RR - Rolls-Royce

[aryadhana]

Don't know why they didn't make an effort to buy sell more earlier.  They can issue current shareholders rights to buy one or two shares at £2.00 (a 20% discount... heck it could be for £1.00 and the economics wouldn't change).  Shareholders who don't want to participate can sell their rights to compensate for any dilution, and nothing is lost.  In fact they should just raise too much and return it in the form of excess dividends or buybacks as the course of assets, liabilities, and opportunities becomes more clear.  It's a company with quality assets and a lot of franchise value making important stuff.  They just need to raise enough to deleverage and have enough cash leftover to very reliably moot questions about unexpected capex or other contractual liabilities. 

 

Anyway trading near March lows today.  Maybe I'm missing something.  (Opened a position today).

[Broeb22]

Don't know why they didn't make an effort to buy more earlier.  They can issue current shareholders rights to buy one or two shares at £2.00 (a 20% discount... heck it could be for £1.00 and the economics wouldn't change).  Shareholders who don't want to participate can sell their rights to compensate for any dilution, and nothing is lost.  In fact they should just raise too much and return it in the form of excess dividends or buybacks as the course of assets, liabilities, and opportunities becomes more clear.  It's a company with quality assets and a lot of franchise value making important stuff.  They just need to raise enough to deleverage and have enough cash leftover to very reliably moot questions about unexpected capex or other contractual liabilities. 

 

Anyway trading near March lows today.  Maybe I'm missing something.  (Opened a position today).

 

One thing that always surprises me is how often companies raise capital at the lows. Your comment totally makes sense, but the same could have been said years ago when the share price was higher and some of these issues were known. I know East probably would have been crucified years ago by investors because the stock was "too cheap" then to be raising capital. Behaviorally its tough to raise capital when you don't need it for a potential, hypothetical time in the future when you may need it, but it sure beats the shit out of massively diluting yourself at the lows.

[TwoCitiesCapital]

Don't know why they didn't make an effort to buy more earlier.  They can issue current shareholders rights to buy one or two shares at £2.00 (a 20% discount... heck it could be for £1.00 and the economics wouldn't change).  Shareholders who don't want to participate can sell their rights to compensate for any dilution, and nothing is lost.  In fact they should just raise too much and return it in the form of excess dividends or buybacks as the course of assets, liabilities, and opportunities becomes more clear.  It's a company with quality assets and a lot of franchise value making important stuff.  They just need to raise enough to deleverage and have enough cash leftover to very reliably moot questions about unexpected capex or other contractual liabilities. 

 

Anyway trading near March lows today.  Maybe I'm missing something.  (Opened a position today).

 

One thing that always surprises me is how often companies raise capital at the lows. Your comment totally makes sense, but the same could have been said years ago when the share price was higher and some of these issues were known. I know East probably would have been crucified years ago by investors because the stock was "too cheap" then to be raising capital. Behaviorally its tough to raise capital when you don't need it for a potential, hypothetical time in the future when you may need it, but it sure beats the shit out of massively diluting yourself at the lows.

 

I'm always shocked when companies decide to do a  new issuance instead of a rights offering. Rights offerings are massively more shareholder friendly in that you give your existing shareholder base first rights of refusal and the ability to participate at the same terms. It's slightly less guaranteed than a new offering (because you don't have to exercise the rights), but you're paying up for the that guarantee with the underwriters :/

 

I get it when you're in dire need of the money, but it doesn't seem to me that RR is knocking on deaths door.

 

Why is it more companies don't do this sort of thing?

[aryadhana]

One thing that always surprises me is how often companies raise capital at the lows. Your comment totally makes sense, but the same could have been said years ago when the share price was higher and some of these issues were known. I know East probably would have been crucified years ago by investors because the stock was "too cheap" then to be raising capital. Behaviorally its tough to raise capital when you don't need it for a potential, hypothetical time in the future when you may need it, but it sure beats the shit out of massively diluting yourself at the lows.

 

That's my frustration.  There's nothing particularly "dilutive" or not about raising equity for good reasons.  Shareholders who think they're getting screwed can and should just participate (or sell their right to do so). 

 

I'm always shocked when companies decide to do a  new issuance instead of a rights offering. Rights offerings are massively more shareholder friendly in that you give your existing shareholder base first rights of refusal and the ability to participate at the same terms. It's slightly less guaranteed than a new offering (because you don't have to exercise the rights), but you're paying up for the that guarantee with the underwriters :/

 

To be honest, I'm not even sure it's less guaranteed.  How could the distribution of decidedly in-the-money rights fail to be subscribed?  Now if the rights offering comes out of nowhere and bespeaks some hidden or otherwise unknown problem then the very indication that the offering would be pursued might push share prices down enough for the offering to fail.  Likewise if there is no franchise value and company is just an option on negative equity.  That's not the case here.  This looks nothing like HTZ and there's obvious value (which is why people are paying for it every day). 

 

Rights issues are more common in Europe than America (guessing that England falls somewhere in between). 

[rb]

Don't know why they didn't make an effort to buy more earlier.  They can issue current shareholders rights to buy one or two shares at £2.00 (a 20% discount... heck it could be for £1.00 and the economics wouldn't change).  Shareholders who don't want to participate can sell their rights to compensate for any dilution, and nothing is lost.  In fact they should just raise too much and return it in the form of excess dividends or buybacks as the course of assets, liabilities, and opportunities becomes more clear.  It's a company with quality assets and a lot of franchise value making important stuff.  They just need to raise enough to deleverage and have enough cash leftover to very reliably moot questions about unexpected capex or other contractual liabilities. 

 

Anyway trading near March lows today.  Maybe I'm missing something.  (Opened a position today).

 

One thing that always surprises me is how often companies raise capital at the lows. Your comment totally makes sense, but the same could have been said years ago when the share price was higher and some of these issues were known. I know East probably would have been crucified years ago by investors because the stock was "too cheap" then to be raising capital. Behaviorally its tough to raise capital when you don't need it for a potential, hypothetical time in the future when you may need it, but it sure beats the shit out of massively diluting yourself at the lows.

 

I'm always shocked when companies decide to do a  new issuance instead of a rights offering. Rights offerings are massively more shareholder friendly in that you give your existing shareholder base first rights of refusal and the ability to participate at the same terms. It's slightly less guaranteed than a new offering (because you don't have to exercise the rights), but you're paying up for the that guarantee with the underwriters :/

 

I get it when you're in dire need of the money, but it doesn't seem to me that RR is knocking on deaths door.

 

Why is it more companies don't do this sort of thing?

I'm with you on this one. Especially because rights offerings are actually quite popular in Europe. When I was in London in 08/09 there were rights offerings left right and center. Sometimes they would do right and then a secondary if the rights didn't bring in enough. Which is also cheaper cause you pay % comish on your secondary.

 

It could be that the situation at RR is worse than it looks.

 

This is one holding that didn't work out as planned for me.

[Spekulatius]

I agree that rights offerings are more shareholder friendly. One issue though is that often foreign shareholders can’t participate due to legal or technical barriers. I think ADR holders won’t be able to participate for example.

[rb]

yea, there are some points in there, but RR doesn't really have a huge ADR. So yeah, it's weird they didn't do rights.

[NotSoWise]

With the current price at GBP 2,13 its interesting to see what RR will do in Sep. If they proceed with GBP 1-1.5bn RI at a price of GBP 1.0 or 1.5 per share (assuming more share price fall) then it means they are in super deep hole without any options and all its PR about good liquidity is BS. Fair to say, IR said "current" liquidity, not long term.

Taking IB advisors (3 of them) usually means they are pretty serious about RI and saying "we consider options" usually means we work on RI. But will they pull the trigger at GBP 1 per share?

 

Interesting bit is the Spanish business - can they sell it and at what price. After signing, would they still proceed with RI? A lot will depend on when the long flights will pick up and to what degree, which is unknown at the moment.

 

Do you guys have any numbers what % of flights are we at the moment?

 

 

 

 

[Spekulatius]

With the current price at GBP 2,13 its interesting to see what RR will do in Sep. If they proceed with GBP 1-1.5bn RI at a price of GBP 1.0 or 1.5 per share (assuming more share price fall) then it means they are in super deep hole without any options and all its PR about good liquidity is BS. Fair to say, IR said "current" liquidity, not long term.

Taking IB advisors (3 of them) usually means they are pretty serious about RI and saying "we consider options" usually means we work on RI. But will they pull the trigger at GBP 1 per share?

 

Interesting bit is the Spanish business - can they sell it and at what price. After signing, would they still proceed with RI? A lot will depend on when the long flights will pick up and to what degree, which is unknown at the moment.

 

Do you guys have any numbers what % of flights are we at the moment?

 

PR around “our liquidity is strong” is almost always BS, because in most cases, solvency is the issue, not near term liquidity. The way RR business is structured (depending on LT contracts and viability), they can’t  afford to have junk credit, as they need the trust of their customers and access to capital markets. It is what it is, the capital raise will take place regardless of price.

 

That’s one of the issues with rights issues - they can take a long time and the stock can get into a death spiral in the meantime. This happened with the Brit banks too post GFC.

[aryadhana]

Do you guys have any numbers what % of flights are we at the moment?

 

I don't have the numbers atm, but worth pointing out that the % of flights number is much, much better than the (much more frequently cited) % of passengers number. 

[Xerxes]

to give you an idea from RTX's Q2 results.

 

"I think, Rob, what you need to think about is, what is the actual number of aircraft flying today. We think it’s the total flights are down about 50% and so well air passenger traffic is down 80%, which is better than the 95% it was. There’s still planes out there flying around and around, again down 50%. That’s really what we’re basing the outlook on."

 

 

i should add that with the statement above, one can get to the conclusion that the focus of airline economics are shifting from unit-costs to trip costs.

[fareastwarriors]

 

Activist shareholder ValueAct sells out of Rolls-Royce: source

 

 

https://www.reuters.com/article/us-rolls-royce-hldg-valueact-stake/activist-shareholder-valueact-sells-out-of-rolls-royce-source-idUSKCN2530HE?il=0

[TwoCitiesCapital]

https://www.ft.com/content/feea2bfb-b5d7-4fd5-a2c9-b2429c5961e2

 

Rolls confirms equity raise for £2B - will not seek sovereign wealth involvement.

 

Thought I saw something about a rights issue - any one know if that has been confirmed?

[Broeb22]

I remember Steven Wood from Greenwood being one of the loudest proponents of this stock, and I remember him being very confident of his conclusions and that the outcome we’re seeing with a capital raise at the lows as being almost impossible. Has he had any recent updates?

[Xerxes]

Rolls got a direct hit due to the pandemic.

No one could have seen it coming. Last year this time if someone asked me the likelihood of an event that will have an outsized severe impact on the wide-body segment, I would have laughed.

 

At the end of the day, as great of an engineering firm it is, it was a one trick pony with an outsized exposure to wide body segment, which itself had an oversupply different models from Boeing and Airbus. (I.e RR got a double hit as it supplies the engines both for A330NEO and A350; the former overlaps with the bottom end of the latter)

[TwoCitiesCapital]

Rolls got a direct hit due to the pandemic.

No one could have seen it coming. Last year this time if someone asked me the likelihood of an event that will have an outsized severe impact on the wide-body segment, I would have laughed.

 

At the end of the day, as great of an engineering firm it is, it was a one trick pony with an outsized exposure to wide body segment, which itself had an oversupply different models from Boeing and Airbus. (I.e RR got a double hit as it supplies the engines both for A330NEO and A350; the former overlaps with the bottom end of the latter)

 

I think his point was that the comments were made after COVID. I believe I also saw something from them saying despite COVID, the company would have ample liquidity and not need to do a stock offering. Obviously that's not the case with them issuing £2B with a £2.5B market cap.

 

 

[coc]

Also another blowup for the Sequoia Fund. About 5% of their capital at cost, I think.

[Broeb22]

I just re-read Wood’s June/July interview and he talks about a 35% FCF yield like what doesn’t the market understand, and this is another good lesson for me where listening to what the market is saying is worth doing to an extent. A healthy large business going through temporary distress simply doesn’t trade at those FCF yields.

 

It’s a delicate balance because you don’t want to look at negative price action and bail, but I’m more thinking sometimes it’s good to reverse engineer the expectations built into the price to get to back to a market average return.

 

It’s kind of surprising to me because I genuinely believe Wood is smart and very hard-working. But he seems lacking in humility or the ability to kill his own thesis.

 

 

 

[Broeb22]

Rolls got a direct hit due to the pandemic.

No one could have seen it coming. Last year this time if someone asked me the likelihood of an event that will have an outsized severe impact on the wide-body segment, I would have laughed.

 

At the end of the day, as great of an engineering firm it is, it was a one trick pony with an outsized exposure to wide body segment, which itself had an oversupply different models from Boeing and Airbus. (I.e RR got a double hit as it supplies the engines both for A330NEO and A350; the former overlaps with the bottom end of the latter)

 

Respectfully, I think the argument that they were hit by an unforeseeable pandemic (while true) is bull$hit for a couple of reasons. 1) the amount of capital they need to raise is so significant that some amount of disposals/capital raise was likely necessary in any event and 2) more importantly, they operate in a cyclical industry where $hit happens every once in a while. If you’re going to argue with a straight face that 9/11, the 2008 crisis, and now this were all unforeseeable at the time you’d be correct, but there is enough history that a prudent thing to do is to have a conservative balance sheet, and if you need to raise capital, do it when things are going OK to avoid 50% dilution like Rolls Is looking at it.

 

Additionally, while you might say this is the worst the airline industry has ever seen, that’s true, but if you look at available seat miles ( which I think is the right metric (not revenue passenger miles) because it captures the number of planes flying regardless of if people are on them) you would see that 9/11 and 2008 were pretty damn bad. 2008 in some ways could have been worse because customers didn’t know when the worst was going to be over so it was a couple of years of pain vs. this still has the potential to be short-lived, depending on the pandemic this winter and the govt fiscal response to it.

 

All that’s said, with Rolls finally getting some breathing room, this looks like a nice speculative long here.

[Spekulatius]

I think it is a bit disingenuous to say that this was just bad luck. While it is true that the COVID-19 crisis was unforeseeable, it was at some point clear that this bet had a substantial risk of permanent impairment.

RR was wounded before COVID-19 - the Trent 1000 engine troubles, years of weak cash flow, manufacturing issues, widebody exposure. When you read this thread here for example, there were pretty clear indicators even for a somewhat casual observer, that this could go seriously or the rails.

 

So in my opinion, the main mistake was not making the bet, it was failing to recognize when things we’re likely to go downhill and bailing out. Turnaround plays are just hard.

[Xerxes]

Great discussion folks:

 

i ll just throw in few qualitative points for the sake of discussion:

 

Aside the development issues RR has had, there has been a few strategic headwinds in recent years. (1) They lost the business jet position with Gulfstream to P&WC early in the decade, (2) they sold their stake in IAE to P&W and effectively removed themselves from the narrow body segment, which is now the absolute place to be (3) they got impacted by Bombardier drop in Global production rate on the legacy aircraft (4) there has been softness in the wide-body market and that is looking like more and more a permanent structural change.

 

On (1) & (3), RR has been working hard to get back into the game (i.e. note the brand new Gulfstream G700 + Global 5500/6500); on (2) P&W and CFM are well trenched in for the long haul; On (4) the wide-body softness looks more and more like a structural change. With the introduction of the likes of Airbus A.321LR, the upper segment of that narrow-body category is making the lower end of wide-body very vulnerable. (dont believe Boeing MOM will happen either) On a positive side, RR has A.350 and A.330NEO to itself.

 

Consolidation:

 

I believe in the long term RR needs scale. Note that Honeywell, future Raytheon Technologies and GE all have market capitalization north of $100B whereas Rolls Royce has a market cap of ~$13B. I cannot believe that with all the consolidation happening in the A&D sector, RR will not be participating as a target.

 

I dont believe Raytheon Technologies will be a buyer given where they are now with Raytheon about to be folded in (that said P&W is very complementary to RR from a product segment point of view); it would definitely not be GE (given their financial troubles and more importantly a GE-RR tie-up would mean a virtual monopoly in the wide-body segment). That leaves Honeywell or other PE-like shop as potential buyers.

 

Broeb22,

 

I don't disagree with anything you or Spekulatius are saying. I don't know the details of how much cash they need, or what they said or didn't say. But if the argument is that pre-pandemic, they should have raised as much as they could as the turnaround was going to be tough anyways, even without the pandemic, I am not pushing back on that.

 

My view however is that, the question of cash raise (how much and when) is rather more tactical. I voiced my view back in January (re-posted above) well before the pandemic, that this is a question of scale and the diversity of the product pipeline.

 

Die was cast more than a decade ago, when RR chose to sell its stake in IAE to Pratt & Whitney, while the latter not only consolidated its hold over the joint venture, it embarked on a brand new development program aim squarely at the narrow-body segment. Rolls Royce didn't plant any seeds while Pratt & Whitney invested heavily.

 

Today, Rolls Royce needs to part of a bigger franchise. It is bad enough to see its market evaporate, but not to have the B/S to be able to continue to develop in the downturn is compounding it.

 

Going back to cash raise, i am not sure what view Warren East was airing before the pandemic about Rolls Royce' stock being undervalued in the market, but I imagine that issuing new equity and saying that the stock is undervalued at the same time would have been double-talk.

 

 

 

[Broeb22]

Shareholders probably would have pushed back and demanded a rights issue, to avoid dilution. So kind of in the same boat either way, but without the massive drawdown.

 

I do think that cutting thousands of staff while raising equity could have been difficult internally. From an outsiders perspective, cutting staff to save money has a similar effect as raising capital, but the average worker would probably feel why do I have to lose my job since we have all this money floating around (after a hypothetical capital raise). I know that sounds silly, but who knows?

 

 

[SharperDingaan]

"From an outsiders perspective, cutting staff to save money has a similar effect as raising capital" ....

 

Sorry, but cutting staff is radically different - it is all about cutting FOH and lowering BE sales as much as you possibly can. When planes don't fly, engines don't wear out, new planes don't get built (engines + spares), and it takes more time until the next overhaul at 'X" hours of service. Revenues drop like a brick.

 

RR is not a lot different to the auto-industry. The supply chain employs a lot of people, and the spend has a material multiplier. Under covid, most would expect the government as a material new shareholder, preserving jobs. Post covid RR goes the way of Airbus, euro nations combining parts to produce a greater whole. The same thing will eventually occur in the US - industry mergers, + government contracts to underpin a minimum cash flow.

 

Ordinarily it's a great business - live on the predictable service revenue, and all new sales are gravy. But it implicitly assumed that planes would ALWAYS keep flying - a very valid assumption. Covid has been the black swan, in the last 2% of probability - tail risk that exists to be exploited.

 

For most RR shareholders, the smartest thing is to just sell it and buy it back later.

Simply ride out the uncertainty in gilts, while being pretty certain of a repurchase at 30-50% less, net of dilution. The more aggressive would use options as well.

 

Different strokes.

 

SD

 

 

 

 

 

 

 

 

 

 

 

 

[Xerxes]

Shareholders probably would have pushed back and demanded a rights issue, to avoid dilution. So kind of in the same boat either way, but without the massive drawdown.

 

I do think that cutting thousands of staff while raising equity could have been difficult internally. From an outsiders perspective, cutting staff to save money has a similar effect as raising capital, but the average worker would probably feel why do I have to lose my job since we have all this money floating around (after a hypothetical capital raise). I know that sounds silly, but who knows?

 

With or without equity raise, production people get cut as production rate plummet with the supply chain unraveling. But if the intent is maintain a robust product portfolio one needs to continue to invest in its engineering workforce and R&D.

[TwoCitiesCapital]

So the rights issue gives you rights to buy 10 new shares for every 3 you own at a steep discount to the market price - ~0.32 GBP instead of the current price of 1.45 GBP.

 

Isn't this a huge incentive to buy the shares currently? For every 3 shares you purchase @ 1.45 GBP, you get the right to buy 10 more at 0.32 GBP giving you a blended average cost of 0.58 GBP while the market value is 2.5x that price. As long as the market price remains above 0.32, shouldn't there be a bid for the shares to get these valuable rights?

 

Seems like a temporary technical lift to the stock and maybe why it's up 18% today. But the further it climbs, the more powerful that force becomes because the more valuable those rights are.

 

Makes one wonder what happens when the rights are issued/exercised though. Would that be the reversal of the trend?