|Shares Out. (in M):||2||P/E||0||0|
|Market Cap (in $M):||15||P/FCF||0||0|
|Net Debt (in $M):||140||EBIT||0||0|
There are people on this board who know a lot more about aircraft leasing than I do, so I defer to their expertise on the space. I am more of a microcap/special situation investor and this to me falls in that bucket. This is a relatively thinly traded stock, so appropriate for smaller funds.
AeroCentury (ACY) is an lessor of regional aircraft. The company has a market cap of less than $15m and a book value of about $42m. In short, this is a leasing company that trades about 35% book.
When a financing company trades at such a wide discount to book, like ACY, there is usually a good reason. Let’s get this out of the way at the top. These aren’t the sexiest planes and they’re not leasing to the crem de la crem, but I think that’s only part of the discount. In ACY’s case, I believe an additional discount has been applied due to an external management contract with an asset management firm controlled by it’s former, now-deceased CEO and its CFO (widow of the deceased CEO) called JetFleet Management Co (JMC).
I hate, hate, hate external advisory contracts and I don’t want to be an investor in the externally managed entity, ever. The incentives are all kinds of facocked. Basically the entity gets milked for fees, the incentive is to usually issue equity out the wazoo, and do deals that are of questionable value. Big discounts to NAV on externally managed entities are justified, in my view. I sold a long time holding when they sold the management company and externalized for this reason and am an investor in several external advisors for the same reasons. I never say never, but I hope not to be on the other end of that incentive structure.
So, that said, why the interest in ACY? The answer is simple, the company is starting to act like one that is run to create shareholder value instead of a source of fees for JMC. They collapsed the external structure in September and the contract with JMC was bought out at a very ACY shareholder friendly price. It is a combination of $3.5m cash and nearly 130k shares of ACY, this at the time, totalled about $5.5m (give or take, it was actually a little less because they used a share price of $18 for the ACY shares received by JMC owners). There were some delays getting the deal closed and the company essentially applied JMC’s profits during the period as a reduction to the cash at closing, so the 6 month delay reduced the cash component about 700k to $2.8m or so. The other thing of note is that the asset management contracted called for a termination fee that’s the greater of $20m or 3x TTM revenue and they unwound it for much less. In 2017, ACY paid JMC nearly $7m in fees under a contract that was locked down through 2025.
The deal officially closed October 1, there should be some sort of accounting adjustment in Q4 for the deal, which means that in Q1 the economics of the combined entity should start to become more apparent, flow through the financials, and the stock can rerate. I don’t think it’ll trade near the peer group, since it is currently subscale and these assets are kind of “meh”, but it can easily trade a lot better.
It’s hard to tease out exactly what ACY earn on a normalized basis, but they are generally profitable over the cycle, maybe earning a 5% ROE, which should improve a little adjusting for tax reform, maybe getting to 6%, or $1.50 or so, and adding back JMC’s operating profits, which look to be another $1 or so per share. For what it is worth, this also appears to be a little sub-scale to me, so even a little bit of growth would come with some pretty good operating leverage as adding a few planes should not add meaningful overhead.
The plan, as far as I can tell, is to grow the company sensibly now that the management is internalized and maybe sell the thing in a couple years. It looks to me, if they sold it, there’s a few million dollars of synergy available to someone already engaged in this kind of business, on top of improvements to the financing, which is mostly floating rate and currently hitting earnings until leases renew. Talking to management, one of the incentives for internalizing the management was to get better financing terms, so maybe there’s opportunity there (though I’d imagine financial conditions need to improve for that now).
The current CFO Toni Perazzo is the widow of the CEO and founder. He died over 2 years ago and now they are unwinding this structure at a very shareholder friendly price. She owns >20% of the shares and is properly aligned.
Quite frankly what is going on seems like the beginning of an estate plan, she’s in her 70’s and simplifying her ownership interests, and it’s possible that she is cleaning this up in order to sell the company or make it easier on her heirs to do so. It’s also possible they got offers to buy the company but there’s no way they’d get shareholder approval if all the upside went to JMC. It’s also worth noting that recently her home was listed for sale on Zillow (to my knowledge it hasn’t sold).
The rest of management owns no stock, but my understanding is that an equity incentive plan is forthcoming. They didn’t have one in place before because everyone was a JetFleet employee. Meaningful skin in the game should keep everyone focused on sensible growth and reward everyone if/when this thing gets sold in a couple years.
Myself and another VIC member were the only two to show up at their merger vote and apparently the only shareholders to show up at their offices in years. We had a nice meeting with the CEO, the CFO, and the rest of the team. They had activists show up bother them in the past, but we thought they seemed like honest people and they knew their niche well enough. The removal of the conflict and the way they behaved as it was delayed gave both of us confidence they are trying to create value in ACY and for ACY shareholders.
Recent tax loss selling has created a nice entry point, in my view. There are other people on this board that know this space a lot better than I do, and I will lose debates to those people, but this looks like a reasonable enough setup to me to make some money over time.
Aircraft leasing is levered and there’s risk in residual values so the book could be mismarked.
The planes are leased and subject to the lessee’s credit risk.
The company pursues a growth for growth’s sake plan and grows imprudently.
All the macro stuff.
Improvements in financials from internalization becoming apparent
Some growth resulting in some operating leverage
|Entry||01/09/2019 04:57 PM|
I thought this was a nice pitch and wanted to look into it more as a result. I have some questions coming out of that which I'd love to get your thoughts on. Please take them as a sign of my interest rather than any issue with the thesis.
1) Does anyone really want their planes or are they just being used because supply is currently tight? Looks like their fleet is primarily 10 year old Canadairs and Embraers. The 3 Embraers are probably fine but I do worry about the 10 Canadairs a little bit. AerCap (which I compare to in order to get a sense of industry standard) doesn't own any Canadairs but instead focuses around Boeing, Airbus, and Embraer. My impression is that most carriers are focused on streamlining their fleets down to 1 or 2 suppliers in order to reduce maintenance expense and spare parts inventory, which would imply to me that smaller players like Bombadier (owner of Canadair) get cut out of the market somewhat. In addition to the planes being lower quality they also have smaller regional airline counterparties - would ACY's planes get cut out first in the event of a downturn?
2) How does the answer to #1 affect residual values? If these planes become less desirable or if Bombadier stops servicing them I would guess the resulting impairment to residual values would be significant although I have no way of knowing. Current net book value for the fleet is $187 million, so even a 16% decline in net book value could wipe out the margin of safety on tangible book ($15M market cap vs. $43M tangible book) and a 25% decline would wipe out book value. Is this something you got a chance to discuss with management at all? They seem to take regular impairments on the fleet's book value ($1.3M in 2016, $1.0M in 2017, $3M in YTD 2018), so this combined with question #1 is my biggest worry with the discount to book value = margin of safety premise.
3) The 10-Q indicates they were out of complaince with their interest coverage, debt service coverage, and revenue concentration covenants as of 9/30/18. Just curious if you discussed with management at all their plan to regain compliance and how achievable they think it is?
4) In building to their LTM pro forma earnings power i used the following calculation and got to ~$4.4M. Do you agree with my adjustments / is there anything you would change? Depending on the answers to #1 and 2 above the PF earnings yield certainly looks compelling.