Description

I recommend shorting the common stock of Bristow Group, Inc.  Admittedly, the timing of this recommendation is not optimal.  It would have been better to hit send ten days ago, before BRS issued its FYE 2017 results and triggered a 50% stock price decline.  Notwithstanding the large drop in the stock price, I believe significant downside remains, as the most likely outcome is that the common is wiped out in bankruptcy.  Even if BRS is able to avoid restructuring, the common will almost certainly be severely diluted.

The stock is volatile, and there is a large short interest (24% of shares outstanding; 51% excluding the stakes held by Ariel and index funds).  Thus, periodic short squeezes are a risk and the position should be sized accordingly.  I suspect the market will provide opportunities to enter or increase the short at more favorable pricing.

I had no difficulty obtaining a borrow at Fidelity.

BACKGROUND.

BRS is the largest provider of industrial aviation services to the global offshore energy industry based on the number of aircraft (primarily helicopters) operated.  BRS's business operations are as follows:

• Oil and gas operations (71% of consolidated operating revenue for the fiscal year ending March 31, 2017).  BRS’s oil and gas clients include multi-national and national energy companies who charter its helicopters primarily to transport personnel to and from offshore production platforms, drilling rigs, and other installations.

• Search and rescue operations (15% of consolidated operating revenue).  BRS provides search and rescue (SAR) operations for the oil and gas industry and government agencies.  In fiscal year 2013, BRS was awarded a contract with the U.K. Department for Transport to provide public sector SAR services for all of the U.K.  The U.K. SAR contract is being phased in to July 2017 and has a contract length of approximately ten years.  This contract is a rare bright spot for BRS.  The company projects that the UK SAR business will generate $40 million to $50 million in EBITDA for the coming year (which compares favorably to projected consolidated EBITDA of $15 million to $50 million).

• Fixed wing operations (14% of consolidated operating revenue).  BRS provides fixed wing and charter services in the U.K, Nigeria, and Australia through its affiliates Eastern Airways and Airnorth.  These fixed wing operations support BRS's industrial aviation services operations in those markets.

BRS operates in the North Sea, Nigeria, and the U.S. Gulf of Mexico, and in most of the other major offshore energy producing regions of the world, including Australia, Brazil, Canada, Russia, and Trinidad.

BRS was previously written up by skierholic as a long on January 26, 2016.  Skierholic's writeup and the comment thread provide an excellent overview of BRS's business and the offshore oil and gas aviation support industry.  Rather than repeat the discussion here, I refer you to skierholic's writeup.  For additional industry information, I refer you to the VIC writeups on several of BRS's competitors, specifically, the October 26, 2015 writeup on CHC Group Ltd (CHC filed for bankruptcy in November 2016), the April 8, 2015 writeup on ERA Group equity, the September 28, 2016 writeup on ERA Group's bonds, and the September 26, 2016 writeup on PHI Inc.

RECENT DEVELOPMENTS.

Financial Results.  Since skierholic's writeup, BRS's revenue and EBITDA have continued to decline, and BRS has hemorrhaged cash.  For its fiscal year ended March 31, 2016, operating revenues declined 6% and adjusted EBITDA declined 33%, and for its 2017 fiscal year operating revenues declined 17% and adjusted EBITDA declined 65%.  For 2016, EBITDA less cap-ex (adjusted for asset sales) was a negative $100 million.  This figure improved to a negative $45 million for 2017 due to reduced cap-ex.  Cumulative negative free cash flow for 2016 and 2017 was $250 million.  In its FYE 2017 earnings release, management stated it expects industry conditions in the fourth quarter of fiscal 2017 to continue into the first two quarters of fiscal 2018 but anticipates sequential quarterly improvement beginning in the third quarter of fiscal 2018.

BRS released its fiscal year 2017 earnings on May 23.  Poorer than expected results for fiscal year 2017 combined with management's commentary regarding continuing weakness into fiscal year 2018 triggered a stock price decline of over 50% and a decline of 21% in the price of BRS's senior notes due 2022.

Debt Covenants; Financings to Augment "Liquidity."  In May 2016, BRS modified the covenants under its revolving credit facility and accompanying term loan that mature in 2019.  Among other amendments, the lenders agreed to (a) replace the maximum leverage ratio (which tested EBITDA against the amount of all BRS debt) with a maximum senior secured leverage ratio (which tests TTM EBITDA against (1) the amount of debt under the facility plus (2) the present value of obligations under operating leases), and (b) replace the interest coverage ratio limitation with a minimum current ratio requirement.  Without these modifications, BRS would have tripped its covenants.  As it is, BRS is at risk of tripping the relaxed covenants, as discussed below.

BRS has also taken steps to maintain or improve its "liquidity," which it defines as cash plus capacity under its revolving credit facility.

In November 2016, BRS entered into two seven-year secured equipment term loans (the "Lombard Debt") under which it borrowed an aggregate of $200 million (U.S. dollar equivalent).  The proceeds of the two loans were used to purchase three Sikorsky S-92 helicopters and five AgustaWestland AW189 helicopters for use in BRS's UK SAR operations.  The Lombard debt is secured by the eight purchased aircraft.

In March 2017, BRS entered into a $200 million five-year secured equipment term loan with Macquarie Bank (the "Macquarie Debt"). The Macquarie Debt is secured by twenty helicopters with an estimated value of $335 million used in BRS's oil and gas operations.  The proceeds from the Macquarie Debt were used to repay portions of (1) BRS's term loan (which is tied to BRS's revolving credit facility) and (2) BRS's "Term Loan Credit Facility" (which is not part of BRS's revolving credit facility and which matures in November 2017).

In February 2017, BRS executed a commitment letter for an approximate six-year, $230 million secured equipment financing with GE Capital Aviation Services (the "GECAS financing"). The GECAS financing is intended to be secured by up to twenty oil and gas helicopters.  The financing is subject to entering into definitive agreements; BRS expects this financing to close no later than June 30, 2017.  BRS intends to use the proceeds from the financing to repay the balance due under the Term Loan Credit Facility (which matures November 2017) and to repay amounts outstanding under its bank credit facility and accompanying term loan (which mature April 2019).  As part of this financing, GECAS's leasing affiliate will defer up to $25 million in lease rentals on certain H225 helicopters leased by BRS.

BRS touts these actions as improving liquidity.  Putting aside classifying borrowing capacity as liquidity, another way to look at these initiatives is that BRS (1) incurred additional debt (the Lombard Debt) to fund additional cap-ex and (2) encumbered a significant portion of its fleet (and has committed to encumber yet more), thereby reducing its financial flexibility, in order to pay near term maturities.  Management should spend less time touting liquidity and spend more time focusing on solvency.

HR225 Grounding.  In April 2016, an Airbus EC225LP (also known as an H225) model helicopter operated by CHC Group crashed in Norway, killing all thirteen people aboard.  The cause of the accident is not yet known and remains under investigation.  In the meantime, BRS's entire fleet of H225 helicopters remains grounded (prior to the accident, BRS operated a total of 27 H225 model aircraft, 16 owned and 11 leased).

Not surprisingly, the grounding of the H225s (now in its second year) has negatively affected BRS.  The H225 is classified as a "large" helicopter; large helicopters are crucial to BRS's business.  The grounding of the H225 created operational challenges, with BRS being required to shuffle aircraft and crews to meet client needs.  These measures resulted in margin compression and reductions in annual hours flown.

As noted above, BRS owns 16 H225s.  All 16 are currently unencumbered.  To the extent they remain grounded, they are obviously less attractive as collateral for potential future financings.  Likewise, to the extent the H225s are candidates for asset sales, continued grounding will have a negative effect on their resale value.

ENTERPRISE VALUE, CAPITAL STRUCTURE, AND DEBT MATURITIES.

BRS's enterprise value:

BRS's capital structure consists of the aforementioned bank credit facility and accompanying term loan (due April 2019), the term loan credit facility due November 2017, the Lombard Debt, the Macquarie Debt, and $400 million of senior unsecured notes due 2022.  Below is a schedule of BRS's debt balances in order of maturity, both as of March 31, 2017 and proforma for the GECAS financing.

SHORT CASE.

The short case for BRS is simple – the company will continue to generate negative cash flow until it is unable to pay or refinance its debts.  The discussion below is in three parts:  (1) the risk that BRS may trip the covenants on its bank credit facility within the next year; (2) BRS's ongoing negative cash flow and ultimate inability to pay its debts; and (3) a review of BRS's asset value, which is often touted as underlying support for the common stock.

Possible Covenant Breach.  As noted above, covenants under BRS's bank credit facility were relaxed in 2016.  Had the covenants not been revised, BRS would have tripped the covenants in its last fiscal year.  BRS is now in danger of tripping the relaxed covenants, specifically, the senior secured leverage ratio.

The senior secured leverage ratio is calculated at the end of each fiscal quarter and is the ratio of the debt under the bank credit facility and term loan (plus the present value of operating lease obligations) to consolidated EBITDA for the trailing four fiscal quarters.  BRS is currently required to maintain a senior secured leverage ratio of not greater than 4.25:1.0; this drops to 4.0:1.0 beginning with the quarter ending December 31, 2017.

In determining the senior secured leverage ratio, consolidated EBITDA is calculated in the normal way, except that (1) in addition to interest expense, rental expense on leases of real and personal property (primarily aircraft leases) is also added to GAAP income, and (2) cash proceeds of up to $20 million from asset sales are also added to GAAP income.

Below is an estimate of the senior secured leverage ratio at March 31, 2018.  The projection is based almost entirely on management guidance which, in light of management's recent propensity to miss to the downside, gives BRS the benefit of the doubt.  Specifically, I use the low range of guidance for revenues and asset sales, the high range for aircraft and other rentals and for G&A expenses, and actual cap-ex guidance.  For direct costs (where guidance was not given) I assumed a reduction of 10% from prior year costs.  Cash paid for interest is calculated based on debt balances, and principal amortization is pursuant to BRS's various credit agreement.

If BRS hits the low end of its guidance, it will not trip the covenant.  However, the margin for error is small.  A reduction in EBITDA of approximately $15 million (only 1.2% of revenue) would result in BRS tripping the covenant.  Given management's recent history of missing guidance to the downside, the risk of a covenant breach cannot be summarily dismissed.

Unsustainable Negative Cash Flow.  The crux of the short case is that BRS will continue to generate negative cash flow until it runs out of money and financing options and is thereby unable to pay its debts.  Below are cash flow projections through the fiscal year ending March 31, 2023.  The projections are based on the following assumptions:

• EBITDA is based on consensus (from Reuters) numbers through FYE 2021, with an assumed 50% increase in 2022 and 20% increase in 2023.  As the sell side has consistently been too optimistic regarding BRS's projected financial performance, using consensus numbers gives BRS the benefit of the doubt.

• Capital expenditures are taken from management guidance and from the aircraft purchase commitments shown in the 10K.

• No cash taxes.

• No dividends paid on common stock.

• The $400 million revolving credit facility is rolled over on or before its maturity in April 2019.

Not a pretty picture.  Without obtaining additional financing, BRS will not have sufficient cash to pay the balance of the term loan in April 2019 and fund its operations for its fiscal year ended March 31, 2020.  BRS also won't have the cash to repay its revolving credit facility (the projections assume it is rolled over).  BRS will not have sufficient cash to repay the balance of the Lombard Debt in March 2022 and fund its operations for its fiscal year ended March 31, 2022.  And even if BRS is able to refinance the Lombard Debt, there appears to be no conceivable path to repaying the senior notes due October 2022.

Management needs to immediately and aggressively cut costs, sell assets, reduce capital expenditures, and reduce leasing expenses.  With respect to the latter, it is significant that, in the face of declining revenues and an industry-wide collapse in aircraft demand, management has managed to increase aircraft leasing expense every year since 2015, including for the upcoming fiscal year.  This not the mark of a management team focused on solvency.

And, of course, BRS should immediately stop paying dividends on its common stock.  Instead, contemporaneously with its disastrous earnings release on May 23, BRS declared its normal quarterly dividend, payable on June 22.

Myth of Asset Coverage.  A staple of the bull case for BRS is that the common stock is supported by net asset value far in excess of the stock price.  In its most recent presentation, BRS gives a "net asset FMV" per share of over $42 (versus the current stock price of under $7), based on aircraft value of nearly $2.1 billion.  However, this fails to take into account the following:  (1) the excess capacity in the oil and gas helicopter market (exacerbated by CHC's bankruptcy filing and rejection of 90 aircraft leases, including 16 Sikorsky S-92 large helicopters and 20 H225s); (2) the placing of encumbrances by BRS on a substantial portion of its fleet, potentially leaving far less value available to the common; and (3) the ongoing grounding of the H225s, which is unlikely to have a positive effect on value.

Below is a schedule showing the aircraft asset value available to the common under more realistic assumptions.  Aircraft values are consistent with (1) values assigned to the aircraft pledged under the 8th amendment to BRS's credit agreement and (2) values assigned by other analysts (including analysts favorably disposed to BRS).  The value of encumbered aircraft shown for the GECAS financing assumes that it will be comparable to the value of the aircraft given to secure the Macquarie debt.

As should be apparent, there is not much value left for the common.  Also relevant is that many of BRS's aircraft are owned by subsidiaries.  Specifically, it is likely that a significant number of aircraft is owned by Bristow Aviation Holdings Limited, a variable interest entity that is consolidated by BRS.  BRS owns only 49% of BAHL; consequently, aircraft owned by BAHL will not necessarily be available to BRS's common shareholders (or to the holders of BRS's senior notes).  BRS's disclosures in this regard are opaque.  I am attempting to obtain more definitive information and will report back if I do.

RISKS.

High short interest; risk of periodic short squeezes.

BRS successfully closes the GECAS financing on favorable terms.  While not materially affecting the underlying thesis, this could trigger a brief rally in the stock.

An earlier and more robust recovery in offshore oil and gas activity, leading to a quicker and stronger recovery in BRS's oil and gas operations.

A large monetary settlement in connection with the grounding of the H225 helicopters.  Several parties have commenced litigation against Airbus in connection the H225, including ERA Group and Macquarie Rotocraft Leasing.  BRS has not joined the litigation, but management has stated that they are monitoring the litigation and that they continue to work with Airbus to explore all options to mitigate the impact of the H225 grounding.

BRS replaces its management.  Many of the positive attributes described in skierholic's January 2016 writeup remain in place.  There is underlying value in BRS's business and assets, and a more competent management team may be able to realize that value.

Catalyst

• BRS is unable to successfully close the GECAS financing.  I don’t view this as likely, but if it occurs I doubt the market would look upon it favorably.

• Tripping covenants on the revolving credit facility and accompanying term loan.

• Suspension of common stock dividends.

• Continued negative cash flow, depletion of cash reserves, and exhaustion of financing alternatives.