CASE STUDY

21.1
Etihad’s Proposed Acquisition
of Malaysia Airlines
Shuvam Dutta

his case study accompanies Chapter 21 of International Corporate Finance.

T A significant strategic shareholding in Malaysia Airlines (MAS) had become availa-
ble in the market. The flag carrier of Malaysia with a fleet of 85 aircraft traveling to 103
destinations worldwide, the airline was trading at an equity value of US$1,316 million
as of March 30, 2010. MAS was led by a strong management team with a proven track
record. Over the past few years, the management had undertaken a strategic business
transformation resulting in a significant positive turnaround of performance, including
Malaysian ringgit (MYR) 2.3 billion in cost savings from 2006 to 2008 and steady
revenue growth from MYR 9 billion in 2006 to MYR 15 billion in 2008.
Etihad Airlines was a Middle Eastern carrier looking to extend its route network
beyond its hub in Dubai, and it hoped to gain access to lucrative routes to Singapore,
Hong Kong, and Australia. Etihad’s bankers at Standard Chartered advised them to
consider a 20 to 25 percent investment stake in MAS, hand in glove with an operat-
ing alliance.
Etihad Airways was established as the flag carrier of the United Arab Emirates
in July 2003 by royal decree with an initial paid-up capital of United Arab Emirates
dirham (AED) 500 million provided by the Abu Dhabi Investment Authority. As of
January 2010, the airline operated passenger and cargo services to 85 destinations
around the world from its home base in Abu Dhabi.
Malaysia Airlines is partially privatized with Khazana Nasional, the Malaysian
sovereign wealth fund, holding a residual equity stake in the airline. Malaysia Air-
lines operates flights in Southeast Asia, East Asia, South Asia, Middle East, and on
the Kangaroo Route between Europe and Australasia. It operates transpacific flights
from Kuala Lumpur to Los Angeles via Tokyo. It flies to 87 destinations in over six
continents. Malaysia Airlines has existing code share agreements with American Air-
lines, Cathay Pacific, and Japan Airlines, among others.
As an international airline, Malaysia Airlines was exposed to the effects of for-
eign exchange rate fluctuations because of its foreign currency–denominated operat-
ing revenues and expenses. Its largest exposures were to the U.S. dollar, followed by
the euro, British pound, Japanese yen, and Australian dollar. Approximately 58 per-
cent of the airline’s sales and almost 65 percent of the airline’s costs are denominated
in foreign currencies. The airline’s trade receivables and trade payables balances had

1
2 CASE STUDY

similar exposures. The airline was also exposed to fuel price volatility, partially miti-
gated by entering into jet fuel hedges.
The bankers articulated several strategic benefits arising from the potential acqui-
sition. The transaction would ensure major presences in two of the highest-growing
air traffic regions in the world (Asia and the Middle East) and allow Etihad to lever-
age consistently growing tourism and trade between Asia and the Middle East. The
acquisition would grant Etihad access to a complementary route network—30 out
of 56 unique MAS destinations in Asia did not overlap with Etihad’s routes. Impor-
tantly, it would give Etihad an opportunity to significantly strengthen its competitive
position on the important Kangaroo Route (London/Dubai to Sydney via Kuala
Lumpur/Singapore). Last, it would create a politically appealing alliance between
two Islamic nations’ flag carriers.
Etihad’s management asked its bankers to value the target based on trading
and transaction comparables. Based on a current share price of US$0.64, MAS was
trading at an equity value of US$1,316 million, which was at the lower end of its
12-month trading range between US$1,092 million and US$2,074 million—an at-
tractive entry price. On the other hand, research analysts were suggesting that prices
could fall further, reducing equity value to as low as US$910 million, which made the
current price less attractive than it seemed initially. However, based on comparable
trading multiples, the airline was undervalued relative to its Southeast Asian peers,
which were trading on higher multiples based on their enterprise value/EBITDA ra-
tios in 2010 and 2011. Market indicators, though, often do not serve as the best
indicators for successful bid prices, as airline mergers and acquisitions (M&A) trans-
actions in Asia cleared the market at significant premiums to traded value—reflect-
ing high investor interest in the market, acquisition synergies, and control premiums.
Thus, if precedent transactions were an indicator, the target could be valued at over
twice its current market value. (See Case Exhibit 21.1.)
Etihad’s management now wanted to embark on a more detailed due diligence
of the airline, culminating in a discounted cash-flow valuation of the airline based on
the projected financials shown in Case Exhibit 21.2. Malaysia Airlines was trading at
a levered beta of 1.06, with a market risk premium of 9.38 percent above a risk-free
rate of 3.68 percent. Its cost of debt based on outstanding bonds, loans, and leases was
3.09 percent. Etihad on the other hand was trading at a cost of equity of 10.5 percent
and a cost of debt of 2.4 percent. Based on these assumptions and the cash-flow projec-
tions provided in Case Exhibit 21.2, the deal team proceeded to value the acquisition.

Current Equity Value:

US$1,316.1 million
Last 12 Month Price Range 1,091.7 2,074.2

Analyst Target Prices 909.8 1,516.2

Southeast Asian Peers 2010E 1,897.8 2,533.2

Precedent Transactions 2,521.8 4,288.7

0 1,000 2,000 3,000 4,000 5,000

CASE EXHIBIT 21.1 Precedent Transactions

 CASE EXHIBIT 21.2 Historical and Projected Financials for Malaysia Airlines

Historical Financials Projected Financials

(In Millions of MYR) 2007A 2008A 2009A 2010E 2011E 2012E 2013E 2014E
Profit & Loss
Revenues 14,630.2 15,035.3 11,309.9 12,971.7 14,038.5 15,192.1 16,439.3 17,787.6
Operation expenses 14,031.9 14,855.2 11,866.6 12,473.8 12,591.4 13,620.2 14,442.8 15,345.5
—Fuel cost 4,915.8 6,531.6 3,497.3 4,330.0 4,335.1 4,509.8 4,619.9 4,763.0
—Depreciation 2,082.5 1,890.8 1,846.7 1,751.4 1,305.6 1,588.6 1,683.7 1,775.8
—Others 7,033.6 6,432.8 6,522.6 6,422.4 6,950.6 7,521.7 8,139.2 8,806.8
EBITDA 2,680.8 2,070.9 1,290.0 2,249.2 2,752.8 3,160.5 3,680.1 4,217.9
EBIT 598.3 180.1 (556.7) 497.9 1,447.2 1,571.9 1,996.4 2,442.1
Net profit 795.5 244.3 490.3 177.3 1,145.1 1,193.9 1,554.2 1,996.7
Balance sheet
Gross debt (includes off-
balance-sheet debt) 8,256.2 8,938.2 7,390.2 6.081.0 7,898.5 10,157,5 10,318.9 9,681.5
Net debt (includes off-
balance-sheet debt) 3,821.9 5,366.4 4,725.4 4,133.5 4,662.1 5,774.9 4,539.2 2,210.0
Cash 4,434.3 3,571.7 2,664.9 1,947.5 3,236.4 4,382.6 5,779.7 7,471.6
PPE 9,457.7 9,984.0 8,182.6 6,764.9 8,594.8 11,070.0 11,572.3 11,440.3
Total assets 17,458.5 17,590.8 13,598.3 11,983.3 15,362.0 19,264.5 21,467.7 23,356.2
Shareholders’ equity
(excluding MI) 3,934.9 4,185.7 735.7 913.0 2,058.1 3,252.0 4,806.2 6,802.8
Cash flow
Cash flow from
operating activities 4,108.5 939.3 (47.7) 925.6 2,606.9 2,951.1 3,421.6 3,973.0
Cash flow from

3
investing activities (2,245.2) (2,922.6) (1,306.0) (1,693.2) (2,942.4) (4,480.2) (2,230.1) (1,747.1)
Cash flow from
financing activities 986.3 489.6 862.5 50.3 1,624.5 2,675.2 205.6 (534.1)
4 CASE STUDY

QUESTIONS FOR DISCUSSION

1. What is a fair value for MAS as a stand-alone firm?

2. What would be the synergistic benefits for Etihad of acquiring a strategic minor-
ity stake in Malaysia Airlines?
3. How much should Etihad bid for MAS shares?