Rolls Royce is hurtling towards failure, could it be saved by spinning off the Aerospace Business?
By Charles Heighton – The London Financial Markets Editor and VP of Trading at King’s Global Markets
It has been a very bad year for Rolls Royce. The company has been haemorrhaging cash since the pandemic halted flights around the world. In the first half of 2020, they lost £5.4 billion. This mostly springs from Rolls Royce’s sales model.
Rolls Royce only starts to profit as their engines fly because they are paid on a ‘power by hour’ model. They mostly manufacturer long haul engines so use and demand has fallen tragically this year. Internal analysts expect it to take five years for long haul traffic to reach pre-COVID levels.
The company is now exploring an equity raise to plug the huge hole in its balance sheet. The target is allegedly £2- 2.5 billion. A huge raise considering that the current market cap of Rolls Royce is around £3.5 billion.
Certain analysts do not believe that this will be enough. David Perry a JP Morgan analyst expects Rolls Royce to need at least £8 billion, of which £6 billion could come from an equity raise. This could decimate existing shareholders, but without it Perry expects government intervention to prevent Rolls Royce from failing.
Debt is a tougher option for Rolls Royce because it already has fewer long-term assets than liabilities and cannot keep adding to its interest payments. At this point, the board should be exploring all options.
I believe that Rolls Royce needs to take drastic action to save the business. The Aerospace division which in 2019 comprised 50% of revenue could be spun off and listed separately.
This would half revenues but remove the most problematic division. The excess debt on the balance sheet could also be offloaded onto this entity. The aerospace division would then have a dedicated management team that could focus on the huge problems it is facing. This spin-off could also avoid a golden share that the government currently has over Rolls Royce. This share enables any takeover from a foreign business to be vetoed. As a separate company, the aerospace division may not be forced into this kind of agreement and could therefore find a buyer more easily.
The remaining divisions are more desirable because they have much higher profit margins and have been significantly less affected by corona virus.
This would leave a stronger more focused and profitable Rolls Royce that could avoid government intervention. This drastic action would also protect shareholders, some of which have been loyal. An equity raise or government intervention would annihilate these loyal investors.
If I was an investor in Rolls Royce, I would expect the board to be exploring more creative solutions like the above. No one wants the company to fail but maybe Rolls Royce is just not built to survive in its current form. It is time that the company adopted.
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