Valuation of Cimber Sterling - PUREpure.au.dk/portal/files/10723/Valuation_of_Cimber_Sterling.pdfOverview of Airline Industry ... The financial analysis also contains an analysis of

Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen

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Executive Summary

The thesis is motivated by the challenges faced by external investors when valuing companies. The

research question of this thesis is to estimate a fair value of Cimber Sterling Groups’ share price at

the 17th March 2010. The discounted cash flow model is applied based on its important place within

valuation theory in contemporary corporate finance. To answer the research question thoroughly

both a strategic and financial analysis is made as a foundation for the later use of the discounted

cash flow model. The strategic analysis reveals the most important strengths, weaknesses,

opportunities, and threats that each will affect the potential value creation to shareholders in the

future in a positive or negative way. The historical financial analysis reveals profitability and risk,

which have affected the value creation over the last three years. The profitability is decomposed to

identify the underlying reasons for the negative development.

By integrating the value drivers identified in the financial and strategic analysis a budget forecast is

estimated. The budget forecast is used to calculate a share price estimate using the discounted cash

flow model, which gives a fair price of DKK 11,07. The residual income model is used as a

calculation check of the DCF model. The theoretical share price is significantly higher than the

actual closing share price the 17th March of DKK 3,89, which suggest that the market undervalues

the share. The theoretical share price is examined through a sensitivity analysis and a peer group

analysis. The sensitivity and peer group analysis suggests a high level of uncertainty combined with

the theoretical share price. The thesis therefore stresses the vulnerability of the valuation models

used and their underlying assumptions.


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Table of Contents

Table of Contents ...................................................................................................................................... 2

1. Introduction ........................................................................................................................................... 5

1.1 Motivation ....................................................................................................................................... 5

1.2 Problem Statement .......................................................................................................................... 5

1.3 Structure .......................................................................................................................................... 6

1.4 Delimitations and Assumptions ...................................................................................................... 7

1.5 Method ............................................................................................................................................ 7

2. Background Information ....................................................................................................................... 8

2.1 The Efficient Market Hypothesis .................................................................................................... 8

2.2 Theory of Valuation Models ........................................................................................................... 9

2.2.1 Theory of the DCF Model ........................................................................................................ 9

2.2.1.1 CAPM .............................................................................................................................. 11

2.2.2 Peer Group Analysis .............................................................................................................. 13

2.2.3 Conclusion Valuation Theory ................................................................................................ 13

2.3. Overview of Airline Industry ....................................................................................................... 14

2.3.1 Airline Industry ...................................................................................................................... 14

2.3.2 Brief Introduction of Cimber Sterling Group A/S ................................................................. 15

3. External Analysis ................................................................................................................................ 16

3.1 PEST ............................................................................................................................................. 16

3.1.1 Political-legal Environment ................................................................................................... 16

3.1.2 Economic Forces .................................................................................................................... 16

3.1.3 Socio-cultural ......................................................................................................................... 17

3.1.4 Technological ......................................................................................................................... 17

3.2 Five Forces .................................................................................................................................... 18

3.2.1 Threat of New Entrants .......................................................................................................... 19

3.2.2 Bargaining Power of Suppliers .............................................................................................. 19

3.2.3 Bargaining Power of Buyers .................................................................................................. 19

3.2.4 Threat of Substitute Products or Services .............................................................................. 20

3.2.5 Rivalry among Existing Competitors ..................................................................................... 20

3.2.5.1 SAS .................................................................................................................................. 21

3.2.5.2 Norwegian ........................................................................................................................ 21

3.2.5.3 Ryanair ............................................................................................................................. 22

4. Internal Analysis ................................................................................................................................. 24

4.1 Resources ...................................................................................................................................... 24


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4.1.1 Tangible Resources ................................................................................................................ 24

4.1.2 Intangible resources ............................................................................................................... 25

4.2 The Initial Public Offering ............................................................................................................ 26

4.3 CSG’s Strategy .............................................................................................................................. 28

4.3.1 Vision, Strategy, and Business Model ................................................................................... 28

4.3.1.1 Vision ............................................................................................................................... 28

4.3.1.2 Strategy and Business Model ........................................................................................... 28

4.4 Critical Review of CSG’s Strategy ............................................................................................... 29

4.5 SWOT ........................................................................................................................................... 31

4.6 Preliminary Conclusion................................................................................................................. 33

5. Financial Analysis ............................................................................................................................... 34

5.1 Reorganizing the Financial Statements ......................................................................................... 35

5.1.1 Statement of Changes in Equity ............................................................................................. 35

5.1.2 The Balance Sheet .................................................................................................................. 35

5.1.3 The Income Statement ........................................................................................................... 37

5.2 Analysis of Profitability ................................................................................................................ 38

5.2.1 Decomposition of ROE .......................................................................................................... 38

5.2.1.1 Financial Gearing and Spread .......................................................................................... 39

5.2.1.2 Net Borrowing Rate ......................................................................................................... 41

5.2.1.3 ROIC ................................................................................................................................ 41

5.2.1.4 Turnover Rate of Asset and Profit Ratio .......................................................................... 42

5.2.1.5 Profit Ratio Drivers .......................................................................................................... 43

5.3 Airline Specific Key Ratios .......................................................................................................... 45

5.3.1 ASK ........................................................................................................................................ 46

5.3.2 RPK ........................................................................................................................................ 46

5.3.3 Load Factor ............................................................................................................................ 46

5.3.4 Yield ....................................................................................................................................... 47

5.4 Risk Analysis ................................................................................................................................ 47

5.4.1 Operating Risks ...................................................................................................................... 47

5.4.2 Financial Risks ....................................................................................................................... 48

5.5 Permanent Earnings ...................................................................................................................... 49

5.6 Preliminary Conclusion................................................................................................................. 49

6. Forecasting .......................................................................................................................................... 50

6.1 Forecast Horizon ........................................................................................................................... 51

6.2 Revenue Growth ........................................................................................................................... 52

6.3 Operating Costs Held for Sale ...................................................................................................... 53


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6.1.5 Rental and Leasing Expenses ................................................................................................. 54

6.1.6 The Effective Tax Rate .......................................................................................................... 54

6.1.7 Other Operating Profit (after tax)........................................................................................... 55

6.1.8 Depreciation, Amortization and Impairment ......................................................................... 55

6.1.9 Net Working Capital and Non-current Net Operating Assets ................................................ 55

6.1.10 NOPLAT .............................................................................................................................. 56

6.1.11 Net Operating Asset ............................................................................................................. 56

7. DCF Valuation .................................................................................................................................... 57

7.1 Estimation of WACC .................................................................................................................... 57

7.1.1 Target Capital Structure ......................................................................................................... 57

7.1.2 Return Demanded by Equity Investors - rEquity ...................................................................... 58

7.1.3 Return Demanded by Debt Investors - rD .............................................................................. 58

7.1.4 WACC .................................................................................................................................... 59

7.2 Calculation of Share Price Estimate from DCF Model ................................................................. 59

7.3 Sensitivity Analysis ...................................................................................................................... 60

7.3.1 Growth Drivers ...................................................................................................................... 61

7.3.2 Financing Drivers ................................................................................................................... 62

8. Peer Group Analysis ........................................................................................................................... 62

9. Conclusion .......................................................................................................................................... 65

References ............................................................................................................................................... 68

Appendices .............................................................................................................................................. 76


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1. Introduction

1.1 Motivation

The process of choosing a topic for our bachelor thesis created many discussions, and many areas of

interest were considered. Our choice fell on a fundamental analysis of a company. The motivation

for choosing a fundamental analysis was primarily to get an understanding of the challenges that an

external investor and analysts have when estimating a fair value through the contemporary

valuation models.

Several companies were then considered for a fundamental analysis however one company

continuously came to our attention through massive media coverage. This company was Cimber

Sterling Group A/S (CSG), a Danish airline. The process of CSG’s initial public offering (IPO), the

fluctuating share price, and the media coverage that followed are all factors that have motivated us

to choose CSG. Furthermore it is a relatively small airline company in a very competitive industry,

which by nature implies great risk and great opportunities. The general shift towards low cost

carriers (LCC) worldwide has increased the competition within the industry dramatically. This shift

makes it harder for everybody to operate profitably, which makes CSG an interesting research

subject. What made it even more interesting was the fact that CSG was a family owned company

that had not publicly reported their financials before, and we therefore had a limited amount of

historical data to work with. By choosing CSG instead of a large company in a steady business it

will make our job difficult but more similar to that of an external investor or analyst.

1.2 Problem Statement

During the last weeks before CSG’s IPO, in November 2009, they were forced to lower their asking

price from the range DKK 20-24 to the range DKK 10-13. The closing price on the 17th of March

was DKK 3,89 (Nasdaq OMX Nordic, 2010). The extreme share price differences are the basis for

an investigation of the fair value of the share. Many different parties are interested in evaluating the

fair price of CSG, these among others include: Current and future investors, banks, creditors,

customers, suppliers, and collaborators. The approach of this paper is to evaluate CSG from an

external investor point of view. The problem faced by external investors today is to evaluate

whether the current price is fair in the light of the acquiring of Sterling A/S’ assets and the

mispriced IPO. On this background we want to make a fundamental analysis of the fair value of

CSG to reach an estimate of the share price after the turbulent IPO. On the 17th of Marts the 3rd


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quarter report was released and it is thereby a natural cut-off date. No information that appears after

this date will be considered in the fundamental analysis.

Research question:

What is the fair value of Cimber Sterling Group’s share?

1.3 Structure

This paper will start with an introduction that contains: motivation, problem statement, structure,

delimitation and assumptions, and method. Following the introduction there is a section called

background information covering the efficient market hypothesis (EMH), theory of valuation

models, and an overview of the airline industry. Then a strategic analysis is carried out based on an

external and internal analysis. The external analysis includes a PEST and a five forces analysis. The

five forces analysis will include a review of CSG’s main competitors. The internal analysis focuses

on CSG’s resources, the recent IPO and a critical review of CSG’s strategy. The strengths,

weaknesses, opportunities, and threats identified in the strategic analysis will be summarized in a

SWOT matrix. After this, a financial analysis will be carried out, which will start with a

reformulation of the financial statements. Having done this, a profitability analysis containing a

decomposition of ROE is made. The financial analysis also contains an analysis of airline specific

key ratios and a risk analysis.

The strategic and financial analysis will then be used as a foundation for budget forecasting. The

budget forecast is then used to perform the actual valuation of CSG’s share by means of the

discounted cash flow (DCF) model. A sensitivity analysis is made to evaluate the certainty of the

share price calculated through the DCF model, and to identify the most sensitive value drivers. A

peer group analysis will be used in the end to find another share price estimate, which can also be

used to evaluate the certainty of the fair price calculated. The overall structure can be seen from

figure 1.


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1.4 Delimitations and Assumptions

This paper will only focus on the European airline industry, as CSG only operates in Europe. Hence

whenever “airline industry” or the “market for air travel” and the like are mentioned it will only

include Europe unless otherwise stated. Throughout the paper the focus will be on three main

competitors. In the section about the airline industry the reasons why these three companies are

used as the main competitors will be described.

The report will be made from the perspective of an external long-term investor and the only

information that will be used will be publicly available information. It is assumed that the market is

not completely efficient, since it would make limited sense doing a fundamental analysis if the

EMH is assumed true. The EMH is discussed in section 2.1

Deviations from the calculated firm value to the actual stock price can have multiple causes, one of

which is the psychological factors behind stock trading. These factors are not always rational, and

they are very difficult to predict. These psychological factors might result in an inefficient market,

and combined with the fact that the psychology surrounding stock market trading is worthy of a

whole assignment by itself, they will not be dealt with in this paper.

1.5 Method

This report sets out to estimate the objective fair value of CSG using fundamental analysis. This is

done with the assumption that there is only one objective fair value, and that an outside investor

cannot calculate the exact objective fair value due to asymmetry of information. We will try to get,

as much information as possible and at the same time be critical about the information used. Any

valuation will be subjective, as we will be influenced by all public information about CSG and other

companies, but we will try estimating the objective fair value of CSG using fundamental analysis.

Budget

Forecast

Financial

Analysis

Strategic

Analysis

Valuation

Figure 1: Own processing with inspiration from Ole Sørensen (2009, p. 21)


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We will have a critical approach to reduce the personal bias that we will consciously or

unconsciously have towards CSG. We will focus on one model and get an in depth analysis of CSG

using this model, an alternative to a more broad analysis using several theories. This paper uses a

practical approach to the valuation, the emphasis is therefore not on an analysis of different

theories. The report will be composed of secondary data, which includes among other things books,

newspaper articles, annual reports, the prospectus, and scientific research reports. No primary data

will be collected as it is evaluated that an external investor or analyst will typically not collect this

kind of information.

2. Background Information

2.1 The Efficient Market Hypothesis

The EMH states that an asset is always traded at a price that incorporates all available information

relevant to that asset. Changes in asset prices only occur when the market receives new information

that cannot be predicted in a systematic manner. This means that a change in interest rate by the

central bank, which is expected by the market, will have no influence on the price of securities.

According to the EMH new information will be reflected in the price of an asset almost

instantaneously, and by using available information all market participants arrive at the same

“rational expectations” forecast for the future. It follows from this that if all relevant information is

incorporated in the price of the asset, and if all market participants are arriving at the same “rational

expectations” forecast, it must mean that there should be no trade. Trade implies that a seller

expects the price of the asset to decline, and a buyer expects the price of the asset to rise.

Furthermore, even if a particular cause is expected by the market it does not mean that all

participants in the market has fully understood the effect it will have and thereby discounted it

(Shostak, 1997, p. 31). It would make less sense to make a fundamental analysis if we were to

assume the EMH to be true, since any deviation in value found would be derived from calculation

errors on our part. The degree to which the EMH is true can be said to influence the importance of

this valuation of CSG. However if the EMH is true then a fundamental analysis can still be used to

detect the implicit expectations that the market has for the given price (Sørensen, 2009, p. 28). It is

believed there are too many assumptions in the EMH that do not hold in the real world, and the

EMH is assumed not to be entirely true; the market is assumed to be semi-efficient.


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31 2

2 3Equity value= ...

1 (1 ) (1 )E E E

DIVDIV DIV

r r r+ + +

+ + +

2.2 Theory of Valuation Models

There are many ways to value a company. Just for a single takeover bid or price setting of an IPO,

investments banks will normally use five to ten different valuation models (Palepu, Healy, &

Bernard, 2004, p. 7-1). Valuation models can broadly be categorized as relative or absolute. The

relative valuation models use a limited amount of information and budget forecasting is not

necessary, since price is estimated relative to other companies. The absolute models require a

budget forecasting based on all relevant information, since the price estimated is based on the

fundamental value of the company. An absolute model is used as the primary model in this paper as

it is believed that an in depth analysis of the entire company is needed to get the fair value. The

primary model used in this paper is the DCF model. It is chosen for several reasons: The focus on

the DCF model in contemporary literature and its prominent place in corporate finance theory

(Sørensen, 2009, p. 41). The method of comparables is used to find a share price estimate that can

be compared with the share price estimate from the DCF model. These two models will now be

discussed in detail to reveal strengths and weaknesses of each model.

2.2.1 Theory of the DCF Model

The basis for all absolute valuation models, including the DCF model, is the dividend discount

model (DDM). The DDM is based on the idea that the present value of all future dividends of a

company must reflect the equity value of the company. This can be expressed as follows (Palepu et

al., 2004, p. 7-2):

The dividend payoffs for each year are discounted at the cost of equity, which is the relevant

discount rate. The reason why the DDM itself is not widely used in practice is that dividend payoffs

do not necessarily represent the value creation of a company, but rather just a payout of value

(Sørensen, 2009, p. 41). The dividend model is unsuitable in the case of CSG, since dividends only

have been paid out in one year (2007/08) in the financial statements available, and no dividends are

expected for the coming years. Furthermore the dividend model can only be used when there is a

good relationship between the dividend payout policy and internal value creation in the company,

which cannot be concluded from the available information.


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Terminal periodForecast period

1

1

Equity value(1 ) ( )(1 )

TNFLT

t Tt WACC WACC WACC

FCFFFCFFV

r r g r

+

=

= + −+ − +

∑

��

The DCF model is using forecasted free cash flows (FCF) instead of dividends. The DCF model can

be used in two ways, direct or indirect. The direct model estimates the equity value directly by

using free cash flow to equity (FCFE). FCFE is the FCF available for equity holders. The indirect

model is using free cash flow for firm (FCFF), which is the FCF available for the whole firm. The

indirect model estimates the enterprise value and deducts net financial liabilities to find the equity

value. The indirect method is chosen since it focuses on the operating activities and ignores

financing activities in relation to value creation (Sørensen, 2009, p. 313).

DCF Model:

The rationale behind the equation is that equity value is calculated by deducting net financial

liabilities from the discounted cash flows from a forecast period and from a terminal period. A

strength of the DCF model is that it incorporates the effects of the tax shield by using WACC. The

DCF model incorporates the tax shield by reducing the WACC (Koller, Goedhart, & Wessels, 2005,

p. 113).

The DCF model assumes that the free cash flows are all generated at the last day in the financial

year, which seems inconsistent with reality; the free cash flows will normally be generated

throughout the year. To get a more realistic picture of the real world the free cash flows are

discounted from the end of the year to the middle of the year; assuming that the free cash flows are

approximately normal distributed throughout the year. This is done by multiplying the share price

estimate with the square root of 1+WACC (Koller et al., 2005, p. 107).

The main criticism of the DCF model is the potential uncertainty when forecasting a company’s

profits. The available information, in form of historical financial statements and their quality, is one

factor that affects the accurateness of the forecasts made.

The value of the terminal period is estimated through perpetuity and it therefore makes up a large

part of the total value. The importance of the terminal period varies depending on the growth

expectations in the terminal period and the number of years forecasted before the terminal period.

This means that very small changes in the terminal period factors will have a significant impact on

the estimated share price.


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Forecasting is based on a mix of strategic and financial value drivers. A forecast will always be

subjective and express personal expectations for the future. According to Benjamin Graham, “(…)

the combination of precise formulas with highly imprecise assumptions can be used to establish, or

rather justify, practically any value one wishes (…)” (Graham, 1958, p. 17). This quote captures the

potential danger and weakness of fundamental analysis and emphasizes an important point. When

using any kind of valuation model to calculate a specific price it is important to see that price in the

light of the assumptions made to reach that specific price. Therefore: “Anchor a valuation on what

you know rather than on speculation” (Penman, 2007, p. 122). The idea of anchoring a valuation

only on what you know is good, but in practice it is seldom the case. CSG have recently had an

IPO, changed their strategy, and they had had negative earnings the last year. Vulnerable

assumptions therefore will be made when estimating value drivers. Forecasting CSG gets more

uncertain because of the limited available historical records. In a case like CSG it is therefore even

more necessary to have a good understanding of the company and its activities to reach a reliable

result.

WACC is an important variable when using the DCF model since it is used to discount all future

cash flows. WACC is calculated from the relation between a company’s capital structure, the debt

investors required return, and the equity investors required return. To estimate equity investors

required return the capital asset pricing model (CAPM) will be used and is therefore briefly

discussed here.

2.2.1.1 CAPM

CAPM provides us with equity investors required return and expresses the expected return from a

security as the relation between the risk free rate, the expected return from an average market

portfolio, and the riskiness of the company.

( ) ( ( ) )

: Risk free rate

: Sensitivity of a stock's return to the market portfolio

E(r ) : Expected return by investing in a market portfolio

E(r ) : Market risk premium

F M F

F

M

M F

CAPM E r r E r r

r

r

β

β

= = + −

−

The expected rate of return depends on two things: “Compensation for the time value of money (the

risk free rate rF) and a risk premium, which depends on beta and the market risk premium (E(rM)-


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rF)” (Brealey, Myers, & Marcus, 2007, p. 304). It is thus based on the relationship between risk and

return. There are many assumptions behind the CAPM and they are often criticized for being

unrealistic. History has shown conflicting results on whether the CAPM is usable in practice or not,

however CAPM remains the leading model for estimating required returns (Brealey et al., 2007, p.

308). Despite its unrealistic assumptions CAPM is widely used and will also be applied in this

paper.

Beta and the market risk premium are difficult to estimate. They will therefore be discussed in the

following.

The market risk premium can change substantially when the market is experiencing a chock. The

market risk premium range from “3 percent to 9,20 percent in texts and research papers” (Penman,

2007, p. 112), which means that the estimation involves a high degree of uncertainty. Considerable

time will be used to find relevant historical risk premiums to reach an estimate of the market risk

premium in Denmark.

The estimation of CSG’s beta is even trickier, which can be emphasized by the following quote:

“No one knows the true beta and inevitably beta are measured with error” (Penman, 2007, p. 112).

Beta expresses the risk of a security in relation to the market portfolio, which will change in the

short run as well as the long run depending on the state of the company and its activities. Some

companies are selling beta estimates, but as the aim of this paper is to use only publicly available

information, these companies will not be used. The beta of a company can also be calculated from

historical records of returns from that company in relation to the return of the market, but with the

information available from CSG this is assumed to be too time consuming compared to accuracy of

the potential result. The beta of CSG is instead estimated by using a framework (Plenborg &

Gruelund, 2002, p. 59), which makes it possible to estimate beta from the degree of operating and

financial risk. This common sense method is believed to be a good approach in CSG’s current

turbulent situation.

An estimation of WACC requires estimation of multiple unknown factors, which increases the

uncertainty of the valuation. It can be emphasized by Penman who points out that "(…) estimates of

required returns are likely to be highly unreliable” (2007, p. 112).


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2.2.2 Peer Group Analysis

Peer group analysis also called the method of comparables is a relative valuation model. The main

idea behind the method of comparables is the “law of one price” (Brealey et al., 2007, p. 604)

meaning that in an efficient market two identical goods must have the same price. Two companies

with the same size, risk, growth opportunities, return, and so on should have the same value. As

already discussed earlier the EMH, supporting “the law of one price”, is based on vulnerable

assumptions that are questionable to hold in real life, especially on a short-term basis. The prices

estimated through relative valuation methods are: “(…) Not anchored in something fundamental

that tells us about value independently of market prices” (Penman, 2007, p. 77). This means that the

market prices set for the comparable competitors must be set right for the result of the valuation to

turn out right, which again is questionable. Relative valuation of a company that recently has had

their IPO will according to Kim and Ritter (1999) be less accurate than in the case of more mature

companies with steady growth rates (Kim & Ritter, 1999, p. 436). This makes sense since young

companies often have more growth potential whereas their future is more uncertain. It is therefore

conflicting that investment bankers often use the method of comparables to get a quick feel of how

the market will value the company (Penman, 2007, p. 77).

The idea behind the method of comparables is to compare relevant price multiples, such as P/E,

with comparable companies (peer group), that are already valued by the market, to arrive at a

relative price for the company under investigation (ibid., p. 76). The precision and applicability of a

relative valuation is primarily dependent on the ability to find an appropriate peer group and price

multiples.

Normally a peer group will be selected from companies within the same country to reduce the

effects of differences in competitiveness and accounting standards across countries. In the airline

industry and in a small country like Denmark it is not possible to find a national peer group.

Therefore international companies are used. The price multiples should be selected in a way so they

reflect CSG in the best possible way. The traditional price multiples can normally give a good

picture of an industry.

2.2.3 Conclusion Valuation Theory

The DCF model is used as the primary valuation model. The DCF model demands a comprehensive

analysis of the company, where all relevant information is considered. This will give us a better


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insight into all aspects of CSG and on that basis estimate a fair share price. The residual income

model will be used as a technical control of the DCF estimate.

The relative valuation models are easy to use and you reach a result quickly since its use of data is

very limited. The possible inaccuracy arising from a heterogeneous peer group and inappropriate

price multiples is the most obvious weaknesses. The peer group analysis will be used for two

primary reasons. It will provide a share price, estimated from a peer group, that can be compared

with the result of the fundamental analysis and to evaluate whether is usable in real life. It will

thereby be a control of the validity of the fair price estimated through the DCF model and it can be

used to reflect on the assumptions made under each model.

The strategic analysis will now be conducted to identify non-financial value drivers.

2.3. Overview of Airline Industry

2.3.1 Airline Industry

The aviation market in Europe was deregulated by the European Union with three policy packages

agreed upon in 1988, 1990, and 1993. As a result full deregulation came into force in 1996-1997

(Consequences of E.U. airline deregulation in the context of the global aviation market.2001, p.

103-104), known as the “open skies” deregulation. The deregulation has changed the industry

structure. The main effects of the deregulation were identified to be: The massive growth of LCC

such as Ryanair and Easyjet, a rise of international airline alliances, an increase of carriers covering

the same routes. The focus on the Hub-and-spoke route system also increased with the deregulation.

The idea of a Hub-and-spoke route system is to bring together passengers from many small airports

to a central big airport (Hub) where connecting long distance flights are available. This can increase

efficiency and reduce costs (Open skies and flights of fancy.2003, p. 65-67). The downside is that

any problems with a Hub can create delays throughout the whole system, which makes it more

vulnerable. The traditional point-to-point route system is as the name suggests direct travelling

without the need for connecting flights.

The increased influence and market share of the LCC relative to the classic network carriers (NC)

characterizes the contemporary European airline industry. The European LCCs Air Berlin, Ryanair,

and Norwegian have performed remarkably in July 2009 with net profits of $142m, $373m, and

$67m respectively. The European NCs British Airways, Iberia and Air France KLM have on the


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other hand performed disappointingly in July 2009 with net losses of $102m, $24m, and $219m

respectively (Dunn, 2009, p. 14).

A similar comparison is emphasizing this tendency. The three LCC’s Norwegian, Ryanair, and

Easyjet generated a compound annually growth rate (CAGR) of approximately 20% while the five

NC’s SAS, Lufthansa, Air France KLM, Finnair, and British Airways generated a CAGR of

approximately 3% (Cimber Sterling Group A/S, 2009g, p. 112). The LCCs share of the market for

European flights increased from 5% to 30% during the period 1998-2008, while the NC’ market

share during the same period dropped from 78% to 60% (Cimber Sterling Group A/S, 2009g, p.

113). The airline industry is undergoing some dramatic changes.

The general deregulation of the air traffic has lead to new market possibilities and a new market

structure, which can be emphasized by the dramatic increase in passengers transported by LCC.

2.3.2 Brief Introduction of Cimber Sterling Group A/S

Until 2008 when Cimber A/S purchased assets from the bankrupted company Sterling A/S it was a

relatively small airline with mainly domestic flights in Denmark. With the purchase CSG acquired a

license to operate larger aircrafts, as well as acquiring new routes going out of Denmark. CSG sees

themselves as a hybrid carrier, with two focus areas, as both a LCC and a NC (Cimber Sterling

Group A/S, 2009g). After the IPO in December 2009 there are now four main groups of equity

owners of CSG. The first and largest are the three former owners and children of Ingolf L. Nielsen,

the founder of CSG, Jørgen Nielsen, Lone Marie Koch, and Hans Ingolf Nielsen, who between

them own 39,57% (Cimber Sterling Group A/S, 2009b; 2009c; 2009d)of the shares, the other is the

Danish billionaire Karsten Ree who owns 11% of the shares (Cimber Sterling Group A/S, 2009e),

and the last is the Bitten and Mads Clausen Foundation, the founder of the Danish industrial giant

Danfoss which owns 6,59% of the shares (Cimber Sterling Group A/S, 2009a). The rest of the

shareholders own a smaller portion of shares.

On the 1st of January the former CEO and major shareholder Jørgen Nielsen took over CSG’s

business development activities and Jacob Krogsgaard took the position as CEO (Cimber Sterling

Group A/S, 2009f, p. 1).


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3. External Analysis

3.1 PEST

To understand the macro environment that CSG is operating in, a PEST analysis will be carried out.

The macro environment is important since it has an effect on CSG’s ability to create value

(Sørensen, 2009, p. 82). The PEST framework consists of Political, Economic, Socio-cultural, and

Technological factors of the macro environment (Lynch, 2008, p. 82), and it will be applied to

Europe, our area of interest. The PEST framework is a tool, which ensures that the most important

aspects of the macro environment are covered. It will in this paper be used very selectively. This

means that more time will be used on the factors that are seen as most important according to an

understanding of the macro environment in relation to the main purpose of the paper – a valuation

of CSG.

3.1.1 Political-legal Environment

In today’s environmentally friendly world politicians try their best to minimize the impact that

different industries have on the environment. As the airline industry is polluting through CO2

emissions (Gross & Schröder, 2007, p. 193), politicians from all countries discuss what can be done

to minimize this pollution. The European Commission is working on ways to impose taxes on

airlines to get them to lower their CO2 emissions (European Commission, 2005). There is much

uncertainty combined with the future political regulations made in relation to CO2 emissions for the

airline industry, but there is a clear tendency towards regulations supporting sustainability of the

environment, which might increase the competition from for example the rail network in Europe

that are a more environmentally friendly transport form. The rail network in Europe will be further

discussed in section 3.1.4.

3.1.2 Economic Forces

The developments in the national and international economies play an important role for the

profitability of airlines. As can be seen from appendix 16 the airline industry is very sensitive to

market fluctuations. The effect of the 9/11 terrorist attack and the financial crisis can be seen on

both graphs; air traffic and GDP growth is correlated. Therefore GDP growth is an important factor

to consider. The financial crisis that became apparent with the collapse of Lehman Brothers on the

15th September 2008, has affected the world economy dramatically (Wearden, Teather, & Treanor,

2008). In Europe it can be emphasized by the GDP development that can be seen from appendix 16.


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From 2007 to 2008 the GDP in Europe1 only grew 0.8%, and from 2008 to 2009 the GDP decreased

4,2% (Eurostat, 2010c). The GDP growth forecast for 2010 is an increase of only 0.70% and 1.60%

for 2011. The non-existent or slow growth will therefore continue to affect the airline industry’s

value creation for the coming years in a negative way.

The European Central Bank’s (ECB) interest rate, hence the prize of money, was 2,50% in 2008

(Eurostat, 2010b). The interest rate has been at a record low 1% (European Central Bank, 2010)

since the 13th May 2009. The lowered interest rate from 2008 to 2010 expresses the ECB’s

intervention during the financial crisis to maintain price stability in the European Union. Greece’s

current financial debt crisis has questioned the survival of the euro currency (Greek tragedy; the

indebted economies of southern europe threaten the financial stability of the eurozone. the need for

a bailout illustrates the flaws in monetary union.2010). The debt crisis in Greece can potentially

spread to the whole European region, with a decrease in financial activity and thereby also affecting

the interest rate level. Interest rates are hard to predict, but will have an impact on the general

economic activity and on the airline industry.

3.1.3 Socio-cultural

The increased integration and interdependency of economies and people across the world and

specifically in Europe has an impact on several social and cultural factors. First and foremost the

EU and its internal market are making it easier for people to work in other EU countries. The time-

space difference is getting smaller and this convergence between countries is changing the

consumer habits. More people travel and work abroad, which can be emphasized by the general

increase in carried air traffic passengers over the last 10 years (Eurostat, 2010a). This increase is a

good opportunity for CSG.

3.1.4 Technological

The development of the Internet has changed almost all businesses in some way. The airline

industry has seen a change in their communication with customers, which has changed from being

through travel agencies and by phone to rely more on e-mail and online ticketing. The Internet has

increased the price transparency and increased competition. It is hard to imagine that the importance

of the Internet will decrease, and new online services for airline passengers are invented all the

1 European union, 27 countries


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time. It is important for CSG to be aware of technological changes and this development should not

be underestimated as it might lead to a competitive disadvantage.

The rail network in Europe has been and will be strengthened by the European Commission. The

focus of the European Commission is a general deregulation of the rail network to increase

competitiveness, improving safety, and a further development of the rail transport infrastructure

(European Commision, 2010). A more competitive rail network demands large investment in the

infrastructure, which to a large degree depends on political willingness, but if heavy investment is

made, “(…) trains in Europe will be able to compete with the airline traffic in the longer run”

according to Adler (Adler, Pels, & Nash, 2010, p. 1). Depending on the degree to which a rail

network will be able to compete with the airline industry it can have a small or heavy impact on the

airline industry in the future. Another scenario is that the airlines and rail network operators will

merge and combine their air and rail transport service to a higher degree than we see today. The

combination of providing air and rail network services is already under planning from the NC Air

France-KLM, which is planning a high speed train connection between Paris and London, but the

plans has been grounded in the start of 2010 by French government regulations, which show the

importance of political willingness (Wright, 2010). It can be said that there are several possibly

scenarios for the future of high-speed transport within Europe, but it seems that the airline industry

will see an increased competition from the rail network throughout Europe.

The PEST analysis has identified value drivers that will influence the macro environment for the

airline industry in the future. In the following, Porters five forces are used to identify the

competitive environment within the airline industry.

3.2 Five Forces

The five forces model, introduced by Michael E. Porter in 1979 (Porter, 2008, p. 79), is a

framework that focuses on the attractiveness of a specific market (Kotler & Keller, 2008, p. 334) by

analysing five specific market forces: Threat of new entrants, bargaining power of suppliers,

bargaining power of buyers, threat of substitute products or services, and rivalry among existing

competitors. CSG’s ability to create value is influenced by these five forces and they are therefore

investigated below.


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3.2.1 Threat of New Entrants

The threat of new entrants is linked to the entry barriers in an industry. There are multiple entry

barriers in the airline industry. The route entry barrier is connected to the limitation on number of

routes from an airport to the same destination; the so-called slots2. Cimber A/S’s acquisition of

Sterling A/S’s assets included Slots for several international routes and technical documentation and

manuals in relation to acquiring and maintaining a B737 AOC, which meant that CSG could start to

operate international flights (Cimber Sterling Group A/S, 2009g, p. 31).

Another entry barrier is that the initial costs when entering the airline industry is high – the industry

is capital intensive. Normally a capital intensive industry would imply a low degree of new entrants,

but according to Michael E. Porter financing of expensive aircraft’s are usually available for

aspiring airline companies because of their high resale value, which is one of the reasons why: “(…)

there have been numerous new airlines in almost every region” (Porter, 2008, p. 81).

It seems that slots and required documentation for operating an airline company is an entry barrier

with low significance, which can be emphasized by the entrance of a significant amount of LCCs in

the past 10 years.

3.2.2 Bargaining Power of Suppliers

The primary supply need and a concern for an airline company is fuel, this also applies to CSG

“Cimber Sterling is exposed to risks associated with the price and availability of aircraft fuel”

(Cimber Sterling Group A/S, 2009g, p. 22). There are numerous reasons for price and availability

fluctuations, one of them are the bargaining power of suppliers. Oil producing countries are

powerful for several reasons. They are concentrated and organized in OPEC, through which they

are able to influence, or even dictate, the oil prices. There are no product substitutes for aircraft fuel

and aircraft fuel is a critical input for airline companies. The bargaining power of oil companies is

significant and reduces the airline industry’s profitability (Porter, 1979, p. 140).

3.2.3 Bargaining Power of Buyers

For several reasons bargaining power of buyers is high in the airline industry. Buyers often face

limited or no switching cost since their previous travels have little or no influence on their future

travel, also it is easier than ever to compare prices between the different airlines through their own

2 Slots are allocated departure and landing times


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websites or through websites dedicated to comparing airline prices. The development of LCCs in

Europe implies that a lot of people do not want to pay extra to get a free soft drink and a snack.

3.2.4 Threat of Substitute Products or Services

According to Michael E. Porter “A substitute performs the same or a similar function as an

industry’s product by a different means” (Porter, 2008, p. 83). Trains, busses, and cars are three

obvious substitute products. The increased focus on high speed trains in Europe has been discussed

in section 3.1.4 in PEST. Bus transport is a substitute product for especially CSG’s domestic flights.

The main factors that speaks in favor of choosing air travel instead is the speed (travel time) and

convenience.

Another substitute product for airline traffic is videoconferencing (Porter, 2008, p. 84), especially

for business travellers. It is hard to forecast to what degree videoconferencing can replace face-to-

face meetings in the long term future, but we do not believe that it will have a significant impact on

air traffic the next decade. Airline transport is a unique form of traveling and we believe that

substitute products in general will increase the competition for the airline industry, but the airline

industry is unique and will continue to be the most important transport form over longer distances.

3.2.5 Rivalry among Existing Competitors

Out of the competitors that CSG have, we will focus on three that we find most relevant. These

three are SAS, Norwegian, and Ryanair. We have chosen SAS as they are CSG’s main competitor

on the Danish market for domestic flights and they also fly to some of the same destinations in

Europe as CSG. We have chosen Norwegian because they are expanding rapidly on the Danish

market for domestic flights and have been gaining market share in Denmark, on top of that they also

fly to some of the same European destinations as CSG. Ryanair was chosen because they are an

industry leader when it comes to LCCs and they move more people than any other international

airline in the world (Ryanair, 2009). Ryanair also serves some of the same destinations as CSG. We

have chosen not to look at the second largest LCC Easyjet because they only have six routes from

Denmark; they only fly from Copenhagen, only three of their routes serve the same destinations as

CSG, and they are not planning to open any new routes from Denmark in 2010 (Easyjet, 2010). The

alliances within the airline will also be discussed.


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3.2.5.1 SAS

In 1946 three small Scandinavian airlines, Det Norske Luftfartselskap, Det Danske Luftfartselskab,

and Swedish Intercontinental Air Traffic, formed a partnership, which they called SAS. The idea

behind the merger was to offer intercontinental flights, and on September 17th 1946 their first

commercial flight to New York took off (SAS Group, 2010b, p. 15). Two years later the

cooperation was extended to all European flights and in 1950 all operations from the three

companies were transferred to SAS. In the following decades SAS introduced several new routes

and initiatives. In 1984 SAS was awarded the ‘Airline of the Year’ award by Air Transport World

(SAS Group, 2010b, p. 17). In 1996 SAS was serving 103 destinations in 34 countries and

celebrated its 50th anniversary. In 2001 SAS was listed on the stock exchanges in Stockholm, Oslo,

and Copenhagen. From 2004 to 2009 several new routes were introduced from Copenhagen and

Stockholm.

Today SAS offers around 70 destinations in Scandinavia alone and they are therefore having the

strongest route network in Northern Europe (SAS Group, 2010b, p. 9). The three main hubs of SAS

are Copenhagen, Oslo and Stockholm. In the recent years SAS has realized huge losses and their

strategy is now focusing around the “core” concept, which is focusing on streamlining the

organization and cost reduction (SAS Group, 2010a). Profitability has thereby replaced growth as

the main focus for SAS.

3.2.5.2 Norwegian

Norwegian Air Shuttle ASA (Norwegian) was founded in 1993. The first 9 years of operation were

focused around regional flights on the West Coast of Norway. A merger between SAS and

Braathens3, Norwegian’s primary partner, forced Norwegian to follow a new strategy to avoid

closure. The new strategy was to serve the whole Norwegian domestic market. Norwegian started

routes at the four busiest airports in Norway in direct competition with SAS Braathens in 2002. 13

additional routes were added before the end of 2003. Norwegian continued to expand, and from

2003 to 2007 revenue increased by 341% and they transported 462% more passengers (Norwegian,

2010a). On December 18th 2003 Norwegian was listed on the Oslo stock exchange, where they

raised 250 million NOK in an oversubscribed offering. The 31st of July 2007 Norwegian bought

FlyNordic, a Swedish based subsidiary of Finnair, and rebranded the whole company as

3 Now known as SAS Norge


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Norwegian.se. After Danish based Sterling A/S’ bankruptcy in October 2008 Norwegian announced

that they would open several new routes from Copenhagen Airport Kastrup. In May 2009

Norwegian operated 23 routes from Copenhagen Airport Kastrup (Norwegian, 2010a).

Norwegian strategy is focusing on growth, which can be supported by the increase in number of

passengers transported in the past 7 years (Cimber Sterling Group A/S, 2009g, p. 112). From

Norwegians vision it can be seen that they want to: “(…) give everybody the possibility to travel by

air [by] a reduction in the price” (Norwegian, 2010b). Norwegian will continue to follow their cost

leader strategy.

3.2.5.3 Ryanair

Ryanair Holdings Plc (Ryanair) started in 1985 with just one airplane going daily from Waterford in

Ireland to London. In 1986 they got permission to operate the route between Dublin and London

and they increased the number of passengers they carried considerably. Over the next couple of

years they grew rapidly but had difficulty making money. In 1990 they had accumulated losses of

£20 million and the Ryan family restructured the company and invested a further £20 million. In

1991 Ryanair reported a profit for the first time. Ryanair continued to grow and in 1993 they

reached 1 million passengers in one year for the first time. Ryanair kept expanding and two years

later, in 1995, they had doubled the number of passengers they served per year. In late 1996 the EU

completed the “open skies” deregulation, and in 1997 Ryanair opened their first European routes.

Up until then Ryanair had only operated routes in the UK and Ireland. Also in 1997 Ryanair became

a public company on the Dublin and NASDAQ (New York) stock exchanges. In 2000 Ryanair

launched their website, which later became the main base for ordering Ryanair tickets, and they

transport more than seven million passengers. Ryanair continue their rapid growth and by 2006 they

carry 42.5 million passengers, becoming the first airline in the world to carry four million

passengers in one month. In 2008 Ryanair traffic grew 15% to more than 58.5 million passengers

they open 223 new routes, and bring their entire fleet to 181 aircrafts. Ryanair is the largest

international airline in the world today (Ryanair, 2009).

Ryanair’s strategy is focused around heavy expansion and cost minimization on all business areas.

Their objective is to: “firmly establish itself as Europe’s leading low-fares scheduled passenger

airline” (Ryanair, 2010). They are cutting all costs associated with any form of service and focuses

solely on providing the cheapest fares in the industry.


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The rivalry is also affected by alliances. NC have alliances with similar companies in other parts of

the world, which make them capable of having a global route network without operating all routes

by themselves; code sharing and interlining agreements. There are also the more broad alliances:

Star Alliance, One World Alliance, and Sky Team Alliance. These alliances all create strategic

groupings worldwide, but its impact on the rivalry in Europe is considered less significant. CSG has

an alliance with SAS on some of its routes and with the new routes in Europe other alliances could

be an opportunity in the future.

The airline industry has become even more competitive than it has previously been, and as more

LCCs enter the European market, capacity increases and there will be a downward pressure on fares

(Cimber Sterling Group A/S, 2009g, p. 20). The rivalry among airlines is of a destructive kind, as it

gravitates solely to price. When companies compete solely on price, it is easy for competitors to see

and match, making sequential rounds of price reductions, thereby transferring profit directly from

the industry to the customers (Porter, 2008, p. 85). As there is already excess capacity in the airline

industry and as airlines keep opening new routes and fly with a higher frequency on existing routes

there is a further pressure on fares (Cimber Sterling Group A/S, 2009g, p. 21). In January 2010

CSG’s competitor Norwegian offered special tickets at DKK 1 between Copenhagen and Karup,

where CSG and Norwegian are both operating. CSG employees bought more than 650 of these

tickets under fake names as: Donald Duck, Bjørn Kjos (Norwegians CEO), Queen Margrethe II,

and others. When none of CSG’s employees showed up for departures, Norwegian realized what

was going on. According to Professor Anders Drejer from Aarhus School of Business this is highly

amoral (Dagbladet Politiken, 2010). The “Donald Duck stunt” is adding to an already low level of

brand image. The stunt is also a sign of the fierce competition in the airline industry. This

increasing focus on fares is a large risk for CSG as they face competitors with greater capital

reserves and better-known brands.


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4. Internal Analysis

4.1 Resources

CSG’s tangible and intangible resources will be analyzed to explore to which degree the resources

are value creating in relation to their competitors and identify competitive advantages4. Furthermore

the analysis of resources will contribute to the identification of strengths and weaknesses.

4.1.1 Tangible Resources

As expected the primary resources are aircrafts and aircraft components, which amounted to TDKK

727.800 at the end of first quarter in the financial year 2009/10, which is July 2009. This is

approximately 95% of CSG’s tangible assets. Land and buildings; other plants and equipment; and

property, plant, and equipment under construction constituted TDKK 15.500, 17.100, and 6.100

respectively. The focus will therefore be on aircrafts and aircraft components.

CSG’s fleet is composed of nine ATRs5, thirteen CRJs6, and five B7377. CSG is only using

seventeen of these aircrafts for its domestic and international operations, while the remaining ten

aircrafts are operated by other airlines on leasing agreements. The three different aircraft types

serve different needs. The idea is to have the right fit between number of seats and passengers to

minimize the cost per passenger on each route. The ATRs and CRJs are primarily used for short and

medium distance routes, which mean domestic and Nordic destinations. The B737 is used for longer

distance routes and whenever there is sufficient passenger volume on shorter distance routes

(Cimber Sterling Group A/S, 2009g, p. 42). On page 8 of CSG’s interim report for the third quarter

of 2009/10 it is stated that CSG will return two of their CRJ200 jets to their owner, two B737 that

were planned to be leased will not be leased, and one ATR72 is expected to remain on lease instead

of being used by CSG.

Many of CSG’s competitors are focusing on one type of aircraft and then they rely on a high load

factor for its specific volume. CSG’s diversified fleet of large and small aircrafts enables them to

operate flights with both relatively high and low passenger volume, which compared to some of

4 The analysis of resources is written with inspiration from: Ole Sørensen page 90.

5 Short-haul turbo prop aircraft used by a number of regional airlines.

6 Short/medium haul small to mid-sized commercial jet aircraft used by a number of airlines.

7 Boeing 737; the world’s most widely used commercial short and medium-haul jet aircraft. Used by a large number of

airlines worldwide.


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their competitors is an advantage. With an average age of 11,84 years and most of the airplanes 10

years or older CSG’s fleet is very old compared to its competitor Ryanair, which has a fleet with an

average age of 2,77 years and with no airplane older than 8 years (Ryanair Holdings plc, 2009, p.

57).

4.1.2 Intangible resources

To identify if CSG has a competitive advantage over their competitors it is important to look at the

intangible assets, since they are a big part of the value creation in a company. Some of the resources

identified in the following section are unique to CSG and some are not, since the most important

parameter the airline companies compete on is price, there will be more resources that are common

to most airlines and only a few that are unique. CSG has a number of different IT systems that

handle everything from the financials to crisis management; since we assume that most airlines

have the same or similar systems we will not go into detail about them (Cimber Sterling Group A/S,

2009g, p. 48). CSG is a member of International Air Transport Association (IATA) and therefore

they also have the IATA Operational Safety Audit (IOSA) safety certification. Only SAS among

CSGs closest competitors have the same certification (IATA, 2010). The certification means that

every other year CSGs safety procedures are thoroughly gone over to make sure that CSG live up to

the highest international safety standards. This certification is a strength for CSG as it proves to its

passengers that safety is a top priority. CSG has interline agreements8 with 31 different airlines

generating about 20% of the total number of tickets sold, this is a big strength since it doesn’t take

much work on CSGs part to get these sales. CSG has registered 20 trademarks and has yet to

experience any of them violated. On top of the trademarks CSG have a series of online domains.

These domains are very important to CSG as 36% of the tickets sold in the first half of 2009 came

from these websites. CSG purchased an Air Operator Certificate9 (AOC) together with some

international routes from the bankrupted Sterling. This certificate is the basis for the expansion into

the European market as the smaller aircrafts that CSG was operating when it was mainly a domestic

airline are not large enough for this expansion.

The employees of CSG constitute an important part of the intangible resources. One example has

shown that the employees have confidence in the management, are flexible, and are willing to fight

8 Interline agreements are agreements where airlines accept each other’s tickets and documents and a passenger can

have their baggage checked in for a whole journey even though they fly with different carriers throughout the trip.

9 An Air Operator Certificate is the right of an airline to operate a certain aircraft.


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for the company. They have accepted a 10% reduction in salary with effect from 2010 (Cimber

Sterling Group A/S, 2010b, p. 1).

CSG’s initial public offering is discussed individually in the section below, as it contains several

important aspects in relation to the future value creation.

4.2 The Initial Public Offering

An initial public offering (IPO) can be defined as the: “first offering of stock to the general public”

(Brealey et al., 2007, p. 374). An IPO means that a company goes public. CSG went public on the

Copenhagen stock exchange10 on the 1st of December 2009. Before the idea of an IPO was raised,

CSG tried to raise capital through private investors, but apparently no one was interested (Hansen,

2010), which can be interpreted as a warning sign for investors. The shares offered were both new

shares and shares sold by the existing owners. The sale of existing shares does not raise any new

capital to the company.

When CSG decided to go public they needed help in form of an underwriter. SEB Enskilda11 was

chosen. Usually the underwriter will buy the shares from the company at a certain price and resell

them at a slightly higher price – the difference between what they buy and sell for is called the

spread. In more risky cases, like CSG’s IPO, the underwriter is not willing to take the risk of buying

the shares at a certain price from the company. CSG’s IPO was therefore handled on a “best effort

basis” (Brealey et al., 2007, p. 375), where SEB Enskilda did not hold the risk of for example low

demand. CSG and its underwriter produced a prospectus that provided potential investors with

relevant information about the company. An important function of the prospectus is to warn

investors about the risks involved in any investment in the company (ibid.). The initial share price

“offer range” was set at DKK 20-24 in the prospectus. The book building method was used to arrive

at share price according to the bids given by investors. The book building method is using the

demand in the market to arrive at a share price. Low investor demand during the start of the “offer

period” starting on the 17th of November and ending on the 25th of November forced CSG to cut its

share price to a level of DKK 10-13. Eventually the share sold for DKK 10. The shares were

thereby sold at around half the price initially expected. Furthermore the share price dropped steadily

10 Copenhagen stock exchange is a part of Nasdaq OMX Nordic

11 SEB Enskilda is a subdivision of SEB, which is a North European bank and pension concern with five million

customers and approximately 20.500 employees in more than 20 countries.


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in the months after the IPO. The average share price on the 4th of January 2010 was DKK 7,30 and

during the day on the 26th of February 2010 the share hit a record low of DKK 2,80 (Nasdaq OMX

Nordic, 2010). Already the 17th of December, only a few weeks after the IPO, the first downgrade

of expected earnings was made (Cimber Sterling Group A/S, 2009f, p. 1). It was justified by CSG

with the general economic slowdown. Stock exchange- and industry experts afterwards claimed that

a downgrade that fast after an IPO might be illegal according to IPO regulation, since the

information given in the prospectus then might have been misleading (Dagbladet Børsen A/S,

2010). It is hard to say whether the parties involved in the IPO knew that the price was

overoptimistic, or if their estimated offer price range was simply the result of a poor research

resulting in a misleading valuation. Stock exchange expert Paul Krüger Andersen from Aarhus

School of Business encourages the Copenhagen stock exchange to investigate the case because of

the seriousness of the allegation the stock exchange has so far not announced any investigation

(ibid.). The share price proposed by CSG and SEB Enskilda was thereby heavily overpriced, which

is unusual for an IPO. Historically IPOs have been underpriced. Some research has found that IPOs

in USA are underpriced on an average of 15% (W.P. Carey, 2008). An underpriced IPO means that

investors cash in profits at the expense of the company, which at first glance seems irrational from

the company’s point of view. There has been substantial research on why IPO’s are underpriced.

One of the most used arguments for underpriced IPO’s is that investors demand a premium for the

risks they are taking when investing in a company with no or little track record of performance

(ibid.). Another argument that favors under pricing of IPOs is that it signals firm quality and

establishes a good relationship between investors and the company(Ljungqvist, 2006, p. 36). This

also gives the company a better foundation to raise equity in the future. Much debate has therefore

risen from CSG’s heavy overpricing. The IPO gave CSG approximately TDKK 251.000 in net

proceeds together with a considerable amount of angry investors.

It is now relevant to look at CSG’s vision, strategy, and business model to understand how they

plan to be more successful than their competitors. The section will end with a discussion of whether

the strategy is sustainable, given CSG’s internal resources and external environment


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4.3 CSG’s Strategy

4.3.1 Vision, Strategy, and Business Model12

The Sterling transaction transformed CSG from being a mainly Danish regional airline into a

European airline based in Denmark. This transformation also required a new strategy.

The next section will investigate the consequences of CSG’s new vision, strategy, and business

model and its impact on CSG’s future value creation. First we will briefly describe the strategy that

CSG has chosen and afterwards comment and discuss implications.

4.3.1.1 Vision

CSG’s vision is to be Denmark’s leading airline. They want to achieve this vision through three

focus areas: To be the market leader in the Danish market for domestic air services, to be a focused

airline serving major European cities, and to be the preferred airline in Denmark for leisure

travelers.

4.3.1.2 Strategy and Business Model

CSG has a defined strategy of being a hybrid carrier meaning that they want to be able to act both as

a NC and a LCC. This strategy is in alignment with CSG’s diversified aircraft fleet that is composed

of different sized aircrafts to obtain maximum flexibility.

CSG’s business model, supporting the strategy of being a hybrid carrier, is based on four core

services: domestic routes, focused European routes, leisure routes, and as a provider of capacity.

The domestic routes involve connection to own routes and connection to other airlines trough code

sharing13 and interline14. European routes involve service to major European cities and connection

to other airlines through code sharing and interline. The capacity should be optimized by the use of

a mix between the ATR/CRJ/B737 aircrafts on both domestic and European routes. The leisure

routes focus on low cost and high volume and only the B737 aircrafts are used. Travel agencies are

used widely for the sale for leisure routes. Leisure routes also involve connection to other airlines

through code sharing and interline. The last core service is provider of capacity to other airlines.

12 The section is written with information from the Prospectus page 32-34

13 Refers to a practice in which a flight operated by an airline under its own code (the operating carrier) is also marketed

under the codes of one or more other airlines (the marketing carriers).

14 Agreement between airlines regarding air travel for which one ticket covers several legs of the journey operated by

different airlines and the baggage can be checked through to the final destination.


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In the interim report for the second quarter of 2009/10 CSG introduced two new initiatives: Odin

and Thor. Odin is established to support growth through implementation of more and broader

marketing activities and other revenue generating activities. Thor is a program established to

minimize costs through renegotiation of supplier and creditor agreements and increased focus on

utilization and continuous adjusting to market demands. CSG estimate that the effect of the

programs will be seen in the coming years (Cimber Sterling Group A/S, 2009f, p. 6).

4.4 Critical Review of CSG’s Strategy

It is clear from CSG’s vision and strategy that they are focusing on different market segments;

domestic flights serving primarily business customers and leisure flights from Denmark serving the

major European cities. The strategy is very aggressive since CSG wants to conquer the Danish

market and expand significantly with European routes knowing they are facing severe competition

on both fronts against bigger and more capital intensive airlines. CSG and its competitors are in

figure 2 placed according to their strategy and business model.

Ryanair is the company that has followed the LCC business model, invented by Southwest airlines,

most strictly (Alamdari & Fagan, 2005, p. 378). The Southwest business model is focused around

specific features: point-to-point, high frequencies, single type fleet, and no free meals or drinks to

mention a few. Ryanair’s strategy is basically based on the Southwest business model and is

therefore placed in the left side in figure 2. Norwegian is a LCC with some product features of a

Figure 2: Own processing with inspiration from Gross (2007, p. 13)

Area of Growing Competition

SAS Norwegian Ryanair

CSG

Standard Basic Budget Premium

No Frills Few Frills Many Frills Extensive Frills

Low Cost Carrier Network Carrier Hybrid Carrier


Page 30 of 93

hybrid carrier. They provide few frills and limited service, focusing on massive expansion through

cheap fares. CSG is a Hybrid carrier placing them in the middle of the spectrum. They have

recently changed their product features slightly by a decrease in frills. Food onboard has been cut

away and luggage in excess of hand luggage is charged extra (Cimber Sterling Group A/S, 2010a).

This change is seen as a move towards the product features of LCC, which is emphasized by the

arrow in figure 2. SAS is a classic NC with many frills. In recent years SAS has also introduced

initiatives moving them towards the product features of hybrid carriers. The initiatives are low fare

initiatives, which were mentioned in section 3.2.5. The strategy and product features of CSG –

being a mix between LCC and NC – is becoming less unique as there is a general trend moving the

airlines closer to LCC strategies with less frills and more focus on cost minimization. As it can be

seen from figure 2 this trend is placing CSG in an area of growing competition. The general

movement towards the classic product features of LCC’s is supported by a study made by Alamdari

and Fagan, which has: “(…) demonstrated that although an increasing number of ‘hybrid’ low-fares

models are achieving low operating costs, offering low fares and returning attractive operating

profit margins, the adherence to the original model, based on cost leadership strategy, could

potentially ensure greater profitability” (Alamdari & Fagan, 2005, p. 391). It can be argued that

CSG will face difficulties with its strategy against the strategies that focus more on low fares and no

or very few frills. As it can be seen from figure 2 CSG’s strategy is “stuck in the middle”. In the

prospectus CSG has emphasized the benefits of being a hybrid carrier serving different customer

segments, by arguing that business customers and leisure customers will ensure a high utilization

throughout the year; minimizing the seasonal fluctuations. However with a hybrid strategy CSG is

focusing more on service than its LCC competitors, which can be seen as a weakness since:

“Passengers are far more sensitive to price than service” (Chiou & Chen, 2010, p. 228). Michael E.

Porter also argues that it is dangerous to be stuck in between different generic strategies (Kotler &

Keller, 2008, p. 94). CSG is trying to deliver a good service for business customers, but on the other

side they are trying to compete on fares with LCCs. It can be argued that the strategy of CSG is

focusing on too many business areas and different activities. The “Strategic fit among many

activities is fundamental not only to competitive advantage but also to the sustainability of that

advantage” (Porter, 1996, p. 1). CSG arguing of potential of high utilization through a diversified

fleet and different customer segments, which is a competitive advantage. They have also recently

introduced the new initiatives Odin and Thor, which should help to minimize cost and increase

growth. History has shown that LCC yield greater profitability and outperform their competitors


Page 31 of 93

and CSG is in direct competition with LCC on both domestic and international flights. In the light

of the Odin and Thor initiatives it is believed that CSG’s strategy will be able to create value for its

shareholders through a continuous adjusting of their strategy to the changing market conditions.

4.5 SWOT

In figure 3 the strengths, weaknesses, opportunities, and threats identified throughout the strategic

analysis is summarized to provide an overview of our findings.


Page 32 of 93

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Page 33 of 93

4.6 Preliminary Conclusion

The most important value drivers from the macro environment identified in the PEST analysis will

be summarized here. The Airline industry’s growth is heavily dependent on the general GDP

growth. The GDP growth forecast for 2010 and 2011 is 0,7% and 1,6% respectively. The slow

growth will continue to affect the airline industry’s value creation for the coming years in a negative

way. The increased globalization and interdependency especially within the euro zone is a factor

that supports good opportunities for increasing airline passenger traffic, though competition from

high speed trains connecting major cities in Europe is a threat to the airline industry in the long run.

In relation to this competition, the aircrafts’ relatively high CO2 emissions might be a disadvantage

in connection with the increased focus on decreasing CO2 emissions in EU and worldwide.

The five forces analysis has identified the competitive situation in the airline industry, where CSG

is operating. The threat of new entrants is moderate. There are some entry barriers, but the high

resale value of aircrafts makes it easier for new airlines to acquire capital from investors. The

bargaining power of suppliers – mainly oil companies – is high and reduces the profitability of

airlines. The bargaining power of buyers is very high, since there is almost no switching cost when

choosing another airline. The threat of substitute products is not considered very high in the nearby

future, since no substitute products are able to compete with the time efficiency of air travel though

in the long run high speed trains might affect the industry. The rivalry among existing competitors

was analysed through CSG’s three main competitors: SAS, Ryanair, and Norwegian. The analysis

of competitors has shown that CSG is fighting against competitors with different history and

different strategies. The difference between failure and success in the airline industry is small,

which can be emphasized by the historical success of SAS and its current struggling with

profitability and liquidity. Both Norwegian and Ryanair have shown that significant growth in a

short period of time is possible in the airline industry with the right strategies. The rivalry among

existing competitors is extreme with excess capacity and very low or negative profits in the

industry.

The internal analysis showed that CSG has a diversified fleet that is supporting their strategy of

being a hybrid carrier. The average age of the fleet is high compared to competitors, which is a

disadvantage in relation to maintenance costs. They have flexible employees that are loyal to the

company.


Page 34 of 93

The IPO in December 2009 decreased the brand loyalty and investor trust. First the initial offer

price was cut in half, from DKK 20-24 to DKK 10-13, and once on the stock exchange the share

price was again reduced by more than half within a very short time. The brand image of CSG has

been weakened in relation to current and potential investors. The overestimated initial share price

combined with the fast downgrade and claims of the downgrade being illegal can be seen as a

significant weakness for CSG. Investors realized a loss on their investment instead of a risk

premium covering their risky investment.

The critical review of CSG’s strategy identified both strength and weaknesses of the strategy. The

potential value creation from the current strategy is uncertain, but it is believed that the two new

initiatives Odin and Thor will be able to create value for shareholders together with a continuous

adjustment of the strategy to the changing market conditions.

5. Financial Analysis

The financial analysis is carried out to investigate CSG’s historical economic performance. Based

on the information available we have chosen to use the financial statements of 2006/07, 2007/08,

and 2008/09, which are conducted with International Financial Reporting Standards (IFRS). The

financial statements of 2004/05 and 2005/06 are available, but they are not used for several reasons:

The different accounting format, Danish Financial Statements Act (DFSA), is used, figures are

rounded to millions (less accurate), and they are assumed to be less relevant in the light of the

recent restructurings from the acquisition of parts of Sterling A/S and the IPO. To gain insight into

the effects of the recent restructurings just mentioned the key figures and results from the unrevised

financial statements from the first three quarters of 2009/10 are used.

First the financial statements of 2006/07, 2007/08, and 2008/09 are reorganized in a valuation

perspective. Secondly profitability of CSG is analysed through a decomposition of ROE. Key

results from the first three quarters of 2009/10 are used to show the development until the end of the

3rd quarter. Lastly the airline specific key ratios are analysed. In this way a comprehensive picture

of the main financial indicators will be revealed. The financial analysis is done using primarily Ole

Sørensen’s framework (2009).


Page 35 of 93

5.1 Reorganizing the Financial Statements

The financial statements are used by all parties that are interested in the company. These could be

creditors, suppliers, customers, competitors, investors and others. For this assignment we will use

the financial statements as if we were an external investor. The financial statements are reorganized,

with the aim of making a better foundation for the analysis of CSG’s performance. The primary

goal of reformulating the balance sheet and income statement of CSG is to identify the main drivers

behind ROE and growth. The primary goal of reformulating the statement of equity is to identify

the comprehensive income. The cash flow statement is not reformulated as it is considered the least

important statement to reformulate. The FCF is instead calculated from the balance sheet and

income statement. In a more general perspective the financial statements of CSG is reformulated to

improve the basis for better forecasting estimates later in the paper.

5.1.1 Statement of Changes in Equity

The statement of changes in equity describes, which changes there has been to the equity during the

year, meaning how the shareholder’s part of the assets changed and what has caused this change. It

shows the profit/loss for the year, payments to shareholders in the form of dividends and buyback of

shares, and sale of shares in the form of new issues or sale of the company’s holdings of own

shares. It also shows activities that are recorded directly on the equity. The statement of changes in

equity is reformulated to give a better overview as the official statement is unnecessarily complex

(appendix 6). The most important information that is given in the statement of changes in equity is

the Comprehensive income for the year. This gives a better representation of the actual profit or loss

the company has made during the year, since it includes all income/expenses the company has had

during the year including the income that is recorded directly to equity. These transactions are

denominated dirty surplus accounts (Sørensen, 2009, p. 134).

In CSG’s case there has been one transaction with the shareholders in 2007/08 with the payment of

extraordinary dividend, but besides that there have been no transactions with shareholders. The

most important transaction on the statement of changes in equity is the value adjustments of

hedging instruments; this is CSG’s dirty surplus account. There are though few changes in the

equity statement and an insignificant development in the equity.

5.1.2 The Balance Sheet

An official balance sheet separates assets and liabilities by the use of time horizons - long or short

term. The balance sheet tells us which assets the company has and how these assets are financed,


Page 36 of 93

either by shareholders equity or liabilities. The balance sheet is used to analyze which assets and

liabilities the company has as well as the company’s financial gearing. It also shows the part of the

assets and liabilities that have to be settled within one year, as well as the cash and cash equivalents

the company possesses.

For the purpose of this paper, the balance sheet is reformulated into operating assets, operating

liabilities, financial assets, and financial liabilities (appendix 4). Operating activities are thereby

separated from financing activities, which make it possible to analyse the dynamics of each activity

within CSG. The most important issues and considerations concerning the reformulation of CSG’s

balance sheet are listed in the following:

Cash at bank and in hand consist of both operating and financial liquidity. According to Ole

Sørensen the operating liquidity can be estimated by taking between 0,5-1% of net revenue an

allocating it to operating liquidity. In the light of the limited liquidity in the financial years 2007/08

and 2008/09, representing less than 0,5% of net revenue in both years, all liquidity will be allocated

to operating activities. In the financial year 2006/07 0,5% of net revenue is allocated to operating

liquidity, this still amounts to a higher operating liquidity than the two following financial years.

CSG’s Operational leasing activities of planes and buildings is an important part of CSG operating

activities. Therefore it can be discussed whether the operational leasing should be reclassified as

financial leasing and thereby be visible as an operating asset on the balance sheet. In this paper a

reclassification is considered too time consuming in relation to what it might bring of accuracy to

the final valuation. Instead rental and leasing expenses is moved up right under production costs to

be deducted before the gross margin is calculated.

Derivative financial instruments are categorized as operating assets, as it is assumed that the

hedging activities are primarily focused on aircraft fuel and not DKK/USD exchange rate. The

assumption is based on the fact that fuel constitutes a substantial part of airline costs (Cimber

Sterling Group A/S, 2009g, p. 22) and also that the price of aircraft fuel has historically been

subject to relatively large fluctuations (ibid., p. 100).

The most important accounts in the reformulated balance sheet are explained below:

Net operating assets are operating assets, such as aircrafts and property, minus the operating

liabilities such as trade payables. This figure is later used to investigate ROIC.


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Net financial liabilities are financial liabilities minus financial assets. This figure constitutes

together with the equity of shareholders the amount invested in “net operating assets”.

Equity is an important account in a valuation perspective, since it shows the owners share of the

assets (Sørensen, 2009, p. 124).

5.1.3 The Income Statement

The income statement shows us at the top how much revenue the company generated on its

activities, and then it follows what expenses the company has had during the year. The income

statement is used to analyze how good a company has been at generating revenue, controlling its

costs and finally how much money the company made/lost in total. The income statement is

reformulated in a way that divides income into the two primary activities – income (expenses) from

sale and financial income (expenses) (appendix 2).

The Rental and leasing expenses is include as part of operating costs since a large part of the leasing

expenses are mostly related to the leasing of planes, and it is considered to be part of the operating

activities. The tax shield is included as part of the tax expense in order to analyze the operating

profit from sales (after tax) as if CSG did not have any debt at all. By doing this the profitability of

sales activities can be calculate no matter what financial gearing CSG has, thus a more “pure” profit

ratio from sales is reached. In the reformulation the tax expense is also split into two parts, one part

relates to operating profit from sales, and the other relates to other operating profit.

The most important accounts in the reformulated income statement are explained below:

Operating profit from sale (before tax): This account shows how much CSG earns from sales

activities only, meaning revenue less costs held for sale and less rental and leasing expenses. It

should be noted that rental and leasing expenses are not only planes but also include buildings and

plant and equipment, but since these are such a small part of the total, it is assumed that they are

essential for sales activity and they are all included in our operating costs.

Net operating profit less adjusted tax (NOPLAT): This account shows the operating profit for the

year without financial expenses but including the dirty surplus account value adjustments of

hedging instruments.

Comprehensive income for the year: When looking at the comprehensive income for the year, it can

be seen that it is the sum of the profit/loss for the year and the dirty surplus account discussed in the


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equity section. The comprehensive income for the year gives us a better representation of the actual

profit/loss since it includes all income/expenses the company has had during the year including the

income that is recorded directly to equity.

5.2 Analysis of Profitability

The return on equity (ROE) measures the profitability to shareholders of a company after all other

creditors have been considered (Sørensen, 2009, p. 256). Put in another way ROE measures a

company’s profitability by revealing the amount of profit a company generates with the money

shareholders have invested. From figure 5 it can be seen that in 2006/07 and 2007/08 CSG have

shown significant returns for shareholders with 13,64% and 27,77% respectively. In the 2008/09 the

picture changes completely with an ROE of -32,48%. In the first three quarters of 2009/10 EBIT

showed a loss of DKK 176 millions (Cimber Sterling Group A/S, 2010b, p. 1), which implies an

increasingly negative ROE.

ROE from 2006/07-2008/09 is decomposed to identify the underlying variables that have affected

profitability. In the first three quarters of 2009/10 market conditions and CSG’s IPO have had a

considerable impact on CSG’s financial situation. It has not been possible to reformulate these three

quarters, but the most important developments in this period will be mentioned and related to the

past three years in the best possible way, whenever appropriate. This is done to ensure that the most

present available information can be used for the budget forecasting later.

5.2.1 Decomposition of ROE

To evaluate the profitability and underlying variables more accurate the ROE is decomposed into

several factors based on the following formula(Sørensen, 2009, p. 256):

ROE = ROIC + [FGEAR * (ROIC – r)]

A graphical overview of the model used as guideline for the decomposition can be seen from figure

4:


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Figure 4: Own processing with inspiration from Ole Sørense (2009, p.255)

2008/09 2007/08 2006/07 Formula

Net income

average equity

Operating profit after tax (NOPLAT)

Net operating assets

Net financial liabilities

Equity

Net financial expenses (after tax)

average net financial liabilities*

ROIC 5,19% 5,86% 8,34%

ROE -32,48% 27,77% 13,64%

FGEAR 2,98 2,48 1,49

Net borrowing rate (r) -14,58% 0,40% -3,88%

ROIC - r

*In the 2006/07 figure we have used a number from the yearly report from CSG where the number is calculatet using

DFSA, and the number is rounded to millions

Spread 4,46%5,47%-9,39%

Figure 5: Own processing

There is no need to reformulate FGEAR since there are no minority interests in CSG. The

decomposition of ROE will enable us to identify the reasons for the extreme development. In the

following table ROE is decomposed:

5.2.1.1 Financial Gearing and Spread

Financial gearing is a double edged sword, if a company is earning money a high financial gearing

will increase the earnings, on the other hand if a company is losing money a high financial gearing

ROE

FGEAR ROIC Borrowing

rate (r)

SPREAD

Profit ratio TRA

Profit ratio

(from sale)

Profit ratio

(other)


Page 40 of 93

will further increase the losses. It is ironic that a company in a bad financial situation is often in

need of more debt financing, and that by acquiring more debt it increases their financial gearing and

often further worsen their situation.

Financial gearing expresses the relationship between a company’s interest carrying debt and equity.

Financial gearing can create a higher ROE if a company’s return on operating activities is higher

than its borrowing rate - a positive spread. If spread is positive a company will earn money with

higher gearing. A negative spread will on the other hand contribute to a lower ROE.

The financial gearing in CSG has developed towards a larger amount of debt in relation equity –

therefore a higher gearing. The gearing in 2008/09 was 2,98 meaning for every DKK 1 of equity

invested in CSG an amount of DKK 2,98 was invested through debt. This means that approximately

25% of the assets are equity and 75% are debt.

The combination of a positive spread and high FGEAR in 2006/07 and 2007/08 has contributed

positively to ROE.

The spread in 2008/09 of -9,39% means that the return on operating activities is far less than the net

borrowing rate paid for debt. The combination of a high financial gearing and a negative spread has

contributed significantly to the 38,48% negative ROE and thereby the negative comprehensive

income of DKK 38 millions in 2008/09.

The financial gearing for the first three quarters of 2009/2010 cannot be calculated on the same

basis as the previous years because of the limited amount of available information. An indication of

the financial gearing is derived from the available information in the following. The equity on the

31st of January 2010 was DKK 280 millions and the equity ratio was 26%. This equity ratio

represents both financial liabilities (interest bearing debt) and operating liabilities (for example

trade payables). The actual financial gearing is therefore expected to be a bit lower, since operating

liabilities should be deducted for making it comparable with the previous years. This means that

around 20-26% of CSG’s asset are financed by equity in 2009/10. CSG has tried to work towards a

lower gearing, less proportion of interest bearing debt to equity, with their IPO in December 2010

but this was offset by a significant negative EBIT.

The same effect is assumed in 2009/10. The capital structure of CSG, with a high degree of debt

financing, increases the financial risk, but also the potential profitability. The financial results of


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CSG will be more extreme with this high financial gearing than if CSG was financed with a larger

amount of equity.

The above calculations show that in the financial years 2006/07 and 2007/08 CSG has had a high

ROE as well as having a financial gearing of 1,49 and 2,48 respectively, with the positive spread in

these two years CSG has earned money on their debt. In 2008/09 they had a gearing of 2,98 and a

negative spread of 9,39% this combined means that they lost money, which in the end resulted in

the need for an IPO because of a liquidity crisis. FGEAR and Spread have had a significant impact

on ROE in all three years.

5.2.1.2 Net Borrowing Rate

In 2007/08 the net borrowing rate was -0.4%. The reason for this negative borrowing rate, that is a

positive net percentage, is that CSG received interests of VAT amounting to TDKK 24.148 this

means that in total CSG received more interest payments than they paid (Cimber Sterling Group

A/S, 2009g, p. 165). This extraordinary receivable has a significant impact on CSG’s net borrowing

rate in 2007/08. If the interest on VAT is excluded from the calculation the net borrowing rate in

2007/08 is 5,62%. This borrowing rate gives a better representation of the actually level of the net

borrowing rate. We will be aware of this difference and its impact on our later forecast estimates. In

2008/09 the net borrowing rate was 14.58% a sizeable increase from the previous year. The increase

can mainly be credited the worsened financial situation and a large foreign exchange loss. The net

borrowing rate in 2009/10 is assumed to be a bit lower than 2008/09 since CSG’s liquidity situation

has not improved and the foreign exchange loss cannot be predicted – the positive IPO effect has

been nearly offset by a significant negative EBIT of TDKK 176.400 in the first three quarters and

the financial situation could be better.

5.2.1.3 ROIC

ROIC expresses the profitability from all invested capital. The strength of ROIC is its focus on

operating activities and their profitability; opposite to ROE that mixes financing and operating

activities. ROIC has developed negatively in the past three years, though not as extreme as the

negative ROE development. Starting at 8,34% in 2006/07, decreasing to 5,86% in 2007/08, and

again decreasing to 5,19% in 2008/09. It can therefore be seen that the negative ROE in 2008/09 of

32,48% is primarily coming from the negative spread together with the negative net borrowing rate

and high FGEAR. The effect of ROIC on ROE is therefore less significant, but the underlying


Page 42 of 93

2008/09 2007/08 2006/07

NOPLAT

Revenue

Revenue


1

Turnover rate of assets0,50020,60730,4979

2,01

Profit ratio (OG) 2,58% 3,56% 4,17%

Turnover rate of assets (AOH) 2,001,65

Inverse value of Turnover rate of assets


drivers of ROIC are very important when forecasting and they are therefore analysed in the

following.

To identify where the decrease in ROIC is coming from ROIC is decomposed into profit ratio and

turnover rate of assets:

ROE = ROIC + [FGEAR * (ROIC – r)] �

ROE = (Profit ratio * Turnover rate of assets) + [FGEAR * (ROIC – r)] (Sørensen, 2009, p. 261)

Profit ratio and turnover rate of assets is therefore now examined individually.

5.2.1.4 Turnover Rate of Asset and Profit Ratio

The turnover rate of assets expresses how much revenue is created for every DKK 1 that is invested

in net operating assets. The turnover rate of asset is affected by different variables for example

marketing efforts. Profit ratio expresses the company’s ability to create profit, that is, how much

profit the company earns every time it has DKK 1 of sale. Profit ratio can be improved by for

example cost reductions.

A mass producer like LEGO can produce a very large amount of goods with relatively cheap

production facilities. They will have a relatively high turnover rate of assets and a relatively low

profit ratio. A more specialized and tailor made production like Vestas will produce few units with

an expensive production facility. They will have a relatively low turnover rate of asset and a

relatively high profit ratio.

It is important to note that CSG is a service company and therefore the concepts cannot be used, as

intuitively as for a production company – it is more abstract. It should be noted that a lot of CSG’s

aircrafts and buildings are not included in net operating assets, since they are leased on an


Page 43 of 93

2008/09 2007/08 2006/07

Profit ratio drivers (% )

production cost

Revenue

Other external costs

Revenue

Staff costs

Revenue

Rental and leasing expenses

Revenue

9,83% 10,22%

-6,59%-6,09%

7,10%

-4,49%

-48,52%-47,83%-51,90%Production cost

-30,96% -31,05% -29,75%

-4,93%-5,21%-5,56%

Staff costs

Other external costs

Rental and leasing expenses

100%-(production costs+Other external costs+staff costs+Rental and leasing)Profit ratio from sales (before tax)


operational lease contract. This means that some of the most important assets used, airplanes and

buildings, are not included.

CSG’s turnover rate of assets saw a slight decrease in 2007/08 but returned to a stable level in

2008/09. The turnover rate of assets has thereby not been affecting ROIC much.

The profit ratio of CSG has decreased over the last three years. CSG’s ability to earn a profit on its

services has thus decreased over the three years. This decrease can be supported by the findings

from the strategic analysis, which showed that there has been an increase in competition on the

market that CSG is operating. It might also reflect the financial crisis and the fact that people are

not flying as frequently during the financial crisis.

One of the reasons for the negative development in ROIC is coming from the decreased profit ratio.

Therefore the profit ratio drivers are examined to identify, which drivers caused the negative

development of ROIC.

5.2.1.5 Profit Ratio Drivers

First we will analyze the drivers of the profit ratio that is related to operating activities.

Overall most of the profit ratio drivers have been relatively stable in relation to revenue over the

past years. The most critical development, which has caused the profit ratio from sales (before tax)

to decline, is the increase in production costs and other external costs.

Production costs comprise different costs associated with operating activities these include costs

associated with the operation and maintenance of the fleet and costs such as handling, catering, and


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booking. There has been an increase in these expenses during the last three years, meaning that

costs have risen faster than revenue. CSG explains this increase in production costs with the

opening of new routes to larger airports which generally have higher airport charges, together with

increased maintenance costs(Cimber Sterling Group A/S, 2009g, p. 87).

Other external costs have developed negatively during the period. It is however difficult to say what

has caused this negative development since this account comprises everything from marketing to

write-downs of trade receivables and goods for resale and administration. We do although expect

that part of this increase stems from increased marketing expenses due to the heavy expansion CSG

has seen and the increased competition.

Staff costs have been steady throughout the whole period and have therefore not had a large effect

on the profit ratio from sales (before tax). It should however be noted that the employees of CSG

have agreed to reduce their salary with effect from the financial year 2010/11. This will be further

discussed in the later forecast section.

Rental and leasing expenses have decreased as a part of revenue during the period, this might be

due to the financial crisis and the fact that leasing prices have decreased dramatically, especially for

out-of-production models (Wall & Flottau, 2009, p. 44). As all of CSG’s airplanes are out-of-

production models this can be the reason why leasing expenses as a part of revenue is lower. From

the third quarter report we can see that rental and leasing expenses as a part of revenue have

increased again, and we expect them to be above 7% for the financial year 2009/10.

The profit ratio from sales (before tax) has developed negatively from 2006/07 to 2008/9 with

10.22% and 7.10% respectively as a part of revenue. The negative development in the profit ratio

from sales (before tax) does not have a single driver, but is caused by a smaller negative

development in the underlying drivers, and even though rental and leasing expenses has developed

positively it could not offset the development in the other drivers.

The second part of the drivers is not directly related to operating activities but are still important

drivers of the profit ratio. As can be seen below all three drivers (tax, value adjustments of hedging

instruments, and other accounts (after tax)) fluctuate quite heavily during the period, and it is

difficult to generally say in which direction they develop. The tax as a part of revenue has limited

meaning here as tax does not have anything to do with revenue but is related to how much profit

CSG generates. Value adjustments of hedging instruments are also hard to analyze since they use


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2008/09 2007/08 2006/07

Tax of operating profit from sale

Revenue

Value adjustments of hedging instruments

Revenue

Other operating profit (after tax)+Depreciation,

amortisation and impairment

Profit ratio from sales (after tax)+other accounts (after

tax)Profit ratio 4,17%

-4,70%

3,56%

-4,40%

2,58%

-7,23%Other accounts (after tax)

Profit ratio from sales (after tax) 8,76%9,14%8,21% Profit ratio from sales - tax

1,46%0,69%-1,11%

Value adjustments of hedging

instruments0,11%-1,17%1,61%

Tax


hedging to reduce uncertainties in future revenue, and from a business perspective this is a sound

thing to do, even though it might seem that they sometimes lose a lot of money on it and other times

they gain a lot on it. It seems that other accounts have risen dramatically from 2007/08 to 2008/09

but this should be seen in light of the other operating profit (after tax) that CSG received in

2007/08; without that extraordinary income other accounts (after tax) would have been close to the

2008/09 level. We can see that depreciation, amortization, and impairment have increased a lot

from 2006/07 to 2007/08. CSG does not give any specific reason why this rise occurred, but it

might be due to an increase in property, plant, and equipment and the purchase of four CRJ and

three ATR airplanes(Cimber Sterling Group A/S, 2009g2009, 89). Overall we cannot make a

general conclusion on how these different drivers have affected the profit ratio, but they have

cancelled out some of the negative development we saw in the profit ratio from sales (before tax).

5.3 Airline Specific Key Ratios

To get a better understanding of the value drivers that affect the revenue and profitability of CSG,

we will now analyze some airline specific key ratios. CSG is benchmarked with Norwegian,

Ryanair, and SAS. The aim of this benchmarking is to identify overall tendencies and to get a

feeling of CSG’s performance relative to its nearest competitors. For this purpose available seat

kilometers (ASK), revenue passenger kilometers (RPK), and load factor will be analyzed.

It should be clarified that the financial years are different. The financial year of CSG is starting in

May, Ryanair’s financial year in April, and Norwegian and SAS’s financial year in January. It is

assumed that these differences will not affect the larger picture, which is the aim of this comparison,


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as all financial statements have the seasonal fluctuations included. The airline specific key ratios

can be seen in appendix 8.

5.3.1 ASK

ASK is a measure of capacity, which is calculated by the number of available seats multiplied by

the distance flown. It is the total supplied capacity, which continuously should be adjusted to

demand to optimize the operating activities.

From 2007/08 to 2008/09 CSG has had an increase of 38,10% in capacity. Norwegian – a

competitor that also expands heavily in Europe – increased their capacity with 52,9% in the same

period. SAS, another close competitor, decreased their capacity from 2007/08 to 2008/09 with

16,30%, which is a good example of the need for capacity adjustments. When looking at actual

capacity it can be seen that CSG is a very small player compared to its competitors. In 2008/09

CSG’s capacity only amounted to 7,4% of Norwegians capacity15.

The three first quarters of 2009/10 has shown a 123% increase compared to the same three quarters

in 2008/09. CSG is thereby still increasing their capacity significantly.

5.3.2 RPK

RPK is a measure of passenger traffic, which is calculated by the number of occupied seats

multiplied by the distance flown.

From 2007/08 to 2008/09 CSG had a passenger traffic increase of 27,67%. With a capacity increase

of 38,10% in the same period it is obvious that CSG has overestimated the level of passenger traffic

for the period. There is an inconsistency between actual capacity and traffic; this has also affected

the profit. Norwegian had passenger traffic growth of 49,76% in the same period, which far better

fits their capacity growth of 52,49%.

5.3.3 Load Factor

Load factor describes the utilisation of the available seats. It is calculated as RPK divided by ASK.

It is thus the ratio of passengers to the number of available seats per flight. Load factor tells us how

well an airline utilizes their capacity, and in general a high load factor would indicate an airline that

is very good in filling their planes, however, the load factor does not take into account the price of

the tickets sold. The load factor can therefore not be taken into account separately but should be

15 Appendix 8: Airline Specific Key Ratios: 857994/11530000 = 7,4%


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considered together with the yield. An airline can increase its load factor by lowering its prices, but

that would reduce the yield and thereby the profit of the airline. As can be seen from appendix 8

CSG has a considerably lower load factor than all of their closest competitor. CSG’s load factor

decreased from 59,40% in 2006/07 to 56,60% in 2008/09. Norwegian on the other hand had a load

factor of 79% both years, and the average passenger load factor for SAS from 2002 to 2009 was

70.9% (SAS, , p. 1).

The low load factor can have several causes. One could be that CSG is not as good as its

competitors at filling the planes. Another cause could be that CSG has chosen to have a higher yield

than its competitors, thereby accepting a lower load factor and instead earning more on each

passenger. It can also be a combination of the two.

5.3.4 Yield

Yield is the total revenue from passenger carriage relative to RPK. It is calculated by taking the

total revenue from passenger carriage and dividing it with RPK. The historical data of yields is very

limited since CSG did not report their yield before the semiannual report covering May to October

2009. The yield is however a very important factor to look at, especially together with the load

factor. Neither the yield nor the load factor makes any sense to look at separately, since the load

factor does not take into account how much was paid for the seats, and the yield does not take into

account how many people were on board. In the interim report for the third quarter it can be seen

that CSG has seen a decline in its yield over the past nine months; this is due to an increased

competition and because of the new leisure routes that have a lower yield than the usual high

frequency short distance routes that CSG has previously had focused on. It can also be seen that

CSG has not increased its load factor despite its lower yield. When looking at the yield and the load

factor together it can be seen that CSG is transporting the same amount of people on each plane, but

each passenger is paying a lower price for their ticket.

5.4 Risk Analysis

The risk analysis will identify the risk factors that will affect CSG in the future.

5.4.1 Operating Risks

A major operating risk for CSG is the development in the Danish market for its domestic flights and

in the European market for its European flight. The demand conditions on these markets can be

affected by a lot of factors for example an increased focus on high-speed trains, increased


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competition, terrorist attacks, or another event that can have dramatic impact on CSG’s profitability.

In the Danish market CSG is fighting for market shares primarily with Norwegian and SAS, and in

the European market CSG is fighting against many different competitors.

As mentioned in the five forces analysis, under rivalry among existing customers, the increasing

focus on fares is a large risk for CSG as they face competitors with greater capital reserves and

better known brands.

5.4.2 Financial Risks

The financial risk regarding FGEAR and spread has been treated in the decomposition of ROE. In

general it can be summarized that as long as spread is positive a higher FGEAR will be

advantageous, but a high FGEAR will always mean increased financial risk.

CSG makes considerable purchases in US Dollars: Fuel, spare parts for aircrafts, and lease

payments (Cimber Sterling Group A/S, 2009g, p. 174). Fuel prices have historically faced

significant changes. According to the prospectus fuel prices have only very limited been hedged but

they have announced that they will use some of the proceeds from the IPO to (ibid., p. 119).

Because of these liabilities in USD exchange rate risk is another factor to consider (ibid., p. 22).

Revenue is primarily received in Danish Kroner and Euro, which means that CSG is facing

exchange rate risks. At the end of the first quarter CSG had TDKK 470.700 in debt with a floating

interest rate (ibid.). A small change in interest rate will have a high impact on the interest paid on

bank debt. No information on hedging of the interest rate is available. The floating rate loan might

be a calculated risk by management to get cheaper loans here and now, but with an interest rate that

is historically low it is a considerable risk.

The use of primarily operating leasing agreements regarding aircrafts is reducing the risk compared

to companies that either own all their airplanes or are using financial leasing agreements. There are

also risks combined with creditors in relation to trade receivables. Business partners and large

customers are continuously evaluated to avoid large losses on creditors (ibid., p. 176). CSG has

historically used a number of derivative financial instruments to prevent currency, interest, fuel

price risks, though only by limited amount or not at all in some areas.

In 2006/07, 2007/08, and 2008/09 the effect of hedging instruments is TDKK 1.100, TDKK -

12.400, and TDKK 8.500 respectively (ibid., p. 80). The liquidity of CSG is a vital concept. The

IPO in December 2009 was made to ensure a better liquidity of the company. The capital injection


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has nearly been offset by a negative EBIT of TDKK 178.100 in the first three quarters of

2009/10(Cimber Sterling Group A/S, 2010b, p. 6). From the third quarter interim report is can be

seen that CSG has cash resources at approximately TDKK 100.000 at 31 January 2010 (ibid., p. 7).

This low level of cash resources is extremely risky, since a single negative unforeseen event that

potentially can cause a decrease in earnings will push CSG close to bankruptcy.

5.5 Permanent Earnings

Permanent earnings are the relevant earnings when making forecasts of future earnings.

Extraordinary earnings are as the title suggests extraordinary and will not be repeated. Normally it

would be necessary to split permanent or core earnings from extraordinary earnings. In the case of

CSG only few extraordinary items have been identified: Other operating profit of TDKK 44.854 in

2007/2008, which was a refund of VAT and financial income of TDKK 24.148, which was interest

received from the VAT case. The significance of these items is small but they will be considered

when forecasting growth.

5.6 Preliminary Conclusion

With the reformulation of the financial statements the most important accounts have been identified

and were used for the purpose of calculating and decomposing ROIC. Both the income statement

and the balance sheet was separated into items relating to operations and items related to financing

it gave a better view of how CSG is financed and how they make/lose money. In the following the

decomposition of ROE and ROIC is comment on.

ROE has seen a large decrease during the period, which means that the return to shareholders has

been negative for the financial year 2008/09. The decrease is caused by a decrease in both the net

borrowing rate and ROIC. The net borrowing rate mainly decreased because of a sizeable amount of

foreign exchange losses in 2008/09 as well as a smaller increase in interest expenses. The financial

gearing increased during the period, the increase might be attributed the increase in activity that

have increased the need for new investments and hence more borrowing. The spread decreased a lot

from 2008/09 due to the increase in net borrowing rate. The spread together with the gearing was

the main driver behind the negative ROE.

ROIC was decomposed to evaluate the main drivers behind the negative development as well as to

find the value drivers to be used in the subsequent forecast. The main driver behind the negative

development in ROIC was identified to be the profit ratio. Since the profit ratio showed to be such


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an important driver of ROIC it too was decomposed to see which drivers affects it. We saw an

increase in production costs and in other external costs together with a decrease in rental and leasing

expenses it all amounted to a decrease in the profit ratio from sales (before tax), which was

identified as the main reason the profit ratio decreased. It is hard to conclude on the effect of the

drivers not relating to operations as they seem to fluctuate a bit randomly, the only thing we can

conclude is that depreciation, amortization, and impairment has increased over the period probably

due to the increased activity and hence investments which was also the driver behind FGEAR.

CSG has increased its capacity considerably more than has been justified by the increase in their

passenger traffic. This smaller increase in passenger traffic compared to capacity growth could be

considered a normal part of expanding so rapidly into new markets, since the customers need to be

informed about this shift before they will change their habits and as soon as people become aware

of this new focus, it is expected that the load factor might increase without much change to the

yield. The yield has decreased over the past three quarters because of the increased competition.

CSG’s load factor is still significantly lower than that of its closest competitors and with the

increased pressure on CSG’s yield, it could become a problem for CSG. With the relatively low

load factor and the decrease in the yield it can be argued whether CSG is able to exploit the synergy

effects between business and leisure travellers, which they say is one of the strengths of their hybrid

carrier strategy.

CSG is facing significant risk in different areas of its operations. Like all other airlines they are

exposed to significant risk in relation to fuel prices, which have historically fluctuated considerably,

on top of that there is the risk related to the USD/DKK exchange rate, which can either increase or

decrease the effect of changes in fuel prices. Though CSG plans to hedge both of these risks with

some of the proceeds from the IPO, they will not have enough money to hedge all of the risk. CSG

also faces risks that are more company specific. They have a substantial amount of floating rate

loans, which makes them vulnerable to changes in the exchange rate. CSG has reduced some of

their risk by leasing a large part of their fleet with operational leases, which mean that they can

return some of the aircrafts if they have overcapacity.

6. Forecasting

The budget forecasts are in the following estimated from the financial and strategic analysis.


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The vulnerability of the financial analysis will be taken into consideration by placing more

emphasis on the strategic analysis, and especially the macro economic trends. The vulnerability of

the financial analysis can be emphasized by the following quote: “Following the completion of the

Sterling transaction, Cimber Sterling’s profile has changed significantly, and comparisons over time

may therefore be difficult” (Cimber Sterling Group A/S, 2009g, p. 19).

Some accounts are excluded from the budget forecast, either because it is impossible to forecast or

irrelevant. Focus will be on the relevant accounts and their estimates. All relevant accounts for the

income statement and balance sheet will now be estimated in relation to the value drivers from the

financial and strategic analysis.

6.1 Forecast Horizon

The forecast period is typically between five to twenty years depending on various considerations in

relation to the company under investigation. The length of the forecast period depends on when

CSG will reach their steady state of growth and also on an assessment of the reliability of

estimating variations in underlying variables in future (Sørensen, 2009, p. 316). In the terminal

period constant growth is expected and all other forecast assumptions will remain unchanged, which

is done by using revenue growth as the primary value driver. All other value drivers are then

forecasted in relation to revenue growth, which ensures a link between all forecasted value drivers.

We have chosen a forecast period that comprises the coming five financial years as it is believed

that CSG has reached its steady state within five years (Sørensen, 2009, p. 315). We also believe

that variations in underlying variables can be estimated reasonable for five years. The airline is

mature and there are few company specific competitive advantages, which imply that the forecast

period should be approximately five years according to Ole Sørensen (Sørensen, 2009, p. 318).

Detailed forecast over a longer period is avoided with the forecast period of five years. The airline

industry is heavily affected by the macroeconomic tendencies, which are not possible to estimate in

the long run. The fluctuation of earnings made by CSG and its competitors over the last five years is

supporting that the airline industry is rapidly changing and to a large degree following the macro

economic trends.

As can be seen below we expect CSG to reach its long-term growth rate in year 2014/15. The first

forecasted year (2009/10) is heavily influenced by the interim reports from the first three quarters.


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2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period

Revenue 18,27% 13,03% 23,00% 16,00% 8,00% 7,00% 5,00% 4,00%

Figure 9: Own processing from Appendix 10

The following years are based on CSG’s historical financial performance and on the estimated

effects of their chosen strategy.

6.2 Revenue Growth

Revenue growth is estimated as follows:

The estimates are based on the following:

From the CSG’s third quarter interim report a revenue growth rate of approximately 23% is

expected. This high level of revenue growth originates primarily from the expansion of the aircraft

fleet and new routes. The best predictor of the revenue growth of 2009/10 is assumed to be the

revenue growth of the first three quarters. It is believed that the extreme growth CSG has seen over

the last couple of years should be seen in the light of a heavy expansion in the world economy and

recently the expansions made with the assets from Sterling A/S. The return of the two CRJ200 jets

to their owner, the two B737 that were planned to be leased will not be leased, and the one ATR72

that is expected to remain on lease instead of being used by CSG, combined with the effect of the

financial crisis and the continuing intense competition in the airline industry means that we believe

CSG will not be able to maintain the historically high growth rate. We expect the focus in the

coming years to be on making the existing routes profitable via the two new initiatives Odin (sales

promoting) and Thor (cost reducing) (Cimber Sterling Group A/S, 2010b, p. 7). Revenue growth in

2010/11 is estimated to be 16%. The growth is expected to rise from late effects of the heavy

expansion, increased load factor, and optimization of the summer traffic program 2010 (Cimber

Sterling Group A/S, 2010b, p. 9). CSG’s load factor is currently very low compared to its closest

competitors and with their hybrid carrier strategy, which should increase their utilization it should

be possible get a load factor closer to its competitors. The revenue growth in 2011/12, 2012/13, and

2013/14 is estimated at 8%, 7%, and 5% respectively. The revenue growths in these years’ stem

from a general increase in economic activity (increased passenger traffic) and the effect of the

growth initiative Odin.

We expect the revenue growth rate to reach its steady state in 2014/15 at 4%. A GDP growth of 4%

is expected. The revenue growth rate of 4% is supported by the estimates of the aircraft


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Figure 10: from Appendix 10


- Operating costs

held for sale -84,08% -88,41% -100,50% -95,00% -91,00% -87,00% -87,00% -86,00%

manufacturer Airbus, who expect a European passenger growth rate of 4,30% over the next 20

years (Airbus, 2010).

6.3 Operating Costs Held for Sale

For the first three quarters of 2009/10 the operating costs held for sale amounts to approximately

100,5% of sale16. Operating costs held for sale thereby exceed revenue in the first three quarters.

This is primarily because of expenses to IPO, increased competition, and a cold winter with many

delays and cancellations. Operating costs held for sale in 2009/10 are estimated to 100,5% of

revenue based on the first three quarters of the year. For the following years a slow decrease in

operating costs held for sale as a part of revenue is expected. This is based on several value drivers:

the Thor initiative (cost reducing), staff costs is cut by 10% with effect from 2010/11, and better

utilization from the diversified fleet. In the analysis of airline specific key ratios it was seen that

there is room for improvement for CSG compared to its competitors, which supports that the value

drivers identified will have the positive effects. It should be noted that several factors in operating

costs held for sale, which are not estimated but held constant in relation to revenue might have a

large impact in the future. An example is the fluctuations in aircraft fuel prices and a possible tax

imposed airline companies from their CO2 emissions to mention a few. It should be noted that

operating costs held for sale has many important variables that could potentially change the forecast

dramatically.

16 Other external costs is included in EBITDAR and not in operating costs held for sale, but it is such a small amount

that it does not affect the calculation remarkably.


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Rental and leasing

expenses -6,09% -4,49% -7,26% -7,00% -7,00% -7,00% -7,00% -7,00%

Figure 11: from Appendix 10

6.1.5 Rental and Leasing Expenses

The rental and leasing expenses have been very low in 2008/9. The low level in rental and leasing

expenses can be supported by the expected overcapacity of airplanes, that originated from the world

financial crisis: “There are instances now where lessors are leaving the asset with an airline even

without a lease payment, just as long as the carrier does not return it and keeps up maintenance”

(Wall & Flottau, 2009, p. 2). From the half year report of 2009/10 it can be calculated that the rental

and leasing expenses amounted to 7,26%, which is used as estimate for the whole year 2009/10. For

the following years a constant level of 7% is estimated. The level of 7%, which is a bit lower than

currently, is based on the fact that CSG will not renew two CRJ aircrafts in April 2010.

Developments in rental and leasing expenses will follow the development in revenue, which is

another reason that a constant level is estimated. The outcomes of the leasing agreements that in a

few years are to be renegotiated are hard to predict (Cimber Sterling Group A/S, 2009g, p. 17). A

substantial part of CSG’s leasing contracts has to be renegotiated/renewed within 3 years (ibid., p.

180). The outcome of the renegotiations of leasing agreements is again vulnerable for our valuation.

Profit ratio from sale (before tax) can know be estimated by subtracting operating costs held for sale

and rental and leasing expenses from revenue.

6.1.6 The Effective Tax Rate

The effective tax rate is estimated from historical efficient tax rates and from the knowledge that the

company tax rate in Denmark is 25%. From the income tax note on page 166 in prospectus it can be

seen that the three previous effective tax rates have been 25,60%, 19,20%, and 27,80%. Our best

estimate, based on the actual tax rate and the historical tax rates, is a tax rate of 25%.

From 2009/10 – 2010/11 the effective tax rate is listed in appendix 11 with a minus because of

negative operating profit from sales (before tax - deferred taxes in these three years.


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6.1.7 Other Operating Profit (after tax)

Value adjustments from hedging instruments are the dirty surplus account from the statement of

equity. Forecasting the effect of hedging adds complexity but not necessarily accuracy. The effect

of hedging will vary from year to year, and an average of zero is forecasted.

By nature other operating profits is hard to estimate and it is therefore set to zero. In the case of

CSG this accounts, will primarily be affected by losses and gains on hedging contracts. The main

reason for hedging is unpredictability in the product being hedged. Therefore it makes absolutely no

sense to guess future outcomes of this account. Another point is that gains and losses will cancel

each other out in the long run. Other operating profit (after tax) is estimate to be 0% of revenue.

6.1.8 Depreciation, Amortization and Impairment

Depreciation, amortization and impairment are not estimated in our budget. Since depreciation,

amortization and impairment are simply an accounting loss, which do not have any cash effect.

Instead we are using the turnover rate of assets to forecast net operating assets, this way we

incorporate depreciation without estimating it directly.

6.1.9 Net Working Capital and Non-current Net Operating Assets

To forecast turnover rate of assets we have to first forecast net working capital (NWC) and non-

current net operating assets. As can be seen from our budget NWC is estimated to be negative

throughout the whole budget period. This is done on the basis of the historical negative NWC,

which means that CSG at first sight cannot pay their bills. The reason that CSG actually can meet

their current obligations is that they receive payment from customers in advance. There is a risk

with having negative NWC, as CSG will be dependent on receiving enough payment from

customers in advance to be able to meet their current obligations (Morrell, 2007, p. 156). This is a

real risk faced by CSG as the airline industry is very seasonal, and unexpected events such as the

terrorist attack in 2001 can have a large effect on CSG. In an event like that they might not have

enough liquidity to meet their current obligations. If CSG manages its liquidity well it can be an

advantage to have a negative NWC, since it increases profitability.

The recent acquiring of new routes and aircrafts through the acquiring of parts of Sterling A/S is

expected to fulfil the capacity needs. There is therefore no reason to believe that CSG will need to

increase its investments in terms of aircrafts, land and building, and other operating assets to

maintain growth in revenue at our suggested level. New big investments are therefore not expected.


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2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period

NOPLAT -92.901DKK -27.775DKK 29.997DKK 96.289DKK 101.103DKK 122.672DKK

Figure 12 from Appendix 11


Net operating assets 697.330DKK 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK

Figure 13 from Appendix 11

Especially for next 3 years a better capacity utilization of the non-current net operating assets is

expected because of late synergy effects from the acquisition of Sterling A/S. Non-current net

operating assets are estimated to grow together with revenue as it is evaluated that CSG will not

need to invest heavily in non-current operating assets. It is estimated that they will need more

inventories of for example aircraft components as their activities increase and planes are worn out

faster. A general adjustment of NWC and the non-current net operating assets to a constant level

relative to revenue is expected for the budget period. Therefore the turnover rate of assets is

assumed to remain constant relative to revenue for the whole budgeting period.

6.1.10 NOPLAT

From the forecasts it is now possible to calculate NOPLAT the calculations can be seen from

appendix 11. NOPLAT will be used later to calculate free cash flows that are discounted back in

time to reach a value of CSG. As can be seen we have estimated a loss in both the financial years

2009/10 and 2010/11, this is actually close to the estimates CSG has come with. For the financial

year 2009/10 a loss of approximately TDKK 93.000 is forecasted. This number is based on the

actual numbers for the first three quarters of 2009/10 and it is therefore believe to be a fairly good

estimate. After the first forecasted year an improved profitability is estimated as they get the new

routes up and running. This forecast is well in line with the fact that CSG is not increasing its fleet

and the rollout of the cost minimizing Thor program and the sales increasing Odin program.

6.1.11 Net Operating Asset

From the estimates of net working capital and long term net operating assets it is possible to

calculate the estimate of net operating assets. As can be seen from appendix 11 the forecast is based

on the Net working capital and the non-current net operating assets to both remain constant relative

to revenue. This is done because it is believed that the underlying operating assets and operating

liabilities will generally increase together with activities; it makes sense because they are all tied

together with operations. This means that the net operating assets will grow together with CSG’s


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revenue. Net operating assets might deviate slightly from our forecast, but the most important

observation is that there will not be a systematic deviation.

The budget forecast can be seen in appendix 11. In the following the cost of capital will be

estimated.

7. DCF Valuation

7.1 Estimation of WACC

“The company cost of capital is a weighted average of the returns demanded by debt and equity

investors” (Brealey et al., 2007, p. 325). All investors will demand a return for their investment.

Shareholders typically demand the highest return, since they will be the last to be considered at a

bankruptcy. Financial institutions and other debt investors will demand a return in relation to the

specific risk of a company. Credit rating agencies, such as Standard and Poor’s and Moody’s, are

often used to identify the level of risk of a company. It has not been possible to get a rating on CSG

from any of these agencies.

7.1.1 Target Capital Structure

When estimating target capital structure it is normally most correct to use the market value of equity

and debt, but since the market value of equity is the goal of a fundamental analysis it makes no

sense to use market value in calculations that should lead us to market value. The concept of target

capital structure is therefore used. The idea is to estimate the capital structure that we believe that

CSG will be aiming for – their target.

For the past three financial years, 2006/07, 2007/08, and 2008/09, equity to the total balance sum

has been 23,20%, 19,17%, and 14,89% respectively. The IPO in December 2010 has added

approximately TDKK 251.000 to CSG’s equity, which have changed the capital structure

significantly. Said in other words, approximately 26% was financed through equity and 74% debt.

This is supported by a listed solvency ratio of 26% (Cimber Sterling Group A/S, 2010b, p. 7). The

equity on the 31st of January 2010 was TDKK 280.000 and the balance sum was TDKK 1.083.000.

The target capital structure is assumed to be with 25% equity and 75% debt.


Page 58 of 93

7.1.2 Return Demanded by Equity Investors - rEquity

The required rate of return on equity is estimated by the use of the Capital Asset Pricing Model

(CAPM) (Brealey et al., 2007, p. 304):.

A survey covering 1000 professors in Europe suggests an average market risk premium of 5,3% in

Europe (Fernandez, 2009, p. 2). The market risk premium average in Denmark has been estimated

to approximately 5% from 1970 to 2002 (Saabye, 2003, p. 73). In the mentioned historical research

dividends are included, which should give a far more accurate number according to Niki Saabye

(ibid.). Market risk premium is estimated to be 5,3%, which is supported by the survey from 2008.

Beta will be estimated through a common sense method of evaluating operating and financial risks.

The strategic analysis showed us that CSG is facing many threats and some weaknesses (see SWOT

section 5.6). Based on this a high level of operating risks is expected. The risk analysis performed

under the financial analysis supports a high level of operating and financial risk as well. The capital

structure, which is highly dominated by debt, supports this argument. Combining a high level of

operating and financial risk a beta of 1,5 is estimated, which is supported by the ideas from FSR

(Plenborg & Gruelund, 2002, p. 59).

7.1.3 Return Demanded by Debt Investors - rD

The required rate of return for CGS’s debt investors can be estimated by (Sørensen, 2009, p. 56):

( )(1 )

Where

: Risk free rate

r : Company specific risk

: Company tax rate

D F C

F

C

r r r t

r

t

= + −

The risk free rate is estimated by a 10-year state bond, which on the 17th of Marts had an interest

rate of 3,374% (Danmarks Nationalbank, 2010). The company tax rate is estimated at a rate of 25%,

which has been estimated earlier in the paper. The company specific risk premium is estimated to

6%. The company specific risk is estimated at a high level for several reasons: Large negative net

loss for the first three quarters of 2009/10, tough competition, and a high level of financial risks.

The survival of CSG has been discussed in the media, which by itself must raise concern for

creditors (Kronenborg, 2009). From figure 14 the historical return to debt investors is calculated


Page 59 of 93

1 (1 )

t

FCFF tt WACC

FCFFPV

r=

=+

∑

1Terminal period

1 ( )(1 )

TT

TT WACC WACC

FCFFPV

r g r

+

=

=− +

∑

from the interest-bearing debt (Cimber Sterling Group A/S, 2009g, p. 176) and actual interest paid

(Cimber Sterling Group A/S, 2009g, p. 166).

The required rate of return for CSG’s debt investors is calculated to be 7,03% (appendix 9). This

rate is somewhat higher than the historical rate this makes sense since CSG is facing a lot of risks in

the future.

7.1.4 WACC

From the estimation of CSG’s capital structure, rE, and rD it is now possible to calculate WACC

from the following formula:

* *D E

D EWACC r r

V V

= +

WACC is calculated to be 8,16% (appendix 9).

7.2 Calculation of Share Price Estimate from DCF Model

The FCFF from the forecast period (2009/10 to 2013/14) is discounted to reach the present value.

The present value amounts to DKK -342.756.487.

The FCFF from 2014/15 and forward are also discounted to reach the present value.

The present value is DKK 1.262.579.414. The enterprise value of CSG is therefore estimated at

DKK 919.822.927 where 137,30% of the value is coming from the terminal period and -37,30%

from the forecasted period. This indicates a high degree of uncertainty, since all value is created


Amount in DKK 1.000

2008/09 2007/08 2006/07

Interest bearing debt 483.892DKK 497.963DKK 329.558DKK

Interests paid 29.338DKK 23.602DKK 16.859DKK

Historical return to debt investors 6,06% 4,74% 5,12%


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from 2014/15 and onwards. It also means that all variables used in the terminal period are extremely

sensitive relative to share price.

The technical share price can now be calculated as the enterprise value less net financial liabilities,

which gives a share price of DKK 9,58 at the 30th of April. The FCFF is discounted back to the 30th

April 2009, as this is the last day of the annual report; the end of the financial year. The cut off date

is the 17th March, which means that the FCFF is discounted approximately ten and a half months

too far back in time. Therefore the technical share price is discounted forward with ten and a half

months, or 321 days to be exact, to reach the value on the 17th of March. At the same time we make

a correction to the DCF model, which brings our FCFF to the middle of the financial year instead of

at the end. The technical share price is thereby DKK 11,07. As a control check of the DCF model

the residual income model is also applied. As it can be seen from appendix 13 it gives the same

result.

Comparison with Share Price Value on the 17th

of March

The closing price for CSG’s share on the 17th March was DKK 3,89. The technical share price

therefore suggests that the stock price was undervalued with DKK 7,18. This means that the actual

share price on the 17th March was 64,86% lower than the technical share price. It is important

realize that the high technical share price can be interpreted in many ways and should be seen in the

light of the assumptions made throughout the thesis. The factors that have influenced our share

price, through forecasting of value drivers, and that the market may have other expectations to, are:

General macro economic trends, CSG’s competitive situation and their strategic opportunities, the

confidence in management, and the risk assessment to mention a few. A sensitivity analysis will

reveal how small changes in value drivers, and thereby changes in the mentioned factors, will affect

the technical share price. The significance of the most important value drivers will be discussed.

7.3 Sensitivity Analysis

To get an insight into how the most important variables affect the technical share price a sensitivity

analysis is conducted. The idea is to change one variable while holding others constant and see the

effect on the share price. It should be noted that this kind of analysis will potentially produce

extreme and in some situations misleading results, since a change in one variable normally will

affect other variables, but in this analysis they are held constant. For the broader perspective of the

sensitivity the analysis still serves a good purpose.


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Change in variable -20% -10% -5% 0% 5% 10% 20%

Analysis of growth drivers

Revenue growth in terminal period 3,20% 3,60% 3,80% 4% 4,20% 4,40% 4,80%

Price per share 8,68 9,77 10,39 11,07 11,81 12,64 14,59

Profit ratio from sales (before tax) 5,60% 6,30% 6,65% 7% 7,35% 7,70% 8,40%

Price per share 0,95 6,01 8,54 11,07 13,6 16,12 21,18

Turnover rate of assets 1,6 1,8 1,9 2 2,1 2,2 2,4

Price per share -109,33 -42,44 -14,28 11,07 34 54,85 91,33

Analysis of financing drivers

WACC 6,53% 7,34% 7,75% 8,16% 8,57% 8,98% 9,79%

Price per share 34,83 15,23 15,12 11,07 7,72 4,93 0,53

Beta 1,12 1,26 1,33 1,4 1,47 1,54 1,68

Price per share 15,51 13,17 12,09 11,07 10,1 9,18 7,47

Company specific risk premium 4,80% 5,40% 5,70% 6% 6,30% 6,60% 7,20%

Price per share 17,68 14,11 12,53 11,07 9,71 8,45 6,17

Figure 15 from appendix 14

Sensitivity calculations are made on the variables that are believed to have the largest impact on the

share price and/or the variables that are estimated with substantial uncertainty in the forecasting

section.

Revenue growth rate, profit ratio from sales (before tax), turnover rate of assets, WACC, beta, and

company specific risk premium are evaluated to be the most important value drivers.

7.3.1 Growth Drivers

From figure 15 it can be seen that the most important value drivers are profit ratio from sales

(before tax), turnover rate of assets, and WACC. These will be discussed in the following. Our

share price estimate is extremely sensitive towards changes in turnover rate of assets. A 5% increase

will increase the share price to DKK 34, and a 20% increase will increase the share price to DKK

91,33. The investment needed to obtain the forecasted revenue growth and other factors that affect

the turnover rate of assets are thereby enormously sensitive.

It can also be seen that our share price estimate is very sensitive towards the profit ratio from sale

(before tax). A 5% increase will increase the share price to DKK 13,60. A 20% decrease gives a

share price of DKK 0,95. The profit ratio from sale (before tax) is dependent on relation between

revenue growth and costs held for sale. The forecast of costs held for sale was among other things


Page 62 of 93

based on a successful implementation of the cost minimizing initiative Thor. A forecasted

implementation failure of Thor would have affected our price estimate substantially.

The least significant growth rate driver is the revenue growth. A 20% decrease in revenue growth

will only make the price drop to DKK 8,68.

7.3.2 Financing Drivers

Our share price estimate is also very sensitive towards WACC. A 10% increase gives a share price

of DKK 4,93. The two important risk measures, beta and company specific risk premium, are used

when estimating WACC, and they are both applied in the sensitivity analysis to understand their

individual impact on share price. The sensitivity of beta and the company specific risk premium - in

relation to our share price estimate - is approximate the same. A 20% increase of beta gives a share

price of DKK 7,47, where a 20% increase of the company specific risk premium gives a share price

of DKK 6,19. As already mentioned WACC is affected by a lot of factors, which are continually

adjusted according to the financial and operating risks of CSG. The static WACC used in our

fundamental analysis is therefore vulnerable and a major uncertainty factor.

8. Peer Group Analysis

The relative value of CSG is calculated by using price multiples also called the method of

comparables. In our peer group analysis the price multiples price/sale (P/S) and price/book value

(P/B) is use to calculate the market value of CSG. P/E and other price multiples using some format

of earnings, is not used since it makes no sense when earnings are negative. Since CSG and two of

our peer group companies have reported losses in their latest annual report P/E is not used. The

different price multiples are calculated for each company with their market capitalization on the 17th

of March 2010, their sales and book value of equity are taken from their latest annual report. This

gives us a problem with the data being from different dates, but as we cannot get the sales and book

value of equity at any specific date we will ignore this error. Simple averages of the multiples are

then calculated and used to estimate a share price of CSG that can be compared and discussed in

relation the technical share price at DKK 11,07.

Four different averages are used to calculate a share price for CSG. First an average of CSG’s three

closest competitors is used. This provides a share price of DKK 20,10 which well above the share

price on the cut-off date and our technical share price. The second average removes Ryanair. They


Page 63 of 93

are excluded for several reasons: They are the largest international airline in the world and they

have been making profit for a long time, they do not operate domestic routes in Denmark, and their

strategy is based on extreme cost minimization, which does not reflect CSG business strategy. The

second share price is thereby only with Norwegian and SAS. Both SAS and Norwegian operate

domestic routes in Denmark. SAS is a NC and Norwegian is a LCC. The idea is that the mix

between the price multiples from a NC and a LCC will reflect a hybrid carrier like CSG. From

appendix 15 the calculations of the market value by using price multiples can be seen. The book

values of equity and revenue (sales) from SAS and Norwegian are taken from their most recent

annual report available before the 17th March. The market values are calculated from the number of

shares and the closing share price on the 17th March 2010. The P/S and P/B give two different share

price estimates, DKK 12,76 and DKK 10,27 respectively. These are averaged to end at a share price

of DKK 11,51, which is close to our fundamental share price.

The difficulties of finding relevant comparable firms motivated us to use the comparable method in

a more general manner. For the third multiples Airline industry standards of P/S and P/B are used to

estimate a share price. Reuters.com provides the “airline industry standard”, which consist of the 17

airlines from mainly US, but also with international airlines represented (Reuters, 2010). Despite

this bias it is found to provide valuable information about the airline industry as a whole, since it is

important to look at industry numbers when using multiples (Penman, 2007, p. 78). The industry

standard yielded two different P/S and P/B share price estimates of DKK 4,56 and DKK 6,35

respectively. The average share price estimate is thus DKK 5,46. This estimate is rather close to the

original share price of CSG on the 17th of March.

It is extremely difficult to find airlines that closely resemble CSG and as a peer group that is similar

to the company under investigation is the basis of the method of comparables the share price

estimated relative to SAS, Norwegian, and the “airline industry standard” is combined and a simple

average is taken to end up with an estimate of DKK 8,49. We use this average as it comprises the

largest group companies for our analysis and it is found to be most likely that an external investor

would use this when comparing the price of CSG with their competitors. This estimate sits in

between our technical price and the actual price on the cut-off date.

From the calculation process in excel it became obvious that the method of comparables is

extremely sensitive to changes to the peer group and price multiples that are used. Depending on the


Page 64 of 93

peer group one ends up with very different share price estimates. This shows one of the deficiencies

in the method of comparables.


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9. Conclusion

The airline industry has had some turbulent years after the deregulation and the emergence of

LCC’s. NC’s are facing challenges regarding their entire business model and in that also their cost

structure. LCC’s are increasing their market share and a lot of NC’s have already started their own

LCC brand or are introducing LCC product features to minimize costs. CSG has seen an

opportunity to expand into the market of LCC and with the purchase of assets from the bankrupted

Sterling A/S they started this expansion. The airline industry has seen a fierce competition for

customers and with the only differentiating parameter being price; profits have been hard to

maintain. CSG has focused on its cost structure but has still been facing problems in relation to its

profits. They have therefore initiated the Odin and Thor projects to increase revenue and decrease

costs. We have not seen the effect of these initiatives yet, but according to CSG the effect of an

improvement in EBIT of TDKK 100.000 will be seen in 2010/11. The strategy has been evaluated

and like other airlines they face significant challenges in the future with regard to customers, and

especially competitors. CSG is facing considerable challenges in relation to the macro environment

as the growth in the airline industry is closely related to the development in the world economy and

with the recent recession and the estimated low growth the next couple of years there will be an

increased focus on costs and profitability. Political decisions can change the market situation

completely and the proposed tax on pollution would have a substantial effect on the competitive

situation for CSG. Another factor that might increase the competitive situation for CSG is a

potential expansion of the rail network in Europe.

The process of the IPO was turbulent and ended with a share price that was half of the minimum

that was initially asked. The share price dropped immediately and together with allegations of an

illegal downgrade shortly after the introduction to the stock exchange CSG ended up with a

considerable amount of angry investors. Nevertheless CSG raised approximately TDKK 251.000 in

the IPO but the recent losses have taken its toll on liquidity.

ROE decreased significantly over the historical period investigated mainly due to a large increase in

net borrowing rate but also a decrease in ROIC. The net borrowing rate was mainly influenced by

large foreign exchange losses, some of which would presumably be hedged in the future. The

reason for the decrease in ROIC was mainly a decrease in the profit ratio from sales (before tax),

which should be increased with the focus on the two initiatives Odin (sales promotion) and Thor

(costs minimizing) in the future. Assuming that CSG has enough liquidity to hedge some of its


Page 66 of 93

foreign exchange obligations and minimize costs in the future, it should be possible to increase

profitability and thereby ROE.

CSG has considerably lower load factor than its closest competitors and together with the decrease

in yield over the past year it is evident that CSG is under a lot of pressure from competitors, which

it seems can only be overcome by increasing its sales activities to increase the load factor, as CSG

has limited flexibility to change the price of tickets. CSG has launched the Odin initiative to try to

increase their sales and assuming this succeeds CSG should be able to increase its load factor.

CSG is facing a lot of risks in the coming years. Almost all of their loans are floating rate loans. At

present the interest rate is low and in the short run the floating rate loans could be an advantage but

as interest historically have fluctuated quite a bit the loans could turn out to be a disadvantage. CSG

faces risks associated with both fuel prices and spare parts, which are both, settled in USD. The fact

that approximately half of CSG’s fleet is leased on an operational lease reduced the risk associated

with overcapacity, as these lease contracts have to be renegotiated ever so often. The reduced risk

from the operational leases and the future hedging of the exchange rate and fuel prices is not

enough to outweigh the other risks associated with CSG. The low level of cash resources, TDKK

100.000, is extremely risky, since CSG cannot survive another year with the same loss as they had

in the first three quarters of 2009/10, without a new capital injection.

This paper has made a thorough evaluation of the strategy of CSG and analysis of the financial

situation of CSG. The future of CSG is very uncertain and the technical share price is characterised

by this uncertainty. The heavy expansion and the focus on low costs is a risky move when looking

at the competition within this segment, but on the other hand a lot of the NCs have been faced with

dramatic losses over the past couple of years, whereas LCC have been able to present sizeable

profits. The forecast is based on our analysis of CSG with regard to their strategy and past financial

performance and the overall development in the industry and in the economy. Most of the emphasis

was put on the developments within the strategy, the industry, and the European economy. The

historical financial performance was used less in the forecasting, since CSG’s has changed so much

in the recent year.

Our technical share price is considerably different from the share price at the cut-off date. The DCF

model yielded a fair price of DKK 11,07 and the price of the cut of date was DKK 3,89. This

difference might stem from several factors. It might mean that the share price of CSG is


Page 67 of 93

undervalued, but as our sensitivity analysis showed even the slightest change in either of the most

important value drivers will have a large effect on the share price. This means that the difference

might originate from different expectations in the development of one or more of the value drivers.

It might also mean that investors do not believe that CSG will survive in the fierce competition in

the long run. Because of the risks associated with CSG and the uncertainty of the future of CSG and

other airlines and the fact more than 137% of the value of CSG lies in the terminal period it cannot

be concluded whether the share price at the cut-off date is fair.

A peer group analysis was also used to evaluate the share price but this analysis revealed flaws of

the method more than it gave us a better estimate of whether the share price was fair. It became

apparent that it is extremely sensitive towards the choice of peer group and in an industry like the

airline industry where it is difficult to find publicly traded peers it has limited value. The method of

comparables yielded a result of DKK 8,49, which would suggest that CSG’s share is undervalued

but it might also just be due to a poor choice of peer group. Again it cannot be concluded whether

the share price at the cut-off date is fair.


Page 68 of 93

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Page 76 of 93

Income statement 1st May - 30th April

Amount in DKK 1.000

2008/09 2007/08 2006/07

Revenue 1.297.757DKK 1.148.192DKK 970.791DKK

Production costs -673.504DKK -549.151DKK -471.021DKK

Other external costs -72.103DKK -59.781DKK -47.865DKK

Staff costs -401.771DKK -356.472DKK -288.790DKK

Other operating income -DKK 44.854DKK -DKK

Operating profit before rental and leasing expenses,

depreciation, amortisation, impairment, etc. (EBITDAR)150.379DKK 227.642DKK 163.115DKK

Rental and leasing expenses -58.257DKK -69.908DKK -63.930DKK

Depreciation, amortisation and impairment -93.841DKK -84.191DKK -45.591DKK

Operating profit/loss (EBIT) -1.719DKK 73.543DKK 53.594DKK

Financial income 1.472DKK 32.585DKK 6.231DKK

Financial expenses -78.888DKK -36.840DKK -24.042DKK

Profit/loss before tax (EBT) -79.135DKK 69.288DKK 35.783DKK

Income taxes 20.210DKK -13.281DKK -9.938DKK

Profit/loss for the year -58.925DKK 56.007DKK 25.845DKK

Attributable to:

Shareholders of Cimber Sterling Group A/S -58.925DKK 56.007DKK 25.845DKK

Appendices

Appendix 1: Official Income Statement of CSG


Page 77 of 93

Reformulatet income statement 1st May - 30th April

Amount in DKK 1.000

2008/09 2007/08 2006/07

Revenue 1.297.757DKK 1.148.192DKK 970.791DKK

- Operating costs held for sale -1.147.378DKK -965.404DKK -807.676DKK

Rental and leasing expenses -58.257DKK -69.908DKK -63.930DKK

Operating profit from sale (before tax) 92.122DKK 112.880DKK 99.185DKK

Reportet tax -20.210DKK 13.281DKK 9.938DKK

Taxshield on net financial costs 5.835DKK 5.901DKK 4.215DKK

Tax allocatet to other operating profit -DKK -11.214DKK -DKK

Tax of operating profit from sale -14.376DKK 7.968DKK 14.153DKK

Operating profit from sale (after tax) 106.498DKK 104.912DKK 85.032DKK

Other operating profit (before tax accounts)

Other operating profit -DKK 44.854DKK -DKK

Tax effect of other operating profit 11.214DKK

Other operating profit (after tax accounts)

Value adjustments of hedging instruments* 20.870DKK -13.464DKK 1.052DKK

Depreciation, amortisation and impairment -93.841DKK -84.191DKK -45.591DKK

Net operating profit less adjusted tax (NOPLAT) 33.527DKK 40.898DKK 40.493DKK

Financial income 1.472DKK 32.585DKK 6.231DKK

Financial expenses -78.888DKK -36.840DKK -24.042DKK

Tax effect 5.835DKK 5.901DKK 4.215DKK

Net financial expenses (after tax) -71.582DKK 1.646DKK -13.596DKK

Comprehensive income for the year -38.055DKK 42.543DKK 26.897DKK

* Dirty surplus account that is reportet in the statement of equity

Attributable to:

Shareholders of Cimber Sterling Group A/S -58.925DKK 56.007DKK 25.845DKK

Earnings per share

Basic/diluted earnings per share -19.642DKK 18.669DKK 8.615DKK

Calculation of taxes

Reportet taxes from income statement 20.210DKK -13.281DKK -9.938DKK

Interest based on Note 9 page 166 in prospectus 23.338DKK 23.602DKK 16.859DKK

Tax shield (interest * 25%) 5.835DKK 5.901DKK 4.215DKK

Appendix 2: Reformulated Income Statement of CSG


Page 78 of 93

Balance sheet

Assets

Amount in DKK 1.000

2008/09 2007/08 2006/07

Non-current assets

Intangible assets

Trademarks 5.081DKK -DKK -DKK

Rights 4.627DKK -DKK -DKK

Development projects 1.451DKK 1.793DKK 1.729DKK

11.159DKK 1.793DKK 1.729DKK

Property, plant and equipment

Land and buildings 15.609DKK 16.871DKK 16.707DKK

Aircraft and aircraft components 731.969DKK 759.470DKK 569.567DKK

Other plant and equipment 19.091DKK 16.468DKK 8.494DKK

Property, plant and equipment under construction 9.080DKK 2.476DKK 1.435DKK

775.749DKK 795.285DKK 596.203DKK

Other non-current assets

Deposits and other receivables 20.462DKK 8.615DKK 16.956DKK

Total non-current assets 807.370DKK 805.693DKK 614.888DKK

Current assets

Inventories, consumer goods and goods for resale 82.145DKK 60.834DKK 45.652DKK

Trade receivables 123.184DKK 137.956DKK 138.845DKK

Derivative financial instruments -DKK -DKK 1DKK

Corporation tax receivable 5DKK 93DKK 183DKK

Other receivables 50.113DKK 33.437DKK 16.103DKK

Prepaid expenses 22.985DKK 4.752DKK 6.264DKK

Securities 128DKK 1.066DKK 26.228DKK

Cash at bank and in hand 4.282DKK 1.814DKK 25.565DKK

Total current assets 282.842DKK 239.952DKK 259.892DKK

TOTAL ASSETS 1.090.212DKK 1.045.645DKK 874.780DKK

Appendix 3: Official Balance Sheet of CSG


Page 79 of 93

EQUITY AND LIABILITIES

Share capital 600DKK 600DKK 600DKK

Share premium 30.652DKK 30.652DKK 30.652DKK

Value adjustments of hedging instruments 8.458DKK -12.412DKK 1.052DKK

Retained earnings 122.668DKK 181.593DKK 170.666DKK

Total equity 162.378DKK 200.433DKK 202.970DKK

Liabilities

Non-current liabilities

Deferred tax 51.762DKK 65.012DKK 55.897DKK

Provisions 750DKK -DKK 51.947DKK

Mortgage debt 20.210DKK 7.378DKK 6.914DKK

Banks 350.837DKK 354.762DKK 217.681DKK

Lease obligations 31.462DKK 38.762DKK 45.520DKK

Total non-current liabilities 455.021DKK 465.914DKK 377.959DKK

Current liabilities

Mortgage debt 1.596DKK 1.012DKK 1.253DKK

Banks 59.523DKK 55.857DKK 28.966DKK

Bank overdrafts 12.964DKK 33.434DKK 22.968DKK

Lease obligations 7.300DKK 6.758DKK 6.256DKK

Derivative financial instruments -DKK 16.546DKK -DKK

Prepayments from customers and accrued income 177.527DKK 90.221DKK 34.736DKK

Trade payables 102.117DKK 83.673DKK 78.496DKK

Other payables 106.914DKK 91.797DKK 121.176DKK

Provisions 4.872DKK -DKK -DKK

Total current liabilities 472.813DKK 379.298DKK 293.851DKK

Total liabilities 927.834DKK 845.212DKK 671.810DKK

TOTAL EQUITY AND LIABILITIES 1.090.212DKK 1.045.645DKK 874.780DKK

Appendix 3: Official Balance Sheet CSG - Continued


Page 80 of 93

Reformulated Balance Sheet

Assets

Amount in DKK 1.000

2008/09 2007/08 2006/07

Operating assets

Trademarks 5.081DKK -DKK -DKK

Rights 4.627DKK -DKK -DKK

Development projects 1.451DKK 1.793DKK 1.729DKK

Land and buildings 15.609DKK 16.871DKK 16.707DKK

Aircraft and aircraft components 731.969DKK 759.470DKK 569.567DKK

Other plant and equipment 19.091DKK 16.468DKK 8.494DKK

Property, plant and equipment under construction 9.080DKK 2.476DKK 1.435DKK

Deposits and other receivables 20.462DKK 8.615DKK 16.956DKK

Inventories, consumer goods and goods for resale 82.145DKK 60.834DKK 45.652DKK

Trade receivables 123.184DKK 137.956DKK 138.845DKK

Derivative financial instruments -DKK -DKK 1.052DKK

Corporation tax receivable 5DKK 93DKK 183DKK

Other receivables 50.113DKK 33.437DKK 16.103DKK

Prepaid expenses 22.985DKK 4.752DKK 6.264DKK

Operating liquidity 4.282DKK 1.814DKK 4.854DKK

= Core Operating assets 1.090.084DKK 1.044.579DKK 827.841DKK

Operating liabilities

Deferred tax 51.762DKK 65.012DKK 55.897DKK

Provisions (non-current) 750DKK -DKK 51.947DKK

Derivative financial instruments -DKK 16.546DKK -DKK

Prepayments from customers and accrued income 177.527DKK 90.221DKK 34.736DKK

Trade payables 102.117DKK 83.673DKK 78.496DKK

Other payables 106.914DKK 91.797DKK 121.176DKK

Provisions (current) 4.872DKK -DKK -DKK

= Total operating liabilities 443.942DKK 347.249DKK 342.252DKK

Core net operating assets 646.142DKK 697.330DKK 485.589DKK

Non Core operating assets -DKK -DKK -DKK

Net operating assets 646.142DKK 697.330DKK 485.589DKK

Appendix 4: Reformulated Balance Sheet CSG


Page 81 of 93

Financial liabilities

Mortgage debt (current) 1.596DKK 1.012DKK 1.253DKK

Banks (current) 59.523DKK 55.857DKK 28.966DKK

Bank overdrafts (current) 12.964DKK 33.434DKK 22.968DKK

Lease obligations (current) 7.300DKK 6.758DKK 6.256DKK

Mortgage debt (non-current) 20.210DKK 7.378DKK 6.914DKK

Banks (non-current) 350.837DKK 354.762DKK 217.681DKK

Lease obligations (non-current) 31.462DKK 38.762DKK 45.520DKK

= Total financial liabilities 483.892DKK 497.963DKK 329.558DKK

Financial assets

Financial liquidity -DKK -DKK 20.711DKK

Securities 128DKK 1.066DKK 26.228DKK

Total financial assets 128DKK 1.066DKK 26.228DKK

= Net Financial liabilities 483.764DKK 496.897DKK 303.330DKK

Total Equity (Equity = asset - liabilities) 162.378DKK 200.433DKK 182.259DKK

Equity

Share capital 600DKK 600DKK 600DKK

Share premium 30.652DKK 30.652DKK 30.652DKK


Retained earnings 122.668DKK 181.593DKK 170.666DKK

Total equity 162.378DKK 200.433DKK 202.970DKK

Appendix 4: Reformulated Balance Sheet – Continued


Page 82 of 93

Statement of changes in equity

DKK’000 Share capital Share premium Value adjustments

of hedging

instruments

Retained

earnings

Total

Equity at 1 May 2006 600DKK 30.652DKK -DKK 130.330DKK 161.582DKK

Changes in accounting policies -DKK -DKK -DKK 14.491DKK 14.491DKK

Equity at 1 May 2006 after changes 600DKK 30.652DKK -DKK 144.821DKK 176.073DKK

Comprehensive income for the year -DKK -DKK 1.052DKK 25.845DKK 26.897DKK

Equity at 30 April 2007 600DKK 30.652DKK 1.052DKK 170.666DKK 202.970DKK

Comprehensive income for the year -DKK -DKK -13.464DKK 56.007DKK 42.543DKK

Extraordinary dividend -DKK -DKK -DKK -45.000DKK -45.000DKK

Costs related to interim dividend -DKK -DKK -DKK -80DKK -80DKK

Equity at 30 April 2008 600DKK 30.652DKK -12.412DKK 181.593DKK 200.433DKK

Comprehensive income for the year -DKK -DKK 20.870DKK -58.925DKK -38.055DKK

Equity at 30 April 2009 600DKK 30.652DKK 8.458DKK 122.668DKK 162.378DKK

Appendix 5: Official Statement of Changes in Equity


Page 83 of 93

Reformulated Statement of changes in equity

Amount in DKK 1.000

2008/09 2007/08 2006/07

Equity at the beginning of the year 200.433DKK 202.970DKK 176.073DKK

Transactions with owners

Extraordinary dividend -45.080DKK

Comprehensive income for the year

Retained earnings (net income) -58.925DKK 56.007DKK 25.845DKK


Comprehensive income for the year -38.055DKK 42.543DKK 26.897DKK

Equity at the end of the year 162.378DKK 200.433DKK 202.970DKK

Appendix 6: Reformulated Statement of Changes in Equity


Page 84 of 93

Key ratios

2008/09 2007/08 2006/07 Formula

Key ratios from statement of equity

Net income

average equity

Operating profit after tax (NOPLAT)


Net income + interest*

average total assets

Change in equity

Equity at the beginning og the year

* Interest payment from note 9 in the Prospectus

ROIC 8,34%5,86%5,19%

-18,99% -1,25% 15,28%Equity growth rate

13,64%-32,48% 27,77%ROE

4,91%8,29%-2,77%ROA

Appendix 7: Key Ratios


Page 85 of 93

Benchmarking of Airline Specific Ratios

2008/09 2007/08 2006/07

Load Factor( RPK divided by ASK. Describes the utilisation of the of available seats.)

CSG 56,60% 61,90% 59,40%

Norwegian 79,00% 80,00% 79,00%

Ryanair 81,00% 82,00% 83,00%

SAS 71,60% 71,90% 74,10%

ASK (Available seat kilometres. Number of available seats multiplied by the distance flown.)

CSG DKK 857.994 DKK 621.281 DKK 485.372

CSG 38,10% 28,00% N/A

Norwegian DKK 11.530.000 DKK 7.561.000 DKK 5.371.000

Norwegian 52,49% 40,77% 55,05%

Ryanair 13,90% N/A N/A

SAS -16,30% 5,20% -0,30%

RPK (Revenue passenger kilometres. Number of occupied seats multiplied by the distance flown.)

CSG DKK 498.060 DKK 390.101 DKK 283.960

CSG 27,67% 37,38% N/A

Norwegian DKK 9.074.000 DKK 6.059.000 DKK 4.223.000

Norwegian 49,76% 43,48% 56,23%

Ryanair 13,80% N/A N/A

SAS -16,70% 2,10% -0,70%

Yield (profit per RPK. Calculated by the average revenue per RPK minus the average cost per RPK.)

CSG 1,43

Appendix 8: Airline Specific Key Ratios


Page 86 of 93

Calculation of WACC

Risk free rate 3,374%

rC 6,00%

Tax rate 25,00%

rD after tax 7,03%

Beta 1,40

E(rM) - rF 5,30%

rE 10,79%

Estimated long term D/V 70%

Estimated long term E/V 30%

WACC 8,16%

Appendix 9: Calculation of WACC


Page 87 of 93

Forecast of Value Drivers

Income statement 2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period

Revenue 18,27% 13,03% 23,00% 16,00% 8,00% 7,00% 5,00% 4,00%

- Operating costs held for sale -84,08% -88,41% -100,50% -95,00% -91,00% -87,00% -87,00% -86,00%

Rental and leasing expenses -6,09% -4,49% -7,26% -7,00% -7,00% -7,00% -7,00% -7,00%

Profit ratio from sale (before tax) 9,83% 7,10% -7,76% -2,00% 2,00% 6,00% 6,00% 7,00%

Effective tax rate 19,17% -25,54% -25,00% -25,00% 25,00% 25,00% 25,00% 25,00%

Operating profit from sale (after tax) 9,14% 8,21% -5,82% -1,50% 1,50% 4,50% 4,50% 5,25%

Other operating profit 3,91% 0,00% 0,00% 0,00% 0,00% 0,00% 0,00% 0,00%


Value adjustments of hedging instruments* -1,17% 1,61% 0,00% 0,00% 0,00% 0,00% 0,00% 0,00%

Net operating profit less adjusted tax (NOPLAT) 3,56% 2,58%

Balance

Net working capital/revenue -0,03776 -0,08377 -0,0500 -0,0500 -0,0500 -0,0500 -0,0500 -0,0500

Non-current net operating assets/revenue 0,64508 0,58166 0,5500 0,5500 0,5500 0,5500 0,5500 0,5500

Inverse value of Turnover rate of assets 0,60733 0,49789 0,5000 0,5000 0,5000 0,5000 0,5000 0,5000

Turnover rate of assets 1,65 2,01 2 2 2 2 2 2

Appendix 10: Forecast of Value Drivers


Page 88 of 93

Budget Forecast

Income statement 2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period

Amount in DKK 1.000

Revenue 1.148.192DKK 1.297.757DKK 1.596.241DKK 1.851.640DKK 1.999.771DKK 2.139.755DKK 2.246.743DKK 2.336.612DKK

- Operating costs held for sale -965.404DKK -1.147.378DKK -1.604.222DKK -1.759.058DKK -1.819.791DKK -1.861.587DKK -1.954.666DKK -2.009.487DKK

Rental and leasing expenses -69.908DKK -58.257DKK -115.887DKK -129.615DKK -139.984DKK -149.783DKK -157.272DKK -163.563DKK

Operating profit from sale (before tax) 112.880DKK 92.122DKK -123.868DKK -37.033DKK 39.995DKK 128.385DKK 134.805DKK 163.563DKK

Operating profit from sale (after tax) 104.912DKK 106.498DKK -92.901DKK -27.775DKK 29.997DKK 96.289DKK 101.103DKK 122.672DKK

Other operating profit (before tax accounts)

Other operating profit 44.854DKK -DKK -DKK -DKK -DKK -DKK -DKK -DKK

Tax effect of other operating profit 11.214DKK -DKK -DKK -DKK -DKK -DKK -DKK -DKK


Value adjustments of hedging instruments* -13.464DKK 20.870DKK -DKK -DKK -DKK -DKK -DKK -DKK


Balance

Net working capital -43.351DKK -108.716DKK -79.812DKK -92.582DKK -99.989DKK -106.988DKK -112.337DKK -116.831DKK

Non-current net operating assets 740.681DKK 754.858DKK 877.933DKK 1.018.402DKK 1.099.874DKK 1.176.865DKK 1.235.708DKK 1.285.137DKK

Net operating assets 697.330DKK 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK

Appendix 11: Budget Forecast


Page 89 of 93

Firm Value Using Discounted Cash Flow Model

Amount in DKK 1.000

Income statement 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period


Net operating assets 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK

FCFF = NOPLAT - Change in NOA -244.880DKK -155.474DKK -44.069DKK 26.297DKK 47.610DKK 77.737DKK

Discount factor (1+WACC)^t 1,08 1,17 1,27 1,37 1,48

PV FCFF -226.406DKK -132.901DKK -34.829DKK 19.215DKK 32.164DKK

PV FCFF to and with 2013/14 -342.756DKK 1.868.887DKK

Terminal value

PV terminal value 1.262.579DKK

PV of operating activities / firm value 919.823DKK

- Net financial liabilities 483.764DKK

On 30.04.2009 On 17.03.2010

Equity value 436.059DKK 503.555DKK

value per share 9,58DKK 11,07DKK

Discount rate (WACC) 8,16%

Appendix 12: Discounted Cash Flow Model


Page 90 of 93

Firm Value Using Residual Income Model

Amount in DKK 1.000

Income statement 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period


Net operating assets 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK

ROIC -14,38% -3,48% 3,24% 9,63% 9,45% 10,92%

Residual income (WACC) -145.624DKK -92.898DKK -45.546DKK 14.703DKK 13.806DKK 31.010DKK

Discount factor (1+WACC)^t 1,08 1,17 1,27 1,37 1,48

PV residual income -134.638DKK -79.410DKK -35.996DKK 10.743DKK 9.327DKK

PV residual income to and with 2013/14 -229.973DKK 745.516DKK

Terminal value

PV terminal value 503.654DKK

PV of operating activities / firm value 919.823DKK

- Net financial liabilities 483.764DKK

On 30.04.2009 On 17.03.2010

Equity value 436.059DKK 503.555DKK

value per share 9,58DKK 11,07DKK

Discount rate - WACC 8,16%

Appendix 13: Residual Income Model

Page 91 of 93

Sensitivity Analysis

Change in variable -20% -10% -5% 0% 5% 10% 20%

Analysis of growth drivers

Revenue growth in terminal period 3,20% 3,60% 3,80% 4% 4,20% 4,40% 4,80%

Price per share 8,68 9,77 10,39 11,07 11,81 12,64 14,59

Profit ratio from sales (before tax) 5,60% 6,30% 6,65% 7% 7,35% 7,70% 8,40%

Price per share 0,95 6,01 8,54 11,07 13,6 16,12 21,18

Turnover rate of assets 1,6 1,8 1,9 2 2,1 2,2 2,4

Price per share -109,33 -42,44 -14,28 11,07 34 54,85 91,33

Analysis of financing drivers

WACC 6,53% 7,34% 7,75% 8,16% 8,57% 8,98% 9,79%

Price per share 34,83 15,23 15,12 11,07 7,72 4,93 0,53

Beta 1,12 1,26 1,33 1,4 1,47 1,54 1,68

Price per share 15,51 13,17 12,09 11,07 10,1 9,18 7,47

Company specific risk premium 4,80% 5,40% 5,70% 6% 6,30% 6,60% 7,20%

Price per share 17,68 14,11 12,53 11,07 9,71 8,45 6,17

Appendix 14: Sensitivity Analysis

Valuation of Cimber Sterling

Jeppe Fredslund and Anders Blokager Olsen

Page 92 of 93

Peer Group Analysis

Market Value calculated relative to Norwegian and SAS

DKK 1.000 Sales Book value Market value P/S P/B

CSG DKK 1.297.757 162.378 ? ? ?

Norwegian NOK 6.226.413 897.368 4.627.480 0,743 5,157

SAS SEK 44.918.000 11.389.000 6.810.300 0,152 0,598

Ryanair EUR 2.343.868 2.425.061 5.466.000 2,332 2,254

Average of Multiples: 1,076 2,670

With Norwegian, SAS, and Ryanair Market Value Share Price

Sales P/S 1.395.894DKK 30,68DKK

Book Value P/B 433.477DKK 9,53DKK

Average 914.685DKK 20,10DKK

Without Ryanair Market Value Share Price

Sales P/S 580.628DKK 12,76DKK



Market Value calculated relative to the "airline industry"

P/S P/B

Industry standards 0,16 1,78

Market Value Share Price

Sales P/S 207.641DKK 4,56DKK



Market Value calculated relative to SAS, Norwegian, Ryanair, and the "airline industry"

8,49DKK

Appendix 15: Peer Group Analysis

Valuation of Cimber Sterling

Jeppe Fredslund and Anders Blokager Olsen

Page 93 of 93

Appendix 16: Air Traffic Growth and GDP Growth

GDP growth in EU 27 countries {{52 Eurostat 2010}}

Figure from IATA.org {{80 IATA 2010}}

Documents

Valuation of Cimber Sterling - PUREpure.au.dk/portal/files/10723/Valuation_of_Cimber_Sterling.pdfOverview of Airline Industry ... The financial analysis also contains an analysis of