Sydney Airport: The end of the discussion or just the start?

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
15 July 2021, 5:00 PM
Sectors Covered:
Infrastructure, Utilities

  • In a move that signals optimism for the future, Sydney Airport's (ASX:SYD) boards have rejected the indicative takeover offer.
  • Given the scarcity of high-quality infrastructure assets such as SYD that unlisted funds can target, we suspect this is not the last takeover approach SYD will encounter while its share price is impacted by COVID. HOLD

Event

Sydney Airport (ASX:SYD) has rejected the indicative all-cash $8.25ps takeover offer, suggesting it undervalued the stock and is not in the best interests of its investors.

Analysis

SYD noted various points around the quality of the asset, its strong performance prior to the sharp negative impact of COVID-19 on its volumes and earnings, as well as its strong balance sheet. We agree with all these points (it was the basis for our ADD rating prior to the takeover bid being disclosed).

SYD acknowledges its share price is likely to trade below the indicative bid price in the short term. However, it will only progress a change of control transaction on terms that deliver and recognise appropriate long-term value for SYD’s investors.

We think the bid price is close to the pre-COVID trading price (c.$9ps) adjusted for 2020’s $2bn capital raising (1-for-5.15 at $4.56ps). Compared to this, a typical 20- 30% takeover premium would imply c.$9.90-10.70ps bid range. We find it unlikely that the bidders could generate reasonable equity returns from such a price range, given the uncertainty on when international pax and thus earnings will return to and exceed pre-COVID levels.

One element of latent value may be SYD’s balance sheet capacity when earnings do return to pre-COVID levels. We forecast SYD’s FFO:debt to be c.14% in FY24, well above the c.10% in FY19 (which in itself was above what was required of a BBB+ rating and even more so above the BBB rating that SYD has said it will protect). This capacity provides the bidders with the potential to extract a significant distribution early in their holding period, improving equity returns.

Forecast and valuation update

No changes to forecasts.

The stock closed at $5.81 prior to the offer being disclosed. Since that time, the broader market has been effectively flat. There is a risk this could be the price that SYD drifts back to if the market believes no more M&A activity will occur. Having said that, the bid has highlighted the value in the asset to unlisted investors.

Our business-as-usual valuation is unchanged at $7.03ps. This assumes pax recovers to CY2019/pre-COVID levels by CY24 as does SYD’s earnings. EBITDA growth is forecast thereafter at c.5-6% pa. We assume a 7.9% pa cost of equity and 12.5x EV/EBITDA applied to the terminal value in 2040 (the concession actually finishes in 2097, and the multiple reflects this and likely slowing growth over time as the airport reaches capacity).

We assess these to be conservative earnings growth, discount rate, and terminal value parameters, albeit in an uncertain COVID-impacted environment for airports.

Target price is set in-line with the indicative bid price of (login to view).

Investment view

The bid decline is a brave move by the SYD boards given the share price may not return to $8.25ps until international pax recovers and there is no certainty on when that will happen. It will be interesting to see if the bid consortium bumps its offer or walks. Whatever the case, the bid is indicative of the long-term value unlisted infrastructure funds see within the asset.

HOLD given corporate activity

Price catalysts

An increased takeover price, either from the Sydney Alliance consortium or a counter-bidder.

Recommencement of the distribution.

Risks

Bid not proceeding or extended delays in an agreed deal’s completion.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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