Description

LONG: MACQUARIE INFRASTRUCTURE CORPORATION (MIC)

We recommend a long position in Macquarie Infrastructure Corporation (MIC), which is a $2.8bn market cap / $3.7bn EV. While MIC has been written up on VIC several times based on sum-of-the-parts theses, the company has been simplified significantly and the path to monetization is not only much clearer, but also likely to occur relatively soon. Following the November 2020 sale of International-Matex Tank Terminals (“IMTT”), MIC’s remaining assets are Atlantic Aviation (“Atlantic”) – the US’ second largest fixed base operator (“FBO”) – and MIC Hawaii (“Hawaii”) – a regulated utility and unregulated propane distribution business in Hawaii.

We believe the risk / reward in owning MIC today is extremely compelling and timely. Simply put, while many sum-of-the-parts theses take many years to play out (as has been the case with MIC to-date), we believe that MIC is highly incentivized and close to fully monetizing its two remaining assets. While the absolute upside may underwhelm some, we believe that the (1) highly asymmetric risk / reward and (2) imminent timing of asset sale announcements, especially Atlantic, present us with an opportunity to generate an attractive, risk-adjusted IRR.

We believe this opportunity exists because of misplaced concern and confusion around timing, taxes, and external manager fees associated with MIC’s forthcoming liquidation, as well as lingering negative investor perception, as many investors were burned by MIC’s unexpected dividend cut in 2018. We believe MIC’s management is highly motivated to sell and has a very clear comparable mark for Atlantic (~90% of EV) based on Signature Aviation’s (“SIG”) sale to GIP, Blackstone, & Cascade. Furthermore, while consummating the Hawaii sale will likely take 12+ months, we believe that MIC’s plan to restructure as an LLC will enable a tax efficient sale of Atlantic well ahead of a Hawaii sale. Ultimately, an Atlantic sale announcement is the most important catalyst and will likely occur in the next 6 months.

Below is a summary of our valuation cases:

Details / Timeline on the Current Situation:

In Oct. 2019 MIC announced that it will pursue strategic alternatives to maximize shareholder value by selling each of its assets or through other strategic transactions. Since then, management has consistently said that it is fully committed to selling its various businesses despite COVID. Consistent with this language, MIC announced that it would sell its IMTT business to Riverstone for ~$2.7bn and use the after-tax proceeds to pay a ~$11 special dividend. The IMTT sale closed in late December and MIC paid the special dividend in early January. Importantly, during the 11/9/20 earnings call (same morning as Pfizer vaccine efficacy news) MIC management reiterated its commitment to selling its remaining two businesses – Atlantic and Hawaii – but also stated that interested buyers likely wanted to see more concrete evidence of a recovery in both businesses before submitting full bids.

However, in December rumors leaked and Signature Aviation ultimately confirmed that Blackstone was interested in buying SIG’s core FBO business for ~$5.2bn. Shortly thereafter GIP confirmed in a press released that it had made an approach to buy SIG prior to the Blackstone offer. Then in early January SIG confirmed press reports that it had received an approach (not an official offer) from Carlyle. The next day Blackstone announced that it would jointly bid for SIG with Cascade (Gates family office / 19% owner of SIG). A few days later SIG confirmed receipt of bid from GIP that valued the business at ~$5.48bn but that it was continuing to field offers from Carlyle and Blackstone / Cascade. Finally, in early February SIG announced that it received a joint bid from GIP, Blackstone, and Cascade that valued the core business at $5.58bn.

This bidding war for SIG amongst several preeminent private equity firms, many of which have or had FBO investments, highlights that buyer interest in FBOs has basically never been hotter. This is clearly a very different picture than what MIC’s management had painted in early November, which, again, was pre-Pfizer efficacy news. We believe that private equity focused on SIG and not Atlantic mainly because MIC was unwilling to sell Atlantic before selling Hawaii due to tax consequences (Atlantic’s tax basis is very low so capital gains tax bill would be significant). MIC needed to sell Hawaii first (would be an asset sale with a relatively small tax bill given small size vs. Atlantic) then MIC could structure a sale of Atlantic as a stock sale, which would result in no capital gain / taxes to shareholders.

Unfortunately, the Hawaii sale process has dragged on and will likely take 12+ months to play out, as buyers likely want to see how well Hawaii’s tourism industry recovers and then the regulatory approval process for a regulated utility can take 9 – 12 months. Given this timeline, MIC’s management has come up with a creative solution, whereby it will restructure as an LLC, which would be taxed as a partnership. By reorganizing itself as an LLC and then distributing the Hawaii asset up to the LLC, MIC can sell Atlantic before Hawaii without any adverse tax consequences. Importantly, MIC will not convert to an LLC until just prior to the close of an Atlantic sale (which would still need to receive unitholder approval) and then upon its sale of Hawaii the LLC will pay capital gains taxes on Hawaii and the net proceeds will be distributed to unitholders. While there is likely some concern around how the LLC will trade, as some investment firms / vehicles cannot hold LLCs, this will likely be a bit of a moot point, as the sale price for Atlantic is what matters and failure to monetize Atlantic at a time when the FBO market is as hot as it currently is would be a terrible mistake.

What is Atlantic Worth?

In our base case, we believe that Atlantic sells for 14.5x ‘19 EBITDA / 15.4x ‘19 EBITDA – maintenance capex, which are slight discounts to SIG's core 2019 FBO EBITDA (14.6x) and EBITDA – maintenance capex (15.9x) multiples for the following reasons:

•  SIG has a scale advantage (178 owned locations vs. 69 for Atlantic), which increases network connectivity / relevance and fuel purchasing power.

• Importantly, Atlantic still has significant scale as the #2 FBO operator (Million Air is #3 with 26 bases and Ross Aviation is #3 with 14 bases) and the difference in fuel costs for SIG and Atlantic is likely marginal.

• Given its scale advantage, SIG also has a higher mix of large fleet and fractional jet customers.

• While this provides consistent volume, the margins are much lower and NetJets (one of SIG’s largest customers) is reportedly bidding out its FBO contract to reduce costs.

• Carlyle’s rumored bid was slightly below GIP, Blackstone, and Cascade’s combined bid.

•  These factors are offset by:

•  SIG has underinvested in its facilities in recent years, while Atlantic has consistently invested in its facilities.

• SIG spent ~$325mm on capex across 178 owned locations from 2015 – 2019 while Atlantic spent ~$388mm across ~70 bases.

• This deferred capex bill will ultimately come due for SIG, especially given that it has 3 major, sole-source locations up for RFP in next 3 years (Boston – RFP out now, SFO – 2023, and Newark – 2023 / 2024).

• Note that capital spending is a key area of focus for airports when they evaluate RFPs, as nicer FBOs, especially those with hangars, attract greater air traffic, which is what airports care about.

• Atlantic focuses more on hangars, which have more infrastructure-like characteristics (recurring rental income).

• This focus showed in 2020, as Atlantic’s EBITDA only declined 29% YoY while SIG’s fell ~34% YoY.

• Note that SIG received CARES Act funding, while Atlantic did not. Excluding the $61.8mm of CARES Act grant income SIG used to offset expenses, SIG’s adj. EBITDA declined ~52% YoY.

• 20% of SIG’s locations are in international markets (mostly Europe), where private / business jet usage is much lower than in the US.

• As such, international FBO locations are generally considered to be less attractive, as traffic and margins are structurally lower.

• Location quality and lease duration are comparable between SIG and Atlantic.

Below are the implied valuations from the various actual and rumored offers for SIG, as well as other precedent transactions in the space.

We believe that our bear sale case multiples for Atlantic (12.5x EBITDA / 13.3x EBITDA – maintenance capex) are conservative given where SIG traded, as well as other precedent transactions done by SIG and Atlantic. Notably, SIG bought Landmark (the largest pre-SIG sale deal) for ~$2bn in late ‘15 for ~12.6x fully-synergized EBITDA and most other sizeable deals occurred in the 12x – 14x range (pre-synergies). These precedents combined with how multiples have moved up across the market since 2016 and the significant increase in the interest in flying privately due to the pandemic provides ample downside protection in our opinion.

Other Valuation Considerations

We believe that Hawaii is worth ~$540mm (9.0x ‘19 EBITDA) in our base case. We believe that this is generally in-line with market expectations based on our read of sell-side notes. Admittedly we have studied this segment less than Atlantic, as a +/- 1.0x change in our multiple only translates to a ~1% change in our base case target price given that the tax bill, disposition fees, and transaction costs vary with the EV. We believe that Hawaii’s tax basis is roughly equal to what MIC paid for it in 2006 ($263mm).

For transaction costs, we assume the same 1% fee rate (fees divided by transaction value) as IMTT for both Atlantic & Hawaii and then assume another $10mm of “wind-down” costs to account for shutting down the business.

For the disposition fees paid to the manager, we would point people to Table A-1 under Exhibit A of the following 8k, which spells out the schedule for disposition payments to the manager. These fees vary based on the cumulative after-tax, debt repayment, and transaction cost proceeds from the sales.

•  Link to 8k: https://www.bamsec.com/filing/115752319002147/2?cik=1289790

We have chosen not to capitalize any corporate costs, as most of the $16mm - $20mm in corporate costs relate to public company, transaction, legal and audit costs, an NYC corporate office (will shut down post liquidation), and some unallocated shared services (HR / other) office in Plano, TX. As it relates to the shared services, MIC already allocates most of these costs to the Atlantic and Hawaii segments, and IR has said that both businesses are effectively standalone entities as is.

We think it is extremely unlikely that MIC does not follow through on its plans to sell Atlantic and Hawaii (i.e., that it remains a public company). However, should this occur, we believe that fundamental downside is likely ~$26 (~20% downside). While the stock may trade below this on announcement, for MIC to trade at $26 per share implies that Atlantic is worth 10.5x 2019 EBITDA / ~11x 2019 EBITDA – maintenance capex, which are multiples that seem completely out of line with precedent transactions, and Hawaii trades for 6x 2019 EBITDA / ~7x 2019 EBITDA – maintenance capex. Given the consistency of cash flow growth at Atlantic, we believe that a structural reset in profitability is highly unlikely, especially given the accelerating interest in flying privately. Furthermore, while Hawaii is clearly facing an unprecedented challenge because of COVID, it has historically generated very consistent levels of EBITDA and unlevered free cash flow. As such, we do not believe there are any structural reasons why this business should not return to pre-pandemic profitability levels once Hawaiian tourism returns.

From a timing perspective, we believe that management is highly motivated based on (1) the disposition fee paid to the external manager ($25mm if sales close by 1/1/22), (2) the CEO is rumored to have received a new chief investment role at Macquarie parent after he closes out MIC (i.e. he has bigger fish to fry than keeping MIC a standalone company), and (3) the fact that the MIC is pursuing a corporate restructuring to expedite an Atlantic sale while the FBO market is hot.

Quick Background on FBO’s & Atlantic’s Business

Fixed base operators (“FBOs”) enter long-term leases with airports to build and operate the facilities needed to support business and general aviation, which is commonly referred to as the “BGS” market. Typically, these leases will be for 25+ years. In exchange for the long-term leases, airports require the FBOs to invest in the facilities (passenger lounges, hangars, fueling stations, etc.). The more an FBO invests in its facilities the better lease terms are (lower rental payments to airport + longer duration). In addition to these facility investments, very busy airports will sometimes demand upfront fees. For example, Boston is rumored to be seeking a $25mm flat payment and then requiring base investments. Our call work suggests that to get into a top 25 airport typically requires >$30mm.

While that does not sound like a great business, the assets are attractive to infrastructure funds and other LT investors given:

1. Long-term nature of leases + structural growth in BGS market

1. The BGS market has grown +LSD% to +MSD% historically (depending on how you cut it) driven by:

1. Growth in high-net-worth individuals (+10% annually).

2. Corporate profits / travel budgets.

1. While COVID will likely impair corporate travel (the “Zoom effect”), we believe that this impact will be offset by an increased desire to fly privately for safety and convenience reasons.

3. Convenience and major airline service levels:

1. FBOs are becoming much more relevant / convenient post-COVID because major airlines have cut service to smaller cities and hubs. As a result, to access certain parts of the country in an efficient manner or even at all by air, customers must fly privately through FBOs.

4. Growth in fractional jet ownership (NetJets) and “on-demand” private aviation (Wheels Up) business models has driven growth, as it has lowered the cost to fly privately.

2. Attractive cash flow profile post-initial investment

1. Short or even negative cash conversion cycle due to low inventory (a typical base carries less than a few days’ worth of fuel) and rapid payment terms (many customers pay via credit cards).

1. Low annual maintenance capex requirements.

1. Atlantic’s “maintenance capex” averaged ~2.8% of gross profits from 2007 – 2020.

2. From 2007 – 2020 Atlantic never generated negative adj. free cash flow (including growth capex).

1. In 2008 and 2009 Atlantic generated $92mm and $98mm of unlevered FCF and $34mm and $31mm of levered FCF, respectively.

2. In 2020 Atlantic’s unlevered FCF was $156mm vs. $184mm in 2019 and its levered FCF was $106mm vs. $135mm in 2019.

3. Many bases have limited to no competition from other FBOs, which provides predictable cash flow visibility.

1. Many bases are landlocked and only have space for one or two FBOs.

2. While the airport can impose pricing limitations in certain instances, frequently the FBOs have leeway to set fuel and other prices that are well ahead of other locations.

The FBO market remains highly fragmented in aggregate with >3k total locations. SIG is the largest US operators (144 locations) followed by Atlantic (69 locations), Million Air (26), Ross Aviation (14), Jet Aviation (11) and then the long tail of smaller players. While the market in aggregate is fragmented, the large bases are mostly controlled by the largest operators. Historically, consolidation was a very attractive means to create value, as increasing scale improved fuel purchasing costs (volume discounts) and network relevance / connectivity (increases customer loyalty and expands customer base).

Atlantic has grown primarily through M&A under its MIC ownership. Please see the precedent transactions page above for details on these acquisitions. Our call work suggests that Atlantic’s management team is tops in the industry and that has manifested itself in the durable and growing FCF that Atlantic has generated over the years. 

We would also point those interested in real time recovery trends to look at WingX, which provides weekly updates on the BGS markets by geography and market segment (aircraft size). While SIG and Atlantic have greater exposure to large cabin jets (more business travel) and are therefore lagging the recovery in terms of total aircraft movements, the important aspect is that all areas of the market are recovering. Here is a snippet from their latest post:

"Unsurprisingly, the first half of April 2021 is several multiples busier than locked-down April 2020. The longer-term view shows that in Europe, gradual easing of travel restrictions are slowly restoring flight demand, whereas the rapid opening up in various US States has already seen pent-up activity surpass the total for 2020, with all-time record demand coming through in Florida and Texas, particularly in Charters.

The US market continues to thrive, with April seeing two and a half times the activity of the first fortnight of locked-down April 2020. Fractional activity has been particularly strong on the rebound, with more than 5 times’ last April’s activity. Year to date, most US States have seen more traffic than comparable 2020, with New Jersey the exception, business aviation departures still off by 9%. Florida has more than 50% of the traffic of next busiest State, Texas, with flights departing airports in Florida up by 40% compared to 2020. A recent peak of 1,388 flights per day this month compared to high points of 1,185 in 2020, and 1,257 back in 2019. Charter activity in Florida is fully 20% higher than peaks in Spring 2019. For charter activity, top airports West Palm, Miami-Opa and Naples are up more than 50% this year compared to same period last year. Only Nevada has seen less business aviation charter this year compared to 2020. Charters out of California are up 16% and from New York State, up 40%. Country-wide, charter rebound of 25% in 2021 is well above the recovery in non-commercial flights, although these are also up 13% compared to 2020. Teterboro and McCarran are two of the only major business aviation airports still trailing 2020 trends this year. Larger business jet cabins are seeing the slowest recovery, with Ultra-Long Range jet sectors up 3%, Heavy Jets flying 6% more, contrast Light through Midsize cabins, flying at least 25% more this year. The Challenger 300/350 is the busiest jet platform, hours up 21%. The Phenom 300 has seen a substantial rebound, flight hours up 40% so far this year compared to 2020."

Source: WingX first half of April update (https://wingx-advance.com/wingx-bizav-weekly-bulletin/)

Catalyst

• Atlantic sale announcement
• Hawaii sales announcement