Morningstar | HK Express Acquisition Confirmed; Cathay FVE Maintained Pending Release of More Information
No-moat Cathay Pacific confirmed its plan to acquire low-cost-carrier, or LCC, Hong Kong Express, or HKE, for HKD 4.9 billion. The acquisition will be financed by roughly 46% cash on hand and 54% promissory notes. Ever since the rumor surfaced, we have said that Cathay Pacific will be a stronger company with a budget airline arm. HKE is the sole LCC based in Hong Kong, and its business perfectly complements that of legacy carrier Cathay. We are maintaining our HKD 12.20 fair value estimate for Cathay for now as limited operating details on HKE are available. We will update our valuation model once Cathay releases operating statistics and full financials on HKE upon completion of the acquisition.With more than HKD 17 billion cash on hand, Cathay should have no problem paying up for this purchase. Based on the limited amount of financial information, the deal values HK Express at 4.41 times price/book value, significantly higher than the trading multiples for Air Asia and Spring Airlines. Yet, price/book ratio is not a good measure of free cash flow generation ability, the heart of a company’s intrinsic worth. Based on HKE’s past news releases, the carrier achieved 30% growth in passengers carried in 2017. HKE was also reported to be on track to achieve a 15% increase for 2018. Assuming the airline reached its target of transporting 4.5 million people for 2018, it would imply the budget airline is already carrying roughly 13% of the current passenger volume of Cathay Pacific. Lastly, we believe the bottom-line figures disclosed are less relevant, as nonrecurring items can often bring airlines’ profitability into wild swings.
Cathay Pacific is an international airline registered and based in Hong Kong, offering scheduled passenger and cargo services to 203 destinations in 50 countries and territories. Co. and its subsidiaries are engaged in other related areas including airline catering, aircraft handling, aircraft engineering and cargo terminal operations. Co.'s airline operations are principally to and from Hong Kong. Co.'s segments include: the airline business, which consist of Co.'s passenger and cargo operations; and the non-airline business, which consist of catering, ground handling, aircraft ramp handling services and cargo terminal operations. As of Dec 31 2014, Co. operated 147 aircraft.
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