Dassault Aviation S.A.

We believe Dassault is incredibly undervalued and recommend it as a long position.

Dassault has three business lines: Aviation (Falcon aircraft), Defense (Rafale and Mirage fighter aircraft) and Space (mainly aerospace vehicles and pyrotechnics)

However, the bulk of the value of Dassault resides in the 25.3% ownership interest they have in Thales. (HO.FP).

So what is Thales?

Thales corporate motto is “whenever safety and security are critical, we deliver”.

From Aerospace, Space and Defense to Security and Transportation, Thales is present as the number 1 or 2 competitor in their respective space.

Suffice to say that Thales is involved in such diverse contracts ranging from London’s underground, the Mexico City security system, civilian and military radars, cloud and financial services security, etc. An interesting fact we discovered during our diligence process is that 10 out of the world’s 12 largest financial institutions use Thales to secure financial transactions such as wire transfers.

We encourage you to dig deeper into Thales since we believe the company by itself is a great company with a wide moat and addressable market trading at a fair price.

For full disclosure, we are also shareholders in Thales.

Let’s go back to the opportunity in Dassault-

When you invest in Dassault you are implicitly buying a controlling 25.3% interest in Thales (we say controlling due to the fact that Dassault plus the French government own the majority equity of Thales and the French government votes along Dassault, therefore effectively Thales is controlled by Dassault), and the core Dassault business.

As we discussed initially, we like Dassault’s business in it by itself but in this case, at today’s prices, you are getting Dassault at an extremely low multiple which in our opinion is far from being reflective of the business that you are buying.

It all comes down to valuation- (all figures in euros)

Number of shares outstanding 9,123

Price (AM.FP) 980

Market cap 8,941

Net cash 2,550

Enterprise value 6,391

25.3% economic stake in Thales 4,600

Adjusted enterprise value 1,791

Normalized free cash flow 400

E.V./FCF 4.47x

Free cash flow yield 22%

Now let’s discuss some things regarding the valuation:

1. We adjust net cash in order to exclude customer advances from cash. This is only cash available to the owners.

2. We use the current market cap of Thales as a proxy to the value of Dassault’s economic interest in the company. Our fair value estimate of Thales is about 12% higher than the current market price using a 6.6% free cash flow yield as a price target.

3. We normalize free cash flow at 400 million which is close to it’s 5yr average. It’s been as high as 502 million in 2012 and as low as 274 in 2010.

Why is the company trading at such depressed levels?

We believe a couple of factors, some more important than others:

• We are in a soft market for business aviation-

• We’ve conducted extensive diligence with General Dynamics (parent company of Gulfstream) and also reached out to Bombardier and Netjets within others to aid our process.

• We do believe we are in a cyclically low when it comes to large cabin aircraft sales. There are just too many aircraft available in the aftermarket today. The channel is clearing though and we believe we could be close to a cyclical trough.

• More importantly, Bombardier has been a player that has demonstrated lack of financial discipline at times. They are used to offering their customers large discounts in order to lure orders away from both Gulfstream and Dassault. (both of the latter companies being extremely prudent when maintaining pricing and margins)

• The current situation that Bombardier faces today (very high debt load, financial distress, product cycle investments) just magnify an already evident problem.

• Both Dassault and Gulfstream have been prudent in terms of their pricing but the net effect has been some orders going to Bombardier.

• An recent example has been the order that Netjets had for 20 Dassault aircraft (Falcon 7x, 8x where the bulk of the order) which the Berkshire subsidiary cancelled after Bombardier offered them an undisclosed rebate on the acquisition price of the Global 7000 and 8000.

• We believe there is a chance Bombardier is weak enough to subside as a stand alone company which would of course benefit both GD and Dassault, however this is not our main scenario by any means.

• We are confident that the current lineup of Falcon aircraft are competitive if not superior to its counterparts in the US or in Canada. Competitive to Gulfstream’s and superior to Bombardier’s should we say. It all depends on the typical flight range, speed and weather the customer flies out or into short strips of hot and high airfields.

• Investors are increasingly nervous about the future of Dassault’s military division as the Euro governments struggle with high indebtedness and low growth

• We believe some investors are justifiably worried about this however, military budgets have been extremely resilient given the difficult geopolitical circumstances that they face in the region. We believe that demand for next generation fighters will continue and both the Rafale and the Mirage have very strong cost vs performance attributes that have made them so successful in the past.

• Investors were also concerned about the Indian contract for 26 Rafale fighters. The contract was expected by mid year but just recently signed for in September

• Light trading in the stock

• AM.FP some days trades about 1 or 2 million euro however this too is misleading since most block trades do not appear in that volume calculation.

What are the facts?-

1. We believe this is a great business to own with a proven management and ownership that have made sure that in 100 years they’ve had no losses, a significant net cash position and 50%+ return on invested capital.

2. Although the civil aviation division is experiencing a cyclical downturn we believe it could be nearing a trough. Even with the latter, backlog is near all time highs at close to 14bn euro and order intake continues to be strong. I.e.-the business is firing at all cylinders.

3. Dassault is buying back and cancelling as many shares it can- recently the company repurchased part of the economic stake that Airbus had in the company, and cancelled the shares). Due to regulations in France, a company can generally re-purchase no more than a 10% stake within a certain timeframe. As of today they’ve reached that limit. However we would expect the latter path to resume as feasible.

Too sum it all up- we believe this is a company that has been penalized with an unfairly low valuation that does not reflect the inherent quality of its underlying business and we thus recommend an investment in Dassault at this prices.