As speculation over its finances mounts, Rolls-Royce (RR.) has confirmed that it is considering tapping investors for up to £2.5bn to shore up its balance sheet. The aero-engine maker has repeated that it continues to “review all funding options” and that “no final decisions have been taken”, but says it is mulling a potential rights issue or issuing new debt.
The announcement follows a report from the Financial Times over the weekend that Rolls is in discussions with sovereign wealth funds – including Singapore’s GIC – over a possible fundraise. According to the newspaper – which cited “people familiar with direct knowledge of the matter” – the group could launch an equity raise as soon as next month.
The need for a cash injection reflects the havoc wreaked by Covid-19 on international air travel and the knock-on effect down the entire civil aerospace supply chain. Rolls operates a ‘power-by-the-hour’ business model, meaning that its typically sells its engines at a loss and earns revenue according to how long they spend up in the air. But as airlines have grounded their fleets, the first six months of the year saw engine flying hours collapse by almost 50 per cent, and they are expected to remain depressed at 45 per cent of 2019 levels by the end of the year. Together with a £1.1bn hit from halting invoice discounting, this saw Rolls register a £2.8bn free cash outflow in the first half of 2020 and it is guiding to a further £1bn outflow in the back end of the year.
Excluding £2.3bn of lease liabilities, the group was sitting on £1.7bn of net debt at the end of June and believes this will hit £3.5bn by the year-end. It also anticipates that net debt will have “significantly increased” by the end of 2021. Adding to the pressure, Rolls has £3.2bn of debt maturing between now and the end of next year, which includes a £1.9bn revolving credit facility (RCF) which it has yet to be drawn upon. However, that RCF – alongside £4.2bn in cash and a £2bn term loan secured in August – does mean that Rolls has £8.1bn of liquidity to hand.
Still, in response to the aviation crisis, the group is restructuring its civil aerospace division, looking to make annualised pre-tax savings of over £1.3bn by the end of 2022. It is also targeting more than £2bn of proceeds from business disposals, including Spanish subsidiary ITP Aero, which makes engines for the Eurofighter Typhoon jet. ITP had attracted the interest of information technology and defence company Indra Sistemas (ES:IDR) last year before talks fell through and private equity is now said to be circling. But this is hardly a seller’s market and it remains unclear how much Rolls would be able to fetch.
Even if it were to secure its desired £2bn from divesting assets and raise a further £2.5bn from a rights issue or placing, this still might not be enough. Analysts at JPMorgan believe that “only a very major capital raise would put Rolls-Royce on a sound footing”, pointing to the need for at least £6bn from disposals and an equity raise.
There are also now questions over Rolls’ independence and a possible state intervention. Pauline Latham, Conservative MP for Mid Derbyshire – which is home to Rolls-Royce’s headquarters – told the Financial Times that the government should take this opportunity to purchase a stake in the company. As a legacy of when Rolls was nationalised in 1971, the state already has a so-called ‘golden share’ that enables it to veto any foreign or hostile takeovers. There are also murmurings that the government could push for a merger with BAE Systems (BA.), an idea that has been kicking around for many years but has never gained any real traction. All things considered, BAE has weathered the Covid storm rather well thanks to its defensive tilt. It is unlikely that it would want to be dragged down by Rolls’ pandemic woes as well as the threat of more technical stumbling blocks emerging, such as the Trent 1000 engine troubles.
