After endless speculation, Rolls-Royce (RR.) has finally unveiled plans for a £2bn rights issue as part of a package of measures to recapitalise its balance sheet. The aero-engine maker has also announced a bond offering to raise at least £1bn and secured conditional commitments for £2bn-worth of additional loans subject to the rights issue being completed. These comprise a new two-year term loan facility for £1bn and a £1bn extension to its existing five-year term loan. The latter is being backed by an 80 per cent guarantee from UK Export Finance, a government credit agency.
The fundraising comes amid the Covid-19 squeeze on international air travel and the civil aerospace industry. Rolls saw its engine flying hours collapse by around 50 per cent in the first six months of 2020, which is significant because it operates a ‘power-by-the-hour’ business model – this means that it typically sells its engines at a loss and earns revenue according to how long they spend up in the air. Throwing in a £1.1bn hit from halting invoice discounting, the knock-on impact was that Rolls saw a £2.8bn free cash outflow in the first half of the year. It also ended the half with £1.7bn of net debt (excluding lease liabilities) and without the rights issue, it believes this will hit £3.5bn by the year-end. Adding to the pressure, Rolls has £3.2bn of debt maturing between now and the end of 2021.
Together with the £2bn it is targeting from business disposals – which includes Spanish subsidiary ITP Aero – Rolls says that the rights issue will help reduce leverage and provide sufficient liquidity for even its worst case scenario. This entails a second wave of Covid-19 and the reintroduction of stringent international travel restrictions. In a reasonable worst case situation, Rolls estimates that engine flying hours would finish the year down 65 per cent versus 2019 and still be down 20 per cent even in 2022. Without the new loans being proposed, Rolls believes that the rights issue proceeds and its existing debt facilities could fund its requirements for the next 12 months.
The £2bn being sought through the rights issue is lower than the £2.5bn widely anticipated. Rolls had been expected to tap sovereign wealth funds from Kuwait and Singapore for a £500m equity investment, but according to Sky News, the group abandoned the plans after existing institutional shareholders expressed concerns over the dilution of their stakes.
The 10-for-3 rights issue will be priced at 32p per share, a hefty 41 discount to its theoretical ex-rights price on 28 October and a 75 per cent discount to its closing price on 30 September. The fundraise will be fully underwritten and is subject to shareholder approval.
Rolls is still guiding to £4bn free cash outflow for the full year, but is targeting at least £750m of positive free cash flow in 2022. This comes as it retains its faith in the future prospects of civil aerospace. The group believes that its relatively young base of installed engines will generate annuity-style cash flows over the long term from aftermarket servicing activity. Aiming to boost returns by scaling back on capital investment, it has already reduced capital expenditure by a third this year as part of a bid to make £1bn-worth of savings. The civil aerospace business is also being restructured to better match market demand.
