Value Investors Club / Hainan Meilan Airports (0357)

Description

Hainan Meilan Airport (0357 HK, $1.38 US): Transformative Acquisition.

All amounts are expressed in US dollars, unless otherwise noted. Amounts are converted

from Chinese Yuan and/or Hong Kong dollars at the exchange rate of $.1465 and $.129

US respectively, as of April 7th, 2010.

Current shares outstanding (fully diluted): 473.3 million.

Pro-forma shares outstanding (assuming proposed "A" share placement): 673.3 million.

Net Cash balance (before dividend and acquisition): $67.3 million

2010 Pro-forma total liabilities (assuming equity placement): $213.7 million

Hainan Meilan Current Enterprise Value: $590.6 million

Pro-forma Enterprise value: $1.19 billion

Hainan Meilan Airports 2009 revenue: $60.2 million.

Pro-forma 2009 revenues: $108.9 million.

2010 pro-forma forecast revenue: $122.5 million.

Hainan Meilan Airports 2009 EBITDA: $36.16 million.

Pro-forma estimated 2009 EBITDA: $65.16 million.

2010 forecast pro-forma EBITDA: $ 73.52 million

2010-2012 forecast revenue CAGR: 14%

2010-2012 forecast EBITDA CAGR: 15%

Hainan Meilan Airports is presently a single airport operator in Hainan Province, China.

The company manages the airport and related non airport facilities of the Hainan Meilan

International Airport, outside of Haikou China. This capital airport represents one of the

main trunk lines in China and was opened in May 1999. Passenger traffic has grown

from 7.02 million persons in 2005, to 8.39 million persons in 2009, a CAGR 4.5%.

In 2005, revenues and EBITDA were $49.06 million and $27.91 million respectively.

In 2009, revenues and EBITDA were $58.7 million and $34.5 million respectively.

The 4 year CAGR of revenues and EBITDA, were 4.5% and 6.3% respectively. EBITDA

margins grew from 56.9% of revenues to 60.6% of revenues over the past 4 years.

Lacking organic growth opportunities, shares of Hainan Meilan have been largely a

"value" investment for the past four years. A major expansion and modernization at the

international airport was completed in late 2005, which added significant capacity. At

year end 2005, the net cash balance stood at $9.9 million. As of year end 2009, Hainan

Meilan's net cash balance (short term cash less ALL liabilities) totalled $67.3 million US.

The company has certificates of deposit on account. For purposes of continuity, I

exclude them from the net cash balance.

Hainan Meilan Airports will shortly transform itself from a highly profitable but

slow growth operator of just one airport; becoming instead a rapid growth operator

of 4 key trunk line airports in China.

Hainan has agreed to pay $322.4 million US for a 54.5% equity interest in privately held

HNA Airports, and is assuming approximately $281 million of total liabilities. The acquired

enterprise value is $603.4 million. (Please note that the HNA Airports provided total

liabilities, but did not disclose short term balance sheet cash.

My method for calculating EV uses total liabilities - ONLY short term cash).

As it is inconceivable for a company to operate without a current cash balance, my

EV/EBITDA estimate is undoubtedly conservative. Nevertheless, based upon the

reported purchase price, and using my format for calculating enterprise value, the 2009

ratio was 20.8X.

Two sellers are surrendering control.

Kingward Investment Ltd. will be liquidating their 24.5% holding in HNA.

Hainan Meilan will purchase this holding for $145 million US,

to be initially funded from cash on hand and a new syndicated bank debt issue.

HNA Group, of which Mr. George Soros is a key shareholder and related party to

Hainan Meilan Airports, is also selling a 30% stake in HNA Airports, and will continue

to hold 21% of HNA Airports. This stake, valued at $177.4 million, will be purchased

concurrently upon a successful placement of up to 200 million "A" shares, to be listed

domestically in China. Assuming that Hainan Meilan floats all 200 million shares in the

open market at the customary 10% premium to "H" shares, at the current market price

and after fees, a total of $313 million US could be raised.

HNA's 2009 passenger throughput at the operated airports was 11.9 million persons. On

a 54.5% equity basis, Hainan Meilan would have added 6.48 million more passengers to

the reported 2009 passenger count of 8.39 millions

HNA Airports growth rates dwarf that of Hainan Meilan Airports.

In 2009 (on a 54.5% basis), HNA Airports reported $48.64 million of revenues, up by

28.1% over the $37.96 million reported in 2008.

Reported operating profits were $22.34 million in 2009, up by 41% over the $15.8

million generated in 2008.

HNA did not disclose EBITDA. Based upon my assumption of a depreciation and

amortization level consistent with Hainan Meilan airports (13.8% of revenues), HNA

may have generated 2009 EBITDA of $29 million, up by 48% from the $19.6 million

reported in 2008. This would represent an EBITDA margin of 59.6%, up from 51.6% in

2008.

Upon completion of the 54.5% acquisition, Hainan Meilan Airports will account for

HNA as a subsidiary, and consolidate the financial statements accordingly.

The transaction has been widely rumoured for several months.

Immediately prior to the trading halt, Hainan Meilan Airports was selling for $1.26 US

per share. The market has bid up the price of the stock by 10.3% upon release of the

news.

HNA Airports adds diversification and rapid growth to a stodgy Hainan Meilan

Airports.

5 of HNA's Airports are very small and are undoubtedly unprofitable at present. However,

3 airports look to be solidly profitable and should demonstrate considerable growth in the

near term.

Sanya Phoenix Airports, for example, was the fastest growing airport in China for 2009.

Passenger throughput was 7.94 million in 2009, up by 33% over 2008. In 2006, Sanya

throughput was just 3.9 million persons. The three year CAGR was 26.5%.

This airport serves the rapidly growing tourist island of Hainan, and is strategically

positioned. Hainan island is considered to be the Chinese equivalent to Hawaii. As

Chinese domestic tourism grows, Sanya Phoenix will logically capture a share of the

leisure travel market. The location of Sanya Phoenix Airport is approximately 200 km

from Hainan Meilan International Airport in Haikou, and is in close proximity to the

many beach resorts now being built. Explosive growth rates through 2020 should

continue, based upon what appears to be a clearly noted secular trend.

As a frame of reference for North American investors to use as context;

by 2011, passenger throughput at Sanya Phoenix could surpass that of

Cancun International Airport in Mexico, another key leisure international airport.

Cancun International Airport accounts for the overwhelming majority of ASR's

(NYSE, $53 US) revenue and EBITDA. ASR has a current Enterprise value of

$1.6 billion US.

Yichang Sanxia Airport, otherwise known as Three Gorges Airport, is located 55 km.

from the Three Gorges Dam, and 26 km from Yichang City Center. The airport served

655,000 passengers in 2009, up from 507,000 passengers in 2006. The three year

compounded annual traffic growth rate was 9.4%

Langzhou Zhonchuan Airport serves the 3rd largest city in northern China bordering

Mongolia. This airport handed 2.86 million passengers in 2009, up from 1.7 million in

2006. The three year annual compounded growth rate in passenger traffic exceeded 18%.

On a go forward basis, investors owning Hainan Meilan airports look to have

several important trends working in their favour.

An investor presently owning Hainan Meilan Airports no longer has the spectre of Sanya

Phoenix airports siphoning off future growth. Sanya Phoenix was the key competitor to

Hainan Meilan airports, as only two airports on the island presently exist.

As Chinese wealth accumulates, the domestic tourist industry should benefit

disproportionately.

Fast growing middle and high income earners in China will likely increase their leisure

travel. This will benefit tourism to Hainan Island, more than any other Chinese province,

on a relative basis.

http://www.smh.com.au/travel/now-its-hainan-fiveo-20100304-plcr.html

The capital airport presently owned by Hainan should also produce moderate passenger

growth in the years ahead, primarily from business travelers.

Yichang Sanxia and Langzhou Airport may also produce above growth for shareholders.

A number of the remaining 5 airports managed by HNA should grow to breakeven or

better, on an EBITDA basis, within the next 24 months.

Based upon my proforma 2010 estimate, the shares are now selling for 15.7X

EV/EBITDA.

Legal, audit, consulting and travel fees will be abnormally high in 2010. This will largely

offset any margin growth in the current year and reduce three year EBITDA CAGR

forecasts. In 2012, revenues could exceed $161.4 million. Net EBITDA could exceed

$98.6 million.

There appear to be limited capital expenditures required in the foreseeable future. This

suggests that the majority of free cash flow may be used towards debt reduction at the

HNA airports subsidiary. If indebtedness remains on the balance sheets by 2013, it will

logically be for expansion of the airport portfolio, or for capacity increases within the

existing portfolio.

My current estimate is that the new Hainan Meilan Airports is selling for 13.2X the 2011

EV/EBITDA and 10.9X my 2012 EV/EBITDA estimate.

My revenue and EBITDA estimates may be deemed conservative.

SWS Research (an Asian investment firm with reports on Hainan Meilan) had previously

estimated that Hainan Meilan's 2010 revenues could advance by 14%+ for 2010, and that

EBITDA could grow by almost 29% year over year, BEFORE the addition of HNA.

They are looking for revenue growth of 30% at HNA Airport, but make not allowance for

the substantial one time acquisition costs.

I, on the other hand, make no allowance for increased retail spending at managed airports,

which is a key revenue stream for destination airports specializing in leisure travel.

My forecast assumes passenger revenue growth of 5% at Hainan Meilan and 22% for

HNA Airport. I assume annual passenger fee increases of 1% per year, and non aeronautical

revenue increases of 1% per year, will occur. This is probably unduly pessimistic.

The merged firm will have scale, which will give them clout for current and potential vendors.

National advertising, a growing component of airport revenues worldwide,

will undoubtedly increase. Rates should easily ramp up, well beyond my forecast.

Thus far in 2010, HNA Airport has produced monthly passenger growth in line with a

30% growth target. Sanya Phoenix Airport served a record 1.22 million passengers for

January 2010, up 32% YOY. February initial statistics appear equally robust.

I have a three year target price of $2.45-$2.78 US per share for Hainan Meilan

Airports.

Looking into 2013, assuming an abatement of growth by that time, the new company may be

generating more than $183 million of annualized revenues. The 9 airports in the current

portfolio should be tracking a net volume rate above 25 million net passengers, based

upon the 54.5% ownership split at HNA Airports.

Considering the high free cash flow and limited capital requirements, all remaining debts

at the HNA Airports subsidiary should be retired. Hainan Meilan will have generated

multiple years of above average growth. All else being equal, a 15X EV/EBITDA

multiple on a debt free firm would produce a valuation of $1.65 billion US. As the

average Chinese publicly traded airport is selling for about 17X EV.EBITDA today, a

15X multiple appears to be conservative. Should Hainan rise in valuation to 17X, the

share price could be fairly valued at up to $2.78 US.

A proposed dividend of $.08 per share will reduce the current investment cost to $1.30

US per 'H" share, as of today's price. Assuming annual dividends of $.04 per share in

the next 36 months produces a total potential return of 97.6%-123%%

Should HNA Group elect to vend in the remaining 21% interest in HNA Airports to

Hainan Meilan via a share exchange, top and bottom line growth rates would have to be

revised higher.

Hainan province is in the early stages of rolling out duty free shopping. Should this

take hold, or if the province is allowed to build casinos, passenger growth forecasts

could soar.

There is little international travel to Hainan Island as of yet. Less than 3% of total visits

to Hainan Island, by air, came from foreign tourists in 2009. This seems destined to

change in the years ahead. The first duty free shops in Sanya have recently been opened.

The state council of China has issued a memorandum declaring Hainan Island to be a test

case; the expressed goal is to develop an internationally competitive tourism industry. A

total of 20 five star hotels are either in the ramp up phase or are in various stages of

construction on the island. The largest hotel in Asia is presently under being built on the

island.

Officials have publicly denied the legalization of gambling on the island at present.

within the next five years. However, the $1.32 billion US Mangrove Tree resort, now

under construction, has just made alterations to its existing design to accommodate a

323,100 square foot gaming area. The amended configuration is stated to allow for

greyhound racing and various sporting events. If gambling status is conferred to the

province, Hainan Meilan Airports will be the single greatest beneficiary of a potential

boom. Irregardless of whether or not gaming restrictions are relaxed, an investment in

Hainan Meilan Airports will nevertheless capture 100% of all the airline passenger traffic

going to Hainan province.

http://www.chinadaily.com.cn/china/2010-02/11/content_9459603.htm

In 2009, the number of Chinese, Hong Kong and Taiwanese visits to Macau were

estimated at more than 22 million, almost exclusively for the purpose of gambling.

I am a current owner of Hainan Meilan Airports "H" shares.

An investment in Hainan airports encompasses two important Chinese trends that I wish to

participate in, the growth of tourism and regional airport development. This is in keeping with

my long investment philosophy that it is better to be roughly right, than specifically wrong.

Haina may therefore represent a more or less permanent investment, based upon

my wish to participate in secular trends through monopolies and oligopolies.

The acquisition of 54.5% of HNA is clearly accretive. It is my belief that HNA

Group's decision to hold a 21% interest in HNA Airports, rather than monetizing the entire

investment, represents tacit support for future growth potential of the airport manager.

This regional airport operator will soon have a monopoly in Hainan province and Gansu

Province. "No cost" retail revenues at the Sanya Phoenix Airport should grow steadily as

duty free shopping is ramped up. The new parent, Hainan Meilan Airports, has a history

of stringent cost controls, which should be extended throughout the new subsidiary in

years to come.

Shares of Hainan will continue to trade at an uncertainty discount pending closure of the

transaction in late 2010. Near term catalysts will be the rerating of Hainan Meilan's

improved growth outlook after closure.

International mutual fund interest will almost certainly increase markedly in the year to

come. If/as/when the market cap surpasses the $1 billion threshold, Hainan Meilan

shares will become eligible for investment by larger capital pools. This could become a

"must" have investment for foreign investors wishing to participate in the Chinese airport

theme. The majority of the publicly traded airports in China are "A" shares and are

unavailable to foreign funds.

A gradually improving global outlook for public airport operators is a sector plus. A

revaluation of the Chinese Yuan is a likely catalyst that would benefit all Chinese equities,

including Hainan. On the heels of the current announcement, I am adding to my position.

The document detailing the acquisition of 54.5% of HNA Airports is attached here

http://www.hkexnews.hk/listedco/listconews/sehk/20100406/LTN20100406013.pdf

The 2009 fiscal report of Hainan Meilan Airports is contained here

http://www.mlairport.com/Meilan_Airport_Web/en/12InvestorRelates.aspx

The 2007 Airports Council world airport traffic survey may be found here.

http://www.aci.aero/aci/aci/file/Press%20Releases/2008/ACI_WATR2007.pdf

Catalyst

Rerating of the company, going forward, given the acquisition of a higher growth subsidiary. Removal of competitive threat through acquisition restores business to oligopoly status. Increased investor interest based upon more complete participation in a secular trend. Rapid deleveraging of the acquired subsidiary's balance sheet with internally generated cash flow.

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			2010	2011
Price:	10.70	EPS	$0.38	$0.62
Shares Out. (in M):	473	P/E	28.1x	17.8x
Market Cap (in $M):	653	P/FCF	19.5x	16.0x
Net Debt (in $M):	0	EBIT	28	57
TEV (in $M):	591	TEV/EBIT	21.0x	20.0x