the leadership of the Board and Management – no individual has unfettered powers of decision-making. This is also in line with the Singapore Code of Corporate Governance (SCCG) Principle 3. 

Secondly, 10 out of 11 directors on the Board are independent non-executive directors. This is way above SGX’s requirement of having 2 independent directors and the SCCG’s requirement of having at least one-third of independent directors on the board. This translates to exercising the director’s independent business judgement in the best interest of the company. 

Thirdly, the board has a high degree of diversity in terms of age, gender, ethnicity, and background expertise [Source]. For example, Directors have expertise across finance, legal, IT, HR, Marketing, Branding, M&A, Risk Management, Food Solutions, Supply Chain and more. As suggested in SCCG Provision 2.4, diversity brings perspective, helps avoid groupthink and fosters constructive debate that would benefit the company.  

However, Euleen Goh (Chairman of the Board) has been serving as an independent director at SATS since 2013, making it a 9-year long tenure thus far. Arguably, 9 years is too long for Euleen to still be considered independent. In fact, the SGX RegCo has recently published a public consultation paper proposing to amend the listing rules to impose a hard 9-year limit on the tenure of independent directors [Source]. Furthermore, there is a case of interlocking directorship between Deborah Ong [Source] and Jessica Tan [Source] where both are presently non-executive and independent directors at CapitaLand India Trust Management Pte Ltd. We also noted that Chia Kim Huat an independent director is also concurrently a partner at Rajah & Tann, a Big 4 Singapore law firm. Independence may be threatened here if SATS receive material services or conduct significant business with Rajah & Tann.  

Moreover, several directors are also serving on multiple other boards or have multiple principal commitments concurrently, giving rise to “overboarding” concerns. In addition, given the relatively large board size of 11 directors, there may be a small risk of social loafing. The Singapore Governance and Transparency Index and ASEAN Corporate Governance scorecard recommend 6-11 directors and the average SGX-listed company has an average of just under 7 directors. 

Overall, the board structure is strong but is definitely not foolproof and there are still slight downside risks that investors should be aware of. 

Shareholding 

The company’s free float accounts for 666.36m or roughly 59% of outstanding shares. Thus, SATS enjoys a diversified base of shareholders, which ensures diversity and reduces the possibility of price attacks from sudden selloffs. 

Temasek stands out as SATS’ only major shareholder (39.7%). This is a double edge sword. On one hand, SATS benefit from the brand premium of being backed by the state-owned investment management company, as well as potential synergies from Temasek’s other portfolio companies (e.g., SATS have been working with Sembcorp Industries on rooftop solar panels). 

On the other hand, minority shareholders typically do not equitably share the growth of companies, especially when a dominant shareholder like Temasek is present. This is known as a Type II agency problem where there is a divergence of interest between majority and minority shareholders. It does not help that the board consist of independent directors with links to Temasek, such as Jenny Lee who is concurrently also a Director at Temasek. A prime example of this concern is illustrated by the recent rights issue offering, a decision minority shareholders had no say in. 

6.2. Other Investment Risks  

Decrease in business flights with work-from-home arrangements gaining preference: As companies acclimatize to the pandemic, many business conferences and meetings were shifted online. Companies may keep them online especially since they are more cost-effective. In a Bloomberg survey published in August 2021, 84% of large companies said they were planning to spend less on travel after the lockdowns [Source]. Nevertheless, steady recovery is in sights. A survey taken in late September by the Global Business Travel Association estimated that employers’ business travel volume in their home countries was back up to 63% of pre-pandemic levels and international business travel was at 50% of those levels [Source]. 

Fears of a recession may dampen the rebound of travel: As the world brace for a possible recession in 2023, businesses will be less keen on unnecessary travel spending. Employers have already started imposing restrictions on high-priced business-class airline tickets for long-haul flights. Employers are instead requiring travellers to take a cheaper connecting flight or fly nonstop in premium economy or regular economy class [Source]. 

The emergence of a new covid-19 variant is of concern, especially with the upcoming Lunar New Year migration: Recovery has always been hampered by the various mutations, such as Delta and Omicron. With China slowly reopening and the Lunar New Year migration approaching, a new variant reappearing could heavily set back the progress of reopening thus far. 

Effects of inflationary pressures on raw material cost: Despite the FED’s continuous interest rate hikes, inflation is still a big issue across many markets in that SATS is operating in. Mitigation efforts in place include the use of inflation-adjusted contracts, expanding global procurement, and developing an integrated value chain from farm to fork. 

Still concentrated in Changi Airport: Despite continuous efforts of diversification, a significant portion of SATS’ revenue is still concentrated in Singapore and Changi Airport in particular. Potential factors that would impact Changi Airport’s attractiveness as a global air hub will inevitably affect SATS’ business as well. 

Counterparty risk: A large portion of revenue comes from airlines, which have proven to be not very resilient to recessions and global crises. Some airlines that ceased operations include: Philippine Airlines in Sep-21, Cathay Dragon in Oct-20, Virgin Atlantic in Aug-20, LATAM Airlines Group in Jun-20, and German Airways in Apr-20. Even Singapore Airlines was extremely badly hit and was only kept afloat thanks to numerous rounds of financing and backing, especially from Temasek. 

Nevertheless, even in the worst-case scenario of bankruptcy, our liquidation value analysis estimates a maximum 85% to 90% downside due to a currently strong balance sheet with a relatively large cash position. 

7. Conclusion – What I am doing and Potential Catalysts 

With the current events unfolding, SATS has shifted from a stable dividend play towards a growth play. This bet is 2-fold. First, a long-term bet is that (i) SATS will be able to turn this acquisition into a success, and (ii) SATS will continue to capture long-term growth. Second, a short-term bet is that there is still covid-19 recovery yet to be priced in. 

There are unlikely to be any near-term catalysts. However, 2 possible medium-term catalysts to look forward to. 

1. Reinstating of dividends: Given that SATS is on track back to profitability (without government reliefs), it is likely to announce a dividend (just like how SIA already did). Thereafter, providing momentum from dividend-seeking investors and better sentiments for the overall markets. Do however note that dividend payout is unlikely to remain as high as previously as much of the operating cash flows need to go back into debt repayment and interest for loans taken up as part of the WFS acquisition. 
2. Successful integration of WFS: Any indication of success or even an announcement of a value-creation strategy may alleviate uncertainties over the acquisition – lifting perhaps the greatest overhang 

Finally, I do believe that the odds are in SATS’ favour. It is likely an undervalued business at this point and deserves a small portion of my portfolio. As of writing, I have bought 400 shares of SATS. However, going forward, I do not plan to increase my exposure to SATS as I do not wish to be overly concentrated on a single stock. However, I will likely subscribe to the rights issue once it is finalized. 

This case is actually quite similar to Adobe, where an announcement of an expensive but highly synergistic acquisition of Figma caused stock prices to tank. Do check it out as well if this case resonates with you.  

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