Description

Innovative Solutions and Support (ISSC) has received a takeover bid from its largest shareholder for $7.25 a share, versus $6.31 where the company is trading now, representing a potential 15% return. 

It is unclear what the board will do, but we think it highly unlikely they will accept this low ball bid. More likely is that the board will turn down the offer or bidder Chris Harborne will be asked to raise his bid, and we think a $9-10 a share could win over shareholders. 

What price could Harborne pay? He likely started buying after ISSC founder and controlling shareholder’s death in Jan 2022 and became a 10% holder in Sept 2022, paying $8.11 a share for most of his holding. He kept buying at prices from $7-9 until ISSC adopted a poison pill at the end of Sept 2022 and now owns 14.92% of shares.  

Who is Harborne? He is an investor big into crypto and with ownership of a number of aviation related companies – jet fuel company AML Global, private plane seller Sherriff Global Group, and IFX Payments, a British money transfer company, and single largest shareholder of UK defense contractor QinetiQ (11.7% of 2.3bn pound company). In 2021, he purchased assets of bankrupt business jet maker Eclipse Aerospace for $6mn, when he may have learned about ISSC. ISSC made the flight management system for their first jet.  

ISSC has total shares outstanding of 17.5mn and current market cap of $110mn. $9 a share would be $157mn, which seems within his means. ISSC put out a PR yesterday saying they are reviewing the offer: 

https://www.sec.gov/ix?doc=/Archives/edgar/data/0000836690/000110465924066269/tm2415820d1_8k.htm

If Harborne and the board don’t reach a deal, we still like ISSC and think it’s undervalued at $6.31 a share. It’s trading a TTM PE of ~17.  

This is a microcap aerospace business, making aircraft systems (utility management system and autothrottle product), flat panel displays for the cockpit, and other aftermarket upgrades. The share price this spring has slid from about $8 a share to $5 a share pre-bid. The founder’s family has been heavily selling shares in the market in recent months, a large overhang for the stock. At last filing in Feb they were down to a 6% stake from 20.5%, and they’ve likely continued selling since then, but have not yet broken 5% which would require a filing. Poor first quarter results have also contributed to the decline. 

Prior to Harborne’s bid, successor CEO Shahram Askarpour has been moving the company in the right direction. He sold the two planes used by the late founder for $3-4mn and changed the company’s articles of association to allow ISSC to take on debt and allow acquisitions, outlining a new strategy to grow the company with bolt-on deals that would add products to their line. The company has a factory in Pennsylvania that was running at 30% capacity pre-acquisition and so any additional products that can utilize the same overhead will help margins. 

Que the Honeywell product line acquisition in June 2023. ISSC got an old product line from Honeywell consisting of inertial, communication and navigation products and customer service support. While it is no longer cutting edge, management says the product line still has years of orders / contracts ahead. 

The acquisition has gone okay though not exactly as management outlined when announced. Revenues for 9 months post-deal are up 64% yoy, but gross margins have come down, especially in Q1, from about ~60% pre-deal to 52% in q1. This has contributed to the recent share price decline. 

Management says they will get back to ~60% after 1. Acquired inventory which was written up at time of purchase is sold down 2. Product sub-assemblies which Honeywell outsourced are brought back in house, starting from q3 this year and into next year. 

The acquisition highlighted the cash generating power of the business. Debt used for acquisition has come down to $10.6mn from ~18mn. (Cash flow in q1 was poor)   

ISSC reports in two segments: product and customer service. Pre-acquisition product sales accounted for 82% of its business, and it is now about 50-50 as product revenue declines, amid declining demand for aftermarket full cockpit upgrades for air transport customers. Askarpour has said this will stabilize in coming quarters.

Askarpour was ISSC president since 2012 after joining the company in 2003 as head of engineering. Prior to taking over as CEO, as president he was expanding the company’s presence in the OEM market embedding ISSC’s products in new programmes, which has historically been less cyclical than after-market upgrades that ISSC specialized in. 

About one-third of business is commercial/air transport, one third business aviation and one third military, with about 60% of revenue tied to OEM programmes or customer service pre acquisition. CEO says post acquisition that would rise to about 75% of revenue, making the business less cyclical. 

In fiscal year 2023, their three largest customers:

Pilatus: business jets, OEM utilities management system – 23% of revenue

ATSG- Air Transport Services Group- Cargo cockpit upgrades– 12% of revenue

Textron – ThrustSense Autothrottle for OEM prop planes – 10% of total revenue 

Pilatus PC-24 is small business jet that can hold 8-10 people, specialized for short runway take off. Pilatus makes about 40 of them a year, though sales do seem to be somewhat declining from 2021-2023, based on records in an aircraft frame database. What is a utility management system? It integrates aircraft utilities like power, fuel, and environment – and is their stepping stone product for greater automation of aircraft.

Company has said nearterm organic growth will come from military programmes. They include Boeing’s KC-46 Air Force Tanker uses IS&S displays for the boom operator station to refuel other aircraft. Boeing T-7A Red Hawk trainer is using ISSC GPS sensor units. Planned production:

Longer term vision laid out in this slide: 

Overall, we think this is a decent business at a fair price, with potential near term upside should Harborne raise his offer.

Catalyst

Near term: Takeover offer closed at $7.25 or bid raised

Longer term: Complete integration of Honeywell product line, new OEM deals and new bolt-ons