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mperial ir Group
Imperial Air GroupFebruary 28, 2002
Frank Burke
Jared Lawrence
Gurkan Salk
David Watson
Travis Young
mperial ir Group Agenda
• Case Introduction
• Recommendation
• Valuation
• Options
• Conclusion – Case Update
mperial ir Group Learning Objectives
• Cost of capital considerations
• Comprehensive DCF Modeling (debt restructuring, optional cash flows)
• Strategic Bidding
• Identification of Option Value
mperial ir Group Why the deal is happening
• China Aviation Industry Consolidation– CAAC effort to revitalize industry
• WTO Acceptance– Will boost Chinese aviation market – Need to be more cost effective– Increased competition
mperial ir Group Imperial Air Group
• Flagship Chinese international carrier
• Industry consolidation expands domestic presence
• Strategic partner would increase operational efficiencies
mperial ir Group Lufthansa AG
• German national carrier
• Europe’s most profitable airline in 2000
• History of investing in China– Existing relationship with Imperial Air
• Looking to diversify international revenues – 63% in Europe
mperial ir Group The Deal
• 20% stake in Imperial Air
• Debt restructuring
• IPO in 2 years– Conditional on performance targets – Additional equity offering of 15%
• Multiple strategic bidders
mperial ir Group Recommendation
• Bid $483 million
• Competitive bid, w/ NPV = $73MM
• Lufthansa is best strategic fit
• Comps analysis not meaningful
0100
200300
400500
600700
Bid
mperial ir Group DCF Model
• Comprehensive 10 year projections
• Main Issues– Revenue Projections– Alliance/Consolidation Benefits– Fuel Costs– Debt Paydown– IPO
mperial ir Group DCF Model
Projecting Airline Revenues
• Passenger Revenue = RPM * Yield• RPM highly correlated with GDP growth• Yield subject to typical competitive forces
(supply & demand, price wars, business cycles)
mperial ir Group Risk Assessment
Operational • Government restricts air routes• Fuel Prices
Financial • Risk of a delayed IPO• High Leverage
Sovereign Risk • Low expropriation risk• High creeping expropriation risk• Low currency risk
mperial ir Group Cost of Capital
• Assumptions:– Risk free rate: 5.5%– Market risk premium: 4%
• ICCRC Cost of Capital
ICCRC Rate 17.8%
Currency Risk (1.3%)
Adjusted CoC 16.5%
mperial ir Group DCF NPV Results
E[NPV] = 607.5MM Rmb, S.D. = 997MM, P[NPV>0] = 72%
Frequency Chart
Certainty is 72.15% from $0.0 to +Infinity
.000
.008
.016
.024
.032
0
16
32
48
64
($2,109.0) ($767.1) $574.9 $1,916.8 $3,258.8
2,000 Trials 12 Outliers
Forecast: NPV
mperial ir Group Multiples Analysis
• Acquisition Multiples – Not meaningful, due to regional and other
differences
• Trading Multiples– P/E: Regional differences, Imperial
negative earnings– EBITDAR: Best multiple for industry, but
also problematic due to high leverage
mperial ir Group
• Financial– Anti-Dilution option to purchase additional
shares at 25% discount in the event that Imperial Air Group conducts an IPO
– Value = $6.2 million
• Real– Option to invite Imperial Air Group into the
Star Alliance– Expansion of cargo service in China
Option Value to Lufthansa
mperial ir Group
• WTO agreements did not liberalize Chinese air markets
• CAAC has opposed debt-to-equity conversions– Some consolidations are in jeopardy
• “Imperial Air” (larger) and CNAC (financially stronger) are in dispute over who should lead the consolidated “Imperial Air Group”
• Smaller independent airlines have formed an alliance to compete with the majors
Conclusion – Case Update