Jack Dutton and Michael Duff examine the European carrier’s distressed balance sheet and the likelihood of an IAG takeover.

When Norwegian Air Shuttle issued its provisional condensed 2017 financial statements on 15 February, it reported book equity of NOK 4.1 billion ($498 million).

However, on 16 April, when the airline released its audited financial statements, it reported equity of NOK 2 billion. What happened in those two months to make half of the airline’s equity disappear from its balance sheet?

The answer is in the notes to the provisional release, which stated that the airline was in dialogue with the Norwegian Financial Supervisory Authority regarding the accounting treatment of the company’s investment in Norwegian Finans, and specifically if Norwegian still had significant influence over Finans.

The note said that reverting to equity accounting under IAS 28 would reduce the value of the investment by NOK 2 billion and contribute a further reversal of NOK 1.7 billion in cumulative net profits.

Norwegian lost the argument with the Financial Supervisory Authority. Subsequently, an urgent capital raising in March 2018 of NOK 1.3 billion of equity in a private placement appeared to have closed just in time to comfort investors concerned about their NOK 4.3 billion outstanding bond issues.

"I think the placement was done deliberately to raise the equity back,” Martin Stenshall, senior equity analyst, Danske Bank Markets tells Airfinance Journal.

Asked about financial covenants, Stine Klund, investor relations officer at Norwegian, tells Airfinance Journal: “The company has never been in breach of our covenants, but we absolutely want to make sure we have a buffer to the covenants. The board wanted to strengthen this buffer to be better positioned against fluctuations in fuel price, currency and market sentiment.”

Norwegian has not raised equity capital since 2009, meaning it has built up most of its long-haul operation from internally generated funds, debt and operating leases.

Klund adds that it was “relevant” for the airline to do a capital raise to get through the last phase of its growth and “also to avoid any further speculations about the company’s financial situation and focus on the operations going forward”.

Over-leveraged
“I think the leverage is very significant,” adds Stenshall. “If you look at Norwegian’s reported leverage that’s one thing, but the real leverage – its off-balance sheet items, the debt is tied to operating leases – you would have an equity ratio of approximately 5%.”

However, thanks to IFRS 16, the airline’s real term liabilities will be on the balance sheet from 1 January 2019. With such high leverage, the airline will need to look at other ways to reduce its debt.

“They did an equity issue but that’s just a drop in the ocean compared with the amount of debt and financing they have to secure for the large amount of aircraft they are taking this year, next year and year after,” says Stenshall.

“Norwegian have been on high leverage for a long time without going bankrupt. It hasn’t been a problem as interest rates have been coming down and a lot of their debt is backed by state guarantees so they got quite cheap bank financing.”

Klund says that his airline is looking to decrease its leverage.

“Clearly, this equity raise was one measure,” he says. “Further on the focus will to a large extent be to go from growth to profitability as the company gets through the peak of its growth. We have also said that we have initiated a process of selling off aircraft, as well as reviewing strategic opportunities for our loyalty programme.”

Enter IAG
After Norwegian posted worse than expected financial results on 12 April, IAG, Europe’s third largest airline group, acquired a 4.6% stake in the airline, before announcing its interest in acquiring the whole platform. The move caused Norwegian’s share price to rally from NOK 175 to NOK 265. Its equity market capitalisation as of 13 April was $1.5 billion at a share price of NOK 265.

However, the day after the IAG announcement, Norwegian founder and chief executive officer Bjorn Kjos told reporters that selling the airline “has not been on our agenda at all”. Kjos, and Bjorn Kise, the airline’s chairman, own over 25% of the airline so the deal may prove difficult to pull off if sentiments do not change.

That said, several market sources believe the deal is still likely to happen. It would make strategic sense for IAG, as it removes a major competitor in the European and transatlantic markets and gives it access to one of the youngest fleets in the world, saving the group from having to strike a deal with OEMs for aircraft deliveries with long lead times. It would also give IAG access to critical airport slots. Acquisition by a financially-stable airline group also makes sense for Norwegian, given the scale of its financial commitments.

It is unlikely that changes in accounting, even ones that involve half of the airline’s equity capital disappearing from its balance sheet, would have a dramatic effect on a potential sale of Norwegian to IAG. IAG would have done its homework and sources say the corporate team has considered a Norwegian takeover for some time.

Klund adds: “First of all, we cannot speculate in IAG’s decision making (or any shareholder for that sake). That being said, remember that this is just an accounting effect that hits the first quarter of 2018 instead of the second quarter of 2017.”

One source close to the discussions tells Airfinance Journal that IAG has already been working on a potential banking facility to acquire Norwegian. However, the conglomerate has over $8 billion in cash on its balance sheet so it could afford to buy Norwegian without tapping banks.

But such an acquisition would come at a price. “It would definitely be above the level NAS is trading at,” says Stenshall. “We might have to see a bid higher than NOK 325-400 a share in order for the shareholders to accept the offer.”