Honeymoon and Divorce: The case of capital alliance of San Miguel Corporation and Philippine Airlines

In the last quarter of 2011, the business community was surprised with the news on the two giants
in the Philippine industry, San Miguel Corporation (SMC) headed by Ramon S. Ang and Lucio Tan Group
headed by Lucio Tan, shall forge an agreement for the former to have a stake in Philippine Airlines
(Agustin; Dumlao; Gutierrez, 2012). Executive officers of PAL, however, denied the airline management
involvement in the sales of PAL (“Talks of PAL Shares to SMC”, 2012). The said agreement will allow SMC
to have 49% stake in both Philippine Airlines and Air Philippines or AirPhils (now PAL Express).
Earlier, PAL had been rumored to be acquired by the Group of Manny Pangilinan, Chairman of the
Metro Pacific Investments Group. But according to Agustin (2012), San Miguel Corporation has been
reportedly offered $500 million in exchange for a 49-percent stake in the legacy flag carrier.
SMCs deal in the planned venture would finance the “refleeting and modernization” of Asia’s first
but ailing airline (Agustin, 2012). The airline was suffering due to confluence of several adverse factors,
like the advent of low-cost carrier model, which rival Cebu Pacific has successfully adopted, the high
operating cost carried over from its days as government-owned enterprise, the soaring fuel costs - its
single largest expense item occupying approximately half of its operating expenses due to old aged, fuel-
inefficient aircrafts, and the effect of decision of the United States aviation regulators to downgrade the
Philippine’s aviation industry to Category 2 that prevented the airline from replacing on U.S. mainland
route its older aircrafts with new and more fuel-efficient jets (Lucas, 2013). But despite all these, Ang is
optimistic about PAL and said, “it is a good company with an excellent brand”. He further said, “Despite
so many problems over the last 20 years, the company has always above water. It makes money a few
years, and loses money on some, despite its labor problem”.
On April 3, 2012, a disclosure issued by San Miguel Corporation to the Philippine Stock Exchange,
Inc. through its Corporate Secretary, Virgilio S. Jacinto., confirmed that SMC has firmed up the deal to
acquire 49 percent of Lucio Tan’s PAL Holdings, Inc. for about $500 million, thereby obtaining a significant
foothold in national flag carrier Philippines Airlines. The purchase price was in line with PAL Holdings
current valuation at the stock market. PAL is over 90 percent owned by publicly-listed PAL Holdings which,
in turn is controlled by Tan. As of April 2, 2012 its share went up by 0.49% at P8.18 a share giving it a
market capitalization of P44.13 billion (SMC Disclosure, 2012). In the same disclosure, it was revealed
that SMC is not only investing on PAL but also on its subsidiary, Air Philippines Corporation inclusive in the
$500 million deal.
Finally, on April 4, 2012, it was on papers – San Miguel Corporation has signed a $500 million deal
to acquire a significant stake in flag carrier Philippine Airlines and affiliate budget carrier Air Philippines
Corporation (Dumlao; Gutierrez, 2012). Many, however, were pessimistic with the SMC’s move. It is “like
buying a headache” was one of the most common descriptions used to describe SMCs acquisition of a 49
percent stake, along with the management control in Philippine Airlines (Lucas, 2012). But Ramon Ang
remains optimistic about PAL.
In a statement jointly issued by the Lucio Tan Group and San Miguel Corporation, the two groups
said this new partnership would allow the two airlines to strengthen operations and stay competitive with
the implementation of PAL and AirPhils’ fleet modernization program (Dumlao, 2012).
SMC President Ramon S. Ang confirmed that under the deal, SMC will buy into PAL and AirPhil
through several layers of holding companies. This will lead to SMC’s acquisition of 49 percent of PAL’s
publicly-listed parent firm PAL Holdings, which in turn will give it effective control of at least 40 percent
of PAL and 4 percent of AirPhils (Dumlao, 2012). In a disclosure of PAL Holdings (2012), its majority
shareholder, Trustmark Holdings Corporation entered into investment agreements with a unit of SMC
resulting in issuance of shares to the San Miguel Group, under which the latter will take a minority stake
in PAL Holdings. As planned, this investment comprises 49 percent of PAL Holdings, as Ang confided. The
investment through Trustmark will be flowed down to Philippine Airlines which is expected to strengthen
and enhance the operation of the airline (Dumlao, 2012). As he continued, the investment will be made
by SMC through a wholly owned unit, San Miguel Equity Investment, Inc. (SMEII). Under the agreement,
Trustmark and Zuma Holdings and Management Corporation (ZUMA), the holding companies of PAL and
AirPhil, will issue new shares to SMEII. Trustmark owns 97.71 percent of the airlines’s parent firm PAL
Holdings, which in turn owns 84.67 percent of PAL through PR Holdings, Inc. (Morales, 2013). PR Holdings,
Inc is owned by Lucio Tan.

1 | Honeymoon and Divorce…. Note: This case is written by Prof. Antonio E. Casurao, Sr. for the final
oral case defense of MBA candidates, reproduction and use without the permission of the author is
prohibited.
 Consequently, PAL and AirPhil had been under the management control of SMC where Ramon S.
Ang has seated as the President, while Lucio Tan remained to be the Chairman of the Board (Lucas, 2013).
As Lucas continued, with the leverage provided by the additional equity, the airline has since embarked
on an aggressive expansion of its route network and launched a $7 billion refleeting program involving
the purchase of at least 54 long and short haul Airbus aircraft. Addressing the challenges earlier
mentioned, the new management, worked on turning the airline around by acquiring newer aircrafts that
consume less fuel to replace its ageing fleet and flew to new destinations in Asia-Pacific and the Middle
East. Morales (2013), disclosed that in the nine months of its fiscal ending March 2013, PAL Holdings,
trimmed its losses 24 percent to P2.74 billion compared with P3.59 billion a year earlier as total revenue
increased by 2.4 percent to P55.68 billion from P54.38 billion on the back of higher revenues from its
passengers and cargo businesses. According to Morales (2013), PAL has embarked on a massive refleeting
program aimed at acquiring 100 new aircraft to replace its existing fleet. It expected to save as much as
$400 million from fuel and maintenance costs yearly as part of its refleeting program. Ang earlier said
that PAL will return to profitability in 2014.
One year after the SMC acquisition of the 49 percent control of PAL, a news broke out: SMC has
been said to have sealed a deal to acquire the entire holdings of Lucio Tan in PAL (Lucas, 2013). This
entails giving up by Lucio Tan the remaining 51 percent to the SMC Group for them to have full control of
the airline in consideration of another $500 million. Morales (2013) confirmed the planned takeover of
SMC on the national flag carrier, Philippine Airlines. SMC has indeed entered into an agreement to buy
the remaining 51 percent stake of PAL owned by the LT Group of Companies. LT Group President, Michael
G. Tan announced they are divesting interest in PAL it will no longer be consolidated into the listed holding
firm of the liquor and tobacco magnate. Instead it will focus on being a consumer-related conglomerate
through units Asia Brewery Inc., Tanduay Distillers Inc., Eaton Properties, Inc., Philippine National Bank
and tobacco firm PMFTC Inc.
Skip to 2014, the business community was hearing an entirely different story between SMC and
PAL. The article “Philippine Airlines: Tan & SMC Battle for 100% Control (2014), disclosed that the existing
alliance in Philippine Airlines between the two giants was about to end. Insiders have suggested that the
two sides were no longer share the same vision, which will ultimately lead to one group buying out the
other and regaining full control of the national carrier. While Ang and SMC have been reporting that Lucio
Tan intended to exit the airline business putting his 51 percent stake up for sale, the Lucio Tan Group have
been pooling funds to purchase back the 49 percent stake that was originally sold to SMC with the
intention of reclaiming complete management control of PAL.
The key issue remained, according to the article, “Philippine Airlines: Tan & SMC Battle for 100%
Control” (2014), is whether Lucio Tan Group will be able to raise money required to buy back the 49
percent stake from SMC. Although SMC signed a $500 million deal to purchase part of Philippine Airlines
and its sister carrier AirPhil (now PAL Express), sources said that it will require at least $1 billion to obtain
full control from SMC in order to cover the cost of buying back the shares held by SMC plus the advances
made on behalf of PAL for the acquisition of several new aircraft under Ang’s ambitious refleeting
program. If Tan cannot raise the necessary funds required, the SMC will be the one to buy out the Tan
family’s remaining 51% stake.
Further on the said article, the animosity between LT Group and SMC Group started as early as
when Ramon Ang took over management of Philippine Airlines. Apparently, Tan did not agree with the
number of decisions made by Ang, such as contracting annual aircraft maintenance to facilities in China,
rather than using the Lufthansa Technik operation; Ang’s offering of generous early retirement option to
PAL employees, which to Tan is a front-loading expenses and weeding out long-term PAL veterans; the
aviation supply arrangement with Petron Corporation, which is controlled by SMC; the leasing of a large
number of aircraft; and the issues of privileges that were lost by the Tan family when SMC assumed
management of PAL.
Bloomberg (2014) has confirmed the break up. SMC is in talks with Lucio Tan to sell back its stake
in PAL, as confirmed by Ramon S. Ang. The Lucio Tan Group also confirmed through its filing of disclosure
with the Philippine Stock Exchange.
According to Bloomberg (2014), change in ownership of PAL came as the carrier began revamping
its fleet, including agreement to acquire at least 64 planes from Airbus Group NV; expansion of code-
sharing agreement with Ethihad Airways PJSC; announced plans to start flying to New York; and
resumption of flights to London after the carrier stopped flying to Europe in 1998. In the last quarter of
2014, Villanueva; Francisco (2014) revealed that Lucio Tan reacquired the 49 percent from SMC. Tan, who
2 | Honeymoon and Divorce…. Note: This case is written by Prof. Antonio E. Casurao, Sr. for the final
oral case defense of MBA candidates, reproduction and use without the permission of the author is
prohibited.
has kept his 51 percent majority stake in PAL, has consequently reacquired full control of the country’s
flag carrier. By this time, Ang has already been steering PAL, highlighted by PAL’s acquisition of a new fleet
of Airbus aircrafts, i.e., ten (10) A330 and seven (7) A321 and PAL Express eighty-seven aircrafts; retiring
20 aged aircrafts. PAL has also been able to open new routes. PAL is back in the “black” after recognizing
a net income of P1.49 billion in the second quarter of 2014, from a net loss of P1.08 billion in the same
quarter of preceding year. The deal is $1 billion that cover shares payout, loans and advances that must
be delivered within a week after the signing of the agreement. In the article, “4 Banks funding PAL
buyback” (2014), it was said that there are four banks who will join the syndicated loan in order to raise
part of the $1 billion for payment of the buyback, i.e., Banco de Oro $360 million; China Bank $100 million;
Philippine National Bank $250 million and Asia United Bank $70 million. Lucio Tan Group was also in talks
with Ethihad Airlines for partnership.
Meanwhile, SMC’s Ang broke the silence of his disappointment as SMC incurred losses with the
partnership. “SMC lost money in this deal”, he said as quoted by Lucas (2014). SMC did not even
breakeven on its PAL venture owing to its failure to recover its cost of funds. “If we fought over it, it would
destroy the value of PAL” he said further.
Was it only the differences in vision and management that caused the breakout of the SMC and
LT Group? Perez (2014), in his article, “Was SMC-Tan capital alliance’s the biggest failure of the year?”,
has traced back where the SMC payment for 49 percent stake went. He said the breakout is bound to
happen in the beginning. According to him, Tan-owned Trustmark Holdings got the money, with $400
million converted at P42.50 to US dollar or P17 billion. The particular posting showed Trustmark
subscribed to additional P17 billion shares in PAL Holdings at P1 per share, which was the par value of PAL
Holdings’ capital stock. The additional infusion effectively increased Trustmark’s ownership in PAL
Holdings to 22.292 billion shares, or 89.776 percent of the outstanding equity. Since SMC owned 49
percent of the Trustmark, its indirect holdings in PAL Holdings would translate to 10.926 billion shares, or
43.99 percent.
Because SMC wanted the airline, PAL Holdings invested the same P17 billion in additional 85
billion shares in Philippine Airlines, Inc. as a par value of P0.20 per share. With increase of its ownership
in its airline unit, PAL Holdings raised its control to 88.823 billion shares, or 98.02 percent, from 8.823
billion shares, or 81.57 percent. In money terms, 88.823 billion shares mean P17.765 billion at a par value
of P0.20 per share and 8.823 billion shares translate to P7.058 billion at P0.80 par value or an increase of
P10.707 billion. But the computation of equity participation and control is not based on par value, but on
the number of shares. Had SMC directly invested its money in PAL, the airline, its acquisition of 85 billion
shares would have made it parent of the new subsidiary in the airline PAL. Its 85 billion shares would have
been equivalent to 93.594 percent, while Mr. Tan and his group would have ended up with a minority
stake of 3.823 billion shares, or 4.21 percent.
SMC through its SMEII, in its joint venture with Lucio Tan, had wanted a part of the airline. But it
did not put its money directly in it or put the money in PAL holdings, which owns the airline. Had it chosen
the first option, it could have become a direct stockholder of the airline. But had it opted for the latter,
PAL Holdings, it could have been an indirect owner of PAL, the airline company. This would mean there
is only a single layer of ownership separating SMC from the airline. Because SMC failed to get into either
PAL Holdings or in the airline unit, its money ended up with Trustmark, which, like PAL Holdings and PAL
the airline, also belongs to the group of companies owned by Mr. Tan. This mean SMC’s money passed
through two other companies before it reached the airline company. There is no doubt money flowed
from SMC to Trustmark to PAL Holdings and finally to PAL the airline (Perez, 2014).
With the return of the full control of PAL to Lucio Tan Group, the business must be going on as
usual. As rumored talks with Pangilinan Group, with Etihad Airways, and another Asian airline, there is no
doubt, PAL needs strategic partnership amidst the opinion of the investing industry upon failed
partnership experience with SMC. As Ang put it, strategic partnership for Lucio Tan Group will be crucial.
Perspectives on Mergers and Acquisitions in Philippine and global airline industry (Lee, 2014 & Abadilla,
2016):
• The Philippines is benefiting from the industry’s consolidation.
• Mergers and Acquisitions (M&As) in recent years have reduced the number of domestic carriers
to four. Cebu Pacific acquiring the local unit of Tiger Airways, Malaysia’s AirAsia absorbing
homegrown Zest Airways.

3 | Honeymoon and Divorce…. Note: This case is written by Prof. Antonio E. Casurao, Sr. for the final
oral case defense of MBA candidates, reproduction and use without the permission of the author is
prohibited.
 • The M&As reduced capacity, which in turn improved the remaining players’ bottom line. Cebu
Pacific saw it profit rise in 2014, Philippine Airlines was back in black after years in red, Tiger
Philippines and AirAsia Philippines narrowed their losses.
• The global airline industry outlook for 2016 sees an average net profit margin of 5.1% being
generated total net profits of $36.3 billion as projected by IATA.
• IATA also announced a revision to its airline industry outlook for 2015 upwards to a net profit of
$33 billion (4.6% net profit margin).
• Lower oil prices (forecast to be $55/barrel in 2015 and averaging a lower $51/barrel in 2016) are
giving airline profits a boost. However, this is strongly moderated in many markets by the
appreciation of the US dollars
• Strong demand for passenger travel (+6.67% growth in 2015 and +6.9% in 2016) is making up for
disappointing cargo demand growth (+1.9% in 2015; strengthening to 3.0% in 2016.
• Weak cargo performance reflects sluggish growth in trade.-
• Stronger economic performance in some key economies, including a faster than expected
recovery in Eurozone, is outweighing the overall impact of slower growth in China and the
downturn in the Brazilian economy.
• Global GDP growth is expected to improve to 2.7% in 2016, up 2.5% last year.
• Efficiency gains by airlines are illustrated by record high load factors (80.6% in 2015, tapering
slightly to 80.4% in 2016).

Note: This case is for the purpose of the final case analysis for oral defense of the candidates of MBA and should not be taken
out, copied, published in any other media without the consent of the author. Attached: PAL Holdings Financial Statement

About the Author: The Author is an Associate Professor in the College of Business and Management both in finance and the
graduate school.

References:
Ramon Ang, Not MVP, to buy Philippine Airlines (PAL). (2011, December 28). Retrieved from
http://www.pinoymoneytalk.com
Agustin, V. (2012, January 21). Cocktail SMC wants AirPhil Express folded into PAL purchase. Retrieved
from http://interaksyon.com/business
Talks of PAL share sale to SMC between shareholders, PAL clarifies. (2012, February 27). Retrieved from
http://interaksyon.com/business
San Miguel Corporation disclosure (2012, April 3). Retrieved from www.pse.com.ph/stockMarket
Dumlao, D. (2012, April 4). San Miguel buys into PAL, Air Philippines. Retrieved from
http://business.inquirer.net
Gutierrez, J (2012, April 5). San Miguel buys 49% stake in PAL for $500 mn. Retrieved from
http://business.inquirer.net
Dumlao, D. (2012, April 5). SMC signs deal to buy stake in PAL. Retrieved from http://business.inquirer.net
Lucas, D. (2012, April 20). SMC chief details plan to revive PAL fortunes. Retrieved from
http://business.inquirer.net
SMC takes over PAL, buys out LT Group. (2013. June 9). Retrieved from www.philstar.com:8080/
Lucio Tan to sell stake in PAL to San Miguel Corporation. (2013, June 10). Retrieved from
http://newsinfo.inquirer.net
Philippine Airlines: Tan & SMC Battle for 100% Control. (2014, July 28). Retrieved from
http://www.philippineflightnetwork.com
Bloomberg. (2014, August 2). Lucio Tan initiates PAL buyback. Retrieved from
http://www.thestandard.com.ph
Villanueva, M. (2014, September 7). PAL buyout a ‘done deal’. Retrieved from
www.philstar.com/headlines
Francisco, R. (2014, September 8). San Miguel signs $1B deal to sell PAL stake back to Lucio Tan group-
source. Retrieved from http://www.gmanetwork.com/news/
4 | Honeymoon and Divorce…. Note: This case is written by Prof. Antonio E. Casurao, Sr. for the final
oral case defense of MBA candidates, reproduction and use without the permission of the author is
prohibited.
Perez, E. (2014, November 20). Was SMC-Tan ‘capital alliance’ the biggest failure of the year?. Retrieved
from http://www.manilatimes.net
Lee, C. (2015, April 21). M&A in Philippine airline industry paying off, says think tank. Retrieved from
http://interaksyon.com/business
Abadilla, E. (2016, January 5). Airline industry sees modest growth in profitability in 2016. Retrieved from
http://www.mb.com.ph/

PAL Holdings
Statement of Income and Expenses
For Year Ended March 31, 2011-2014

2011 2012 2013 2014

REVENUE
Passenger 62,667,001 62,259,024 45,401,360 81,751,504
Cargo 5,941,290 5,753,699 4,707,729 7,842,315
Other 5,758,866 5,887,036 5,875,295 11,360,071
Interest income 240,163
74,607,320 73,899,759 55,984,384 100,953,890
EXPENSES
Flying operation 40,301,308 46,634,132 36,400,572 62,920,648
Maintenance 8,754,940 8,924,776 7,415,019 8,316,115
Aircraft and traffic servicing 9,324,494 9,736,499 7,262,517 10,937,891
Passenger service 4,881,594 5,330,093 4,623,225 7,486,314
Reservation and sales 4,382,572 4,547,445 3,727,677 6,198,487
General and administrative 2,646,022 2,966,693 1,937,969 2,497,946
Financing charges 1,661,570 0 0 0
Others (384,713) 256,010 129,131 223,602
71,567,787 78,395,648 61,496,110 98,581,003
LOSS FROM OPERATION 3,039,533 (4,495,889) (5,511,726) 2,372,887
Financing charges - (1,365,785) (1,307,410) (1,940,871)
Share in net loss of an associate - - (92,505) 550,337
Other income (charges) - 105,633 (5,088,061) (693,293)
0 (1,260,152) (6,487,976) (2,083,827)
EARNINGS (LOSS) BEFORE TAX 3,039,533 (5,756,041) (11,999,702) 289,060
PROVISION FOR INCOME TAX 46,615
INCOME TAX BENEFIT - 1,172,072 146,572 (159,320)
NET INCOME (LOSS) 2,992,918 (4,583,969) (11,853,130) 129,740
OTHER COMPREHENSIVE INCOME (LOSS)
Net changes in fair value of available-for-sale
39,934 35,114 123,504 -131,562
investments, net of deferred income tax effect
Net realized losses (gains) on sale of available-for-sale
investments, net of deferred tax
Net changes in fair values of cash flow hedges,net of
(277,077)
deferred income tax
Remeasurable gains (losses) on defined benefit plans, net
- (1,012,773) 1,805,663 745,444
deferred ncome tax effect
Increase in revaluation increment due to appraisal, net of
453,087 - - -
income tax effect
Effect of foreign exhange translation (110,743) 55,375 807,059 43,220
TOTAL OTHER COMPREHENSIVE INCOME (LOSS) 105,201 (922,284) 2,736,226 657,102
TOTAL COMPREHENSIVE INCOME (LOSS) 3,098,119 (5,506,253) (9,116,904) 786,842

Net income (loss) attributed to:

Equity holders of the parent company 2,533,394 (3,881,841) (11,648,102) 127,336
Non-controlling equity 459,524 (702,128) (205,028) 2,404
2,992,918 (4,583,969) (11,853,130) 129,740
Total comprehensive income (loss) attrbuted to:
Computed based on net income (loss) 2,628,538 (4,821,358) (8,957,081) 770,787
Computed based on total comprehensiveincome (loss) 469,581 (865,873) (159,823) 16,055
3,098,119 (5,687,231) (9,116,904) 786,842
Basic/Diluted Loss Per Share
Computed based on Net Loss 0.4673 0.8455 (0.5286) 0.0057
Computed based on Total Comprehensive Loss 0.4848 1.0490 (0.4066) 0.0344

5 | Honeymoon and Divorce…. Note: This case is written by Prof. Antonio E. Casurao, Sr. for the final
oral case defense of MBA candidates, reproduction and use without the permission of the author is
prohibited.
6 | Honeymoon and Divorce…. Note: This case is written by Prof. Antonio E. Casurao, Sr. for the final
oral case defense of MBA candidates, reproduction and use without the permission of the author is
prohibited.