Few companies have been hit as hard as Sabre Corp. (SABR). A travel technology and services provider, the company illustrated in its second quarter earnings release earlier this month that demand for its offerings has collapsed in a manner perhaps previously deemed impossible. Following this reveal, management embarked on a series of financial maneuvers aimed at shoring up the business. These will ultimately prove costly to shareholders in the firm, but assuming management’s guidance is accurate, they will help the firm survive this downturn. At the end of the day, these moves will probably be seen as a necessary evil, but if the business can survive the crisis caused by the COVID-19 pandemic, then the future for it and shareholders who get in at the right price should be bright.
A lot of pain
Most companies, at least in the US, have been negatively affected by the COVID-19 pandemic. Much of this pain ended up coming in the second quarter this year as shutdowns became the name of the game. Few firms, however, were hit as hard as Sabre. According to management, revenue in the second quarter this year came out to just $83.04 million. This represents a nearly 92% decline compared to the $1 billion the business generated in the second quarter of its 2019 fiscal year.
This historic plunge in sales was accompanied by a massive drop in profitability for the business as well. In its second quarter this year, Sabre reported a net loss of $444.13 million. This compares to a profit of $27.83 million a year earlier. Operating cash outflows totaled $395.04 million. This stacks up against the net inflow in the second quarter of the company’s 2019 fiscal year of $257.66 million.
In some respects, Sabre is well-positioned to withstand some pain. In other respects, it’s not. Take, for instance, cash into consideration. Cash and cash equivalents at the end of the second quarter totaled $1.31 billion. Not only that, the firm’s current ratio is a robust 2.27. So long as the business does not trigger any covenants that accelerate debt repayment, this current ratio provides it with plenty of runway. But debt as a whole, from a long-term perspective, isn’t exactly great. Gross debt as of the end of the latest quarter was about $4.69 billion. With that amount outstanding, quarterly interest of $58.58 million takes up a large chunk of the business’s paltry sales.
Management is doing what it must
Between August 18th and August 24th, the management team at Sabre initiated a series of changes aimed at improving the company’s chances of survival long term. These changes will ultimately come at the expense of shareholders, but with as much debt as the company currently has, it’s unlikely there were other options available to the firm. The first step worth mentioning here is a common stock offering. Management ended up issuing 35.71 million shares of common stock at a price of $7 per unit. This will result in $250 million of gross proceeds, with net proceeds estimated to total $239.38 million.
In addition to these shares, management has provided underwriters with the option to buy a further 5.36 million units at the same price. This should result in a further $50 million in gross proceeds, bringing total net proceeds from the raise up to $287.50 million. If shares were still up around $20 per unit, this size of a raise would have cost investors just 5.2% of the business. But with shares priced at $7 a piece, the cost nearly triples to 13%. That alone is a costly move for the firm.
If you thought that dilution stopped here, think again. Management has also announced plans to issue Mandatory Convertible Preferred Stock to investors. Initially, the goal was to make this amount $250 million with an underwriter’s option of $50 million for gross proceeds of up to $300 million and net proceeds of up to $287.50 million just like with the common units offering. However, management has since upsized these units. In all, the firm is issuing $300 million worth of preferred units, plus it’s providing an underwriter’s option of $45 million. Net proceeds should end up being around $330.63 million in all.
During the time that these units remain outstanding, investors are to be paid an annual dividend of 6.50%. The plan is to make this a cash payment, but under certain circumstances, management may pay it with additional stock or a mix of cash and stock. On September 1st of 2023, these units will mandatorily convert, with the firm’s common share price leading up to that point dictating the conversion ratio.
The lower bound set is 11.9048 shares for every $100 liquidation preference unit, and the upper bound is 14.2857 shares. Holders of these units may convert prior to this date, but then it would be done at the minimum conversion ratio. These preferred units will cause between 41.07 million and 49.29 million additional common units to be issued if the business sees them converted. This will increase shareholder dilution from the aforementioned 13% to between 22.9% and 24.7%.
Not every move made by management involves dilution though. The company is also issuing $850 million worth of Senior Secured Notes that will come due in 2025. They bear an annual interest rate of 7.375%. The amount issued is a significant increase over the $300 million initially intended. Management intends to use the proceeds from this issuance to redeem its 5.375% Senior Notes due in 2023 in full. This works out to $530 million in principal value of debt.
It’s unsure how the rest will be allocated, but management did say that they intend to allocate it toward other senior indebtedness. One bad thing about this move is that it will cause annual interest expense to rise. Just on the $530 million notes alone, the difference in interest rate will result in additional annual interest expense of $10.6 million moving forward.
A return to normal will create significant value
These moves by management should be viewed as an extra form of support while the company goes through these turbulent times. While annual interest expense is likely to increase (unless management allocates the cash proceeds from its share issuances toward debt reduction), management is working to keep costs lower. You see, according to the firm, if it sees no new net bookings this year, it will burn through around $80 million in cash every month.
However, management is active in pushing costs lower. This $80 million each month includes $275 million in estimated net savings caused by cost-cutting initiatives that should be realized this year. In 2021, net savings of $200 million per year (relative to 2019) should be realized. Examples of initiatives embarked on by management include a reduction in the base compensation of its US-based salaried workforce. This also includes a 25% reduction in pay for the business’s CEO. Another big move is the suspension of its 401(k) match for employees.
It remains to be seen which cost reductions will stay with the firm long term, but if someday the business can return to normal, upside for shareholders could be significant. To understand why we need only consider the company’s historical financial results before 2020 came around. Between 2015 and 2019, for instance, sales at the firm continuously increased, rising from $2.96 billion to $3.97 billion.
While operating cash flow was quite volatile, it did remain in a fairly narrow range of between $529 million and $724.80 million. Free cash flow was far more consistent, rising nicely from $242.51 million in 2015 to $466.09 million last year. Taking into consideration maximum dilution associated with its share issuances, returning to 2019’s level of free cash flow would result in a price/free cash flow multiple on the firm of just 2.8. That’s incredibly low. No, investors should not expect this to happen overnight. It will probably take two or three years. But it should happen.
Based on the data provided, it looks like Sabre has been hit hard and, as a result, the firm has been forced to take some painful measures. Though investors may not be happy about this, the cash the business has raised should help it survive the current downturn. So long as it makes it out of this without further dilutive moves, the long-term picture for the business should be bright. All investors will have to do is wait for the storm to pass.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.