Description

Summary:  BBA Aviation represents an opportunity to invest in a niche orphaned security with high quality assets, an under levered balance sheet, and high return capital investment opportunities trading at 10x 2016 FCF with significant upside volume potential driven by a cyclical upturn in the business jet market

Business Description

• BBA is the largest provider of aviation services and aftermarket support to operators of business and general aviation (B&GA) aircraft, i.e., business jets.  BBA is divided into two segments, Flight Support and Aftermarket Services, each of which contain two operating units
• Flight Support – $1.4bn revenue, $116m pre-corporate operating profit
  • Signature Flight Support (SFS) – operator of the largest global FBO (fixed base operator) network, with 115+ locations concentrated in the U.S.  SFS is the key profit driver for BBA (~45% of total company revenue and operating profit)
  • Aircraft Service International Group (ASIG) – outsourced commercial into-plane refueling (19% of revenue)
• Aftermarket Services – $0.8bn revenue, $101m pre-corporate operating profit
  • Engine Repair & Overhaul (ERO) – service and repair for rotorcraft engines (28% of revenue)
  • Legacy – supply of out-of-production parts for a variety of legacy aircraft models (8% of revenue)
• ~80% of revenue is generated in North America, reflecting the concentration of B&GA aircraft and activity in this market

The FBO Industry

• FBOs are granted commercial licenses by airport authorities to service and support B&GA aircraft on airport leasehold property
  • The number of FBOs on at each airport is determined by the airport authority and depends on a number of factors including B&GA flight volumes and space availability, with a typical airport having 1-3 FBOs on long-term leases (20-30+ years)
  • The number of leases available to FBOs is limited by a variety of factors, including: minimum FAA standards and requirements favoring FBOs with long operating histories; scarcity of land; and capital investment required to build new FBO
• The majority of FBO revenue is derived from the fueling of aircraft (they also provide hangaring, tie-down and parking, aircraft maintenance, etc.)
  • The cost of fuel is a pass-through on top of which the FBOs charge a dollar (not percentage) margin
  • The dollar margin per gallon of fuel pumped has been increasing slowly but steadily for 15  years, regardless of the underlying cost of fuel
• The primary growth driver for FBOs is B&GA flight activity, which is in turn a function of general economic growth (corporate profits and investment, GDP growth, stock market performance) and structural trends driving increasing usage of private aviation (network shrinkage as commercial carriers consolidate)
  • The majority of B&GA activity is not wealthy individuals and Fortune 500 companies, but rather SMBs (http://www.nbaa.org/business-aviation/fact-book/business-aviation-fact-book-2014.pdf is a helpful resource for background on B&GA trends)
• The FBO industry is highly fragmented, with only three players of meaningful scale—Signature Flight Support/BBA Aviation;  Atlantic Aviation (owned by Macquarie Infrastructure); and Landmark Aviation (owned by The Carlyle Group)
  • Together, these three groups control ~200 of the 3,000 FBOs located in the U.S. (of these 3,000, there are ~300-400 that capture the majority of flight activity)

Thesis

• Collection of high quality niche businesses with significant barriers to entry and attractive financial characteristics
  • Economies of scale driven by large network with concentration of strategically important locations
    • SFS is of similar size to Atlantic and Landmark in terms of # FBOs.  However, factoring in the amount of traffic and network concentration near major metros and leisure travel destinations, SFS is effectively 2x its next closest competitor
    • This large and strategically located FBO network allows SFS to drive attractive system-wide pricing
  • Finite number of FBO leases at each airport with long durations limits in-market competition
    • Signature is either sole source or one of two FBOs at 65% of its locations. These sole source/duopoly locations generate higher fuel margins and are an offset to more competitive fields, limiting downward pressure on prices system-wide
    • The average remaining lease term on SFS’s FBO network is 18 years
  • Stable through-cycle margins (pass-through fuel costs and highly variable cost structure) and strong FCF generation (75% EBITDA to FCF conversion)
• Cyclical tailwinds should drive steady revenue growth and significant margin expansion
  • U.S. biz jet flight volumes and flight hours are still 20-25% below peak levels
  • While flight activity is well below peak, the size of the global biz jet fleet has actually increased dramatically (global fleet +30% vs. peak; U.S. fleet +15%)
  • Despite a 20% drop in flight volumes, 2013 EBITDA was flat vs. 2007 peak, creating potential for structurally higher earnings once volumes increase
• Secular drivers enhance cyclical tailwinds
  • Increasing business jet usage driven by shrinking commercial carrier networks
  • Growth in emerging markets, which today account for 45% of commercial aviation but only 16% of B&GA
• Significant cash flow generation, which BBA deploys towards double-digit ROIC investments (e.g., FBO acquisitions, facility expansions, new engine/part authorizations, etc.) and/or share repurchases
  • SFS has long runway for continued acquisitions in the highly fragmented FBO market
  • FBO acquisitions drive both revenue (increased pricing, market share) and cost (lower fuel costs, more efficient operations) synergies, with management targeting low/mid-teens ROIC within 2-3 years
• In addition to status quo capital allocation, there are numerous options by which BBA could create more shareholder value
  • Balance sheet – At ~2x net debt/EBITDA, business is underleveraged relative to peers (Atlantic / Landmark both leveraged at north of 3.5x)
  • Transformative M&A – Consolidation of “big 3” FBO networks down to two (BBA could be acquirer or target)
  • Re-domicile/list in U.S. – Historically, BBA has been limited by its U.K. listing and an investor base that favors a more conservative capital structure.  Over the past 5-6 years, U.S. shareholders have grown from ~5% of the share registry to ~40%, reflecting the fact that BBA’s revenue is concentrated in North America (80% of revenue; the company also reports in USD) and a lack of familiarity with the B&A industry in the U.K.

Valuation and Financials

• £3.19 ($5.41) share price; $2.6bn market cap; $3.0m TEV (~2x net debt/EBITDA); 481m shares
• Currently trades at 15x 2015 consensus earnings, which are still far from peak levels.  Consensus numbers assume very conservative trajectory for flight activity and understate the earnings impact of volumetric growth
• The combination of still depressed flight activity and a global fleet that is almost 30% larger than pre-recession levels creates the potential for meaningful volume growth going forward (well in excess of 3-4% structural growth rate)
  • Return to peak levels of flight operations by 2016 implies high single digit volume growth.  Adjusting for larger current/prospective fleet size and depressed utilization levels implies double-digit annual growth
• Per management, BBA lost ~$88m of EBIT contribution from market declines in B&GA and commercial activity from 2007-2012.  Management believes the current cost structure is sufficient to support peak volumes, implying 200bps of margin upside
• We see potential for the business to earn $0.50 2016 in a “base case” using conservative assumptions around organic growth, incremental margins, and capital allocation.  At BBA’s current forward multiple, this implies over 50% upside to today’s share price

Risks

• Macro – SFS, ERO, and ASIG all levered to flight volumes (B&GA in the case of SFS and ERO, commercial in the case of ASIG)
  • Recent data points and related management commentary suggest that flight activity is stable and accelerating, with U.S. business jet aircraft movements posting seven consecutive months of >3% growth
• Fractional programs/NetJets contract
  • Management expects to renew the recently lapsed NetJets contract on more favorable terms than prior contract
• Other: irrational behavior on the part of competitors; increasing fuel efficiency of aircraft; ASIG pricing pressure

Catalyst

• Steeper acceleration in B&GA activity
• More aggressive capital allocation strategy
• New Chairman of the Board with history of deal-making

Disclaimer: We and our affiliates are long BBA.  We may buy or sell shares without notification. This is not a recommendation to buy or sell shares.

Catalyst