The perfect selling storm at AirAsia

By Stephanie Jacob

A well-written report full of doom and gloom, merged with at least three key factors to trigger the perfect selling storm for AirAsia Bhd’s stock over the past two weeks. They are high foreign shareholding, a bleak investing and economic climate and the depreciating ringgit. But was all this just to turn a trade or two to benefit a privileged few?

Over the past two weeks, AirAsia Bhd (AirAsia) has lost about RM1.2 billion in market capitalisation and seen its stock price plummet by about some 20% from RM2.02 on June 10 to RM1.60 on June 25.

The steep decline was triggered when a small Hong Kong based independent research house called GMT Research (GMT), called the airline’s accounting, corporate governance and financial health into question.

GMT questioned why the airline had not consolidated its associates and suggested it was deliberate because consolidation would paint a rather clearer but less rosy picture of the airline’s financial health. It also opined that even on its own, AirAsia has serious financial concerns and needs RM7 billion in recapitalisation

As expected, in the days after the report was published, AirAsia has come out strongly to defend itself against the allegations which were published in the report. It has also moved to assure its investors that plans are afoot to deal with the significant amount of debt owed by associates like Indonesia AirAsia and AirAsia Philippines (AAP).

Primarily the plan is for the two associates to issue US$300 million worth of bonds to raise capital to pay of some of the RM2 billion plus in debt owed to the parent company, AirAsia.

GMT has been in the press before for taking on energy and metal trader Noble Group earlier this year. It questioned the group’s practice of booking debt and profit from projects yet to be completed.

Then GMT had company – well-known short seller Muddy Waters LLC and an anonymous research house Iceberg Research also trained their guns on the group.

Noble hit back by questioning their motives. It noted that Muddy Waters had publicly stated short positions on it. It also filed a suit against Iceberg and a former employee which it believed was behind its reports.

Nonetheless, the three-pronged attack had a similar impact on Noble’s stock price as GMT’s reports have had on AirAsia’s. Its share price has not recovered to the levels it was at in February 2015 when Iceberg first claimed Noble’s balance sheet overvalued its commodities contracts and associate companies.

According to a WSJ report, Muddy Waters have made similar moves before. “In 2012, it attacked Olam International Ltd’s accounting practices and investments, which left Muddy Waters facing off with Singapore state-investment firm Temasek Holding Pte Ltd. Temasek eventually helped lead a buyout of Olam,” said WSJ.

Now back to AirAsia. Interestingly, although agreeing with certain issues broached by GMT, local analysts have said most of it is nothing new.

Maybank Research aviation analyst Mohsin Aziz said the report contained “nothing new, nor anything groundbreaking that I and the rest of the analyst community have not raised already.”

He noted that it was sometimes the modus operandi of research houses to release reports which aim to “spark fear and let the momentum sway things down.”

“First short sell, when it breaks technical support the technical traders will push it down, and the final leg is for fatigued long-term shareholders to give up. I call this the three pillars of death strategy,” he added.

GMT insists it is not a short seller, but rather a licensed research house which has identified concerns it needed to share with its clients. Its founder and the author of the AirAsia related reports Gillem Tulloch said he had been surprised by the market reaction the reports had caused.

An article in the Malaysian Reserve quoted Tulloch as saying that reports were solely for its clients who paid a substantial amount for GMT’s services and was not meant for public consumption. Tulloch said that one of those clients appears to have shared the report without permission, and it then spread like wildfire.

The veracity of Tulloch’s claims that GMT are not short sellers and had not anticipated the potential reaction of the report, is impossible to determine. However his first report called ‘New Dog, Old Trick’ released on June 10, clearly advised clients to ‘sell’ or ‘short’ AirAsia’s stock.

Then in a response to AirAsia’s rebuttal, Tulloch apologised that the initial report had been leaked. He said “we believe our business model only works if you and our other clients have enough time to make an informed investment decision and this was not the case with AirAsia.”

Later in that report, Tulloch acknowledged that some clients had been finding it difficult to short sell the airline’s stock and suggested they look at alternative plays. He said “some of our clients have commented on the difficulties in shorting AirAsia. This suggests it is primarily long only holders which are selling. However there are still ways for short sellers to play AirAsia’s financial woes.”

Tulloch then advises clients to look at AirAsia’s partnership with aircraft maker Airbus, as the airline is a significant client of the latter. He opined that cancellations or delays from AirAsia would put downward pressure on Airbus’ earnings.

So while Tulloch denies that GMT itself is a short seller, their coverage of AirAsia certainly advises clients to sell the stock short. Either way since the report came out, there has been a clear winner in GMT and a loser in AirAsia.

GMT has gained credibility because its reports have led to a sustained drop in the share price – enough for privileged, high-paying clients to have made much money from the trades. And even if the reports turn out to be inaccurate if and when AirAsia’s associates turn around, the depressed prices have already enabled clients to make a tidy profit.

The other interesting question, is why despite most of what was highlighted by GMT being known by the investment community, was there such a drastic reaction from investors?

Three factors appear to immediately stand out. They are the high foreign shareholdings in AirAsia, the tough investment and economic environment, and the depreciating ringgit against the US$.

AirAsia has a substantial amount of foreign ownership at about 54% of total shareholdings. This makes it susceptible to large amounts of selling at any one time. This coupled with the deteriorating investment climate in Malaysia has placed AirAsia in a rather precarious position.

When commenting on the share price plunge, the airline’s founder and group chief executive officer Tony Fernandes admitted that the report had a significant impact. But added there were other factors impacting the stock market. He said “volume is very small and I think not just (the report), there are also issues in Malaysia, stock market, currency etc. Which is also adding to the fact that volume has slowed down a lot. There are no buyers at the moment, so the stock keeps going down.”

AirAsia is also facing the most amount of competition it has ever faced since Tony Fernandes and Kamarudin Meranun first started the airline back in 2004. Malindo Air in Malaysia, Cebu Pacific Air in Philippines for example are all making the low-cost carrier game in Southeast Asia much more competitive.

The third and final reason is the ringgit’s continuing weakness against the US$. Almost 79% of AirAsia’s debt and 55% of operating expenditure is denominated in US$. In contrast its passenger revenue is largely in ringgit, Thai baht and Indonesian rupiah.

Analysts say the impact of the stronger US$ leads to a larger recognition of translation losses on borrowings, a heavier operating expenditure burden and pressure on cash flows due to the more onerous US$ debt repayments. Research house Alliance DBS said it estimates that AirAsia could incur RM500 million to RM600 million in net translation losses in financial year 2015 (FY15).

And while the translation losses on US$ borrowings is non-operating and non-cash in nature, Alliance DBS opined it must not be ignored from the analysis of the stock’s underlying fundamentals.

It said “we take the view that these translation losses are potentially real losses, as it can be realised if the currency trends do not reverse. The higher borrowings in ringgit terms (due to translation adjustments) will in turn lead to higher annual finance cost and more onerous debt repayments in ringgit terms going forward.”

All three factors have perhaps made AirAsia’s financial situation look bleaker than it is. For its part, the airline insists that as the aviation sector environment normalises, things will get better especially for the associates and this will be good for the parent company.

Fernandes has said “no point in me talking, just let me do it. Then we will see who is right. I think our record speaks for itself…I think the main message is, despite everything that is happening we are going to have a record year in profits.”

Whether or not he is proved right will only be seen in the latter half of 2015. But for now, either by coincidence, expert execution or pure luck, the GMT report appears to have hit the market at exactly the right moment to create a perfect selling storm of AirAsia’s shares. This has allowed some at least to come away with a tidy profit on their investing, or rather, trading activities.

GRRRRR!!!

Yesterday: Is AirAsia in trouble?