Blog & Opinion

Jun 11, 2018

The real value of Kenya Airways Share price is Kshs.1.00; market irrationality to blame for current overvaluation

Are investors always rational? This is a question that has been subject of a number of academic studies and theories. Top of the list of theories is the famous Efficient Market Hypothesis (EMH), which evolved in the 1960’s from Eugene Fama’s Ph.D dissertation. It states that at any given time, asset prices fully reflect all available information. The basis of the EMH is the simple economic theory of competitive markets. Indeed basic economic theory teaches that arbitrage competition among investors and their profit motive will create efficient markets.

As new information is dribbled into the marketplace, all investors will act on it rationally to adjust price to a new intrinsic value. Should price deviate from its true value, so-called ‘noise’ arbitrageurs will compete to bring that price back to that value at which the price will be at equilibrium with its value. But there are two cardinal problems here, especially in as far as information dissemination is concerned. First, we have the problem of information asymmetry-where a certain group of market participants have information that another party doesn’t. It always happens. Second, we have the problem of interpretation.

The information maybe too numerous and too complex, and, thus, not easily or inexpensively interpreted. Information interpretation and decision making is subject to cognitive bias and limits. Indeed, the new science of behavioral finance studies the irrational behavior of investors and how they interpret information. Some of the results have shown illogical behavior, such as comfort in crowds-also called herding-and overconfidence based on little information. I have always known the stock market to dribble a certain dose of irrationality, but not to the extent that investors have continued to display on Kenya Airways (or KQ) stock. In 2017, Kenya Airways restructured its balance sheet in a rather benignly complex transaction.

The whole objective of the transaction’s entirety was to equitize the company’s unsecured lenders as well as re-equitize Government’s cash and non-cash advances. The Government remains the largest shareholder. To achieve this, it needed to tweak its share capital to create room. So the company first split the par value of its shares from Kshs.5 a share to Kshs.0.25 a share. This shrank the existing nominal value of its issued and fully paid share capital to Kshs.374million, from sh7.48 billion-and representing a 95 percent dilution. Out of each ordinary share, they then created 19 deferred shares via a share split, to the extent that the process hatched 28.4 billion shares. It’s a process that appeared to technically create new shares, yet it didn’t.

The deferred shares have been stripped of core privileges typical of ordinary shares. Indeed according to the Extra-ordinary General meeting (EGM) notice supplied by Kenya Airways in July 2017, holders of the deferred shares were stripped of the following privileges: (i) receipt of any dividend or any distribution; (ii) receipt of a share certificate in respect of the relevant shareholding; and (iii) receipt of notice of, nor to attend, speak or vote at, any general meeting of the company. What a deferred ownership. Summed up with the non-deferred shares, the company’s new issued and fully paid shares surged to 29.9 billion shares-or, as I aforementioned, the equivalent of 95 percent dilution. Suddenly, existing shareholders, who owned the non-deferred shares, found themselves in the super-minority cabin. It is from the deferred shares pool that the company allocated its lenders, including Government, quasi-ownership as well as allocate additional ownership to one of its key owners-Royal Dutch Airlines.

The Government of Kenya was allocated a total of 13.5 billion shares, increasing its overall ownership to 45 percent. Royal Dutch Airlines (or KLM) was allocated a total of 3.7 billion shares, increasing its overall equity in the company, diluting its shareholding to 12.4 percent, from 26.7 percent. KQ Lenders Co. Ltd, the vehicle formed to consolidate equity allocation to the unsecured lenders, who consisted of eleven local banks, was allocated a total of 10.6 billion shares, split into two: the first portion of 8.3 billion shares was a straight direct equity in Kenya Airways by the vehicle. However, the unsecured lenders, who were owed a total of $220.7 million, did not convert the entirety of the outstanding. Instead, the direct equity of 8.3 billion shares was swapped for $170.7 million of debt. The balance of $50million debt was transformed into a mandatorily convertible instrument scheduled to fall due over a two financial year periods, beginning 2018. In that respect, slightly over two billion shares have been allocated.

Finally, the company’s employees, under an Employee Ownership Scheme (ESOP), were allocated the balance of 568.6 million shares. Because of the voluminous nature of handling nearly 30 billion shares, a first for any listed company in Kenya, the company decided to consolidate its shares in the ratio of one share for every four shares-an action referred to as reverse split. This also explains why holders of the company’s shares pre-restructuring suddenly had their holdings in the Central Depository System (CDS) shrank by a quarter. The net effect of all this balance sheet restructuring was the initial listing of 6.8 billion Kenya Airways shares at the Nairobi Securities Exchange (NSE) on November 29, 2017-which would later fall to the current level of 5.68 billion shares. But here is the madness. Because pre-restructuring investors had their worth cut into quarter, the market’s immediate reaction was to adjust the market price to the equivalent of previous worth-while ignoring changed dynamics of the company.

First, the company’s listed shares surged from nearly 1.5 billion shares to the current 5.68 billion shares. These are tradable shares by all means. Further, the par value of the company’s shares, after the reverse split, dropped to Sh1.00 from previous sh5.00. At the point trading on the company’s shares were being suspended-the suspension had to be effected to enable adjustment in the share adjustment after the entire process-there existed a parity between par value and market value. On that basis alone, the company’s market price post-suspension was worth Sh1.00 a share.

Secondly, the market ought to further discount the company on two accounts: (i)significant share overhang which typically represents as a much as 20 percent downside-this discounting is hinged on the fact that there exists potential dilutive impacts if the new blocks allocated to the employees and the lenders’ vehicle were to be released to the market; and (ii) government discount on account of its increased ownership of the company from 29.8 percent to 45%. The market has typically assigned anything between 25-30 percent government discount-and the discounting is premised on the fact that Governments tend to interfere with businesses without notice. Consequently, if you factor in these discounts as well as the prior par value-market price parity, the stock is massively overpriced solely on the basis of investor irrationality.

Last modified on Monday, 11 June 2018 13:21

Leave a comment

Recent Blog Posts