Description

I am recommending a long position in Macquarie Infrastructure Company ("MIC," or the "Company") at a price of $14.40 per share.  MIC owns, operates and invests in a diversified group of infrastructure businesses in the United States.  I believe the company is worth at least $28, or 94% upside from the current stock price, based on my 2011 estimates.  MIC has a market capitalization of $660 million and trades approximately $6m a day, based on the last 30 days' average trading volume.

The Company's infrastructure businesses consist of 4 subsidiaries:  3 energy related businesses and an airport services business:

• Bulk Liquid Storage Terminals, or IMTT: a 50% interest in a bulk liquid storage terminals business in key strategic locations, the two primary facilities located in New York Harbor and the Lower Mississippi.
• Gas Production and Distribution: a full-service gas energy company, making gas products and services available in Hawaii.
• District Energy: a 50% controlling interest in a district cooling business, which operates the largest such system in the U.S. and serves various customers in Chicago and Las Vegas.
• Airport Services:  operates a network of 72 fixed base operations (FBOs), providing products and services including fuel and aircraft hangaring/parking to owners and operators of private jets at 68 airports and one heliport in the U.S.

Over the medium-term, I believe MIC's equity value will accrete substantially as the market realizes that the three energy businesses are all defensive and show growth characteristics.  I believe these three businesses alone are worth $20/share based on my 2011 EBITDA estimates and more than justify the current stock price by themselves.  The remaining juice comes from the Airport Services business, which I believe you are completely getting for free.  The Airport Services business carries significant leverage, but it is well below covenant levels and industry trends have shown remarkable improvement in recent months.  All the debt at Airport Services is due in 2014, and with the interim FCF generated and debt paydown, the company should not have a problem addressing that debt maturity.  During the past year, Airport Services has done a very good job of cutting costs and paying down debt with all available FCF, and EBITDA is recovering nicely from 2009 trough levels.  Even with its high leverage and using conservative assumptions for EBITDA, I believe there is currently $5-10/share of value. The value could far exceed this, based upon your assumption on the trajectory of the recovery of business jet travel.  The combination of gross profit recovery, a streamlined cost structure ($25 mm of costs removed) and the financial leverage creates powerful upside optionality.  To illustrate a much more bullish scenario, let's look further out and assume flight activity recovers back to early 2008 levels.  That would imply gross profit of $380 million, and with the new cost structure at ~ $180 mm, leaves you with $200 mm of EBITDA.  If I assume a 10x EBITDA multiple (transactions have been done up to the 12x area historically) multiple and subtract the debt balance forecasted at the end of this year, I get equity value from Airport Services alone of $26 / share.  Add in my value of the energy businesses and you have a share price of $46.

Why is the market giving us this opportunity?  In addition to being underfollowed (only Wells Fargo, Jefferies and Stifel Nicolaus publish on the stock, and only one of them has published a full note on the recently reported Q1 2010 results), the holding company structure does not provide for a straight forward valuation.  The stock does not screen well as the company has 50% ownership positions in two of the three energy businesses, Bulk Liquid Storage Terminals and District Energy.  Some people may also get quickly turned off by the high leverage at Airport Services.  It is important to note that there is no debt at the holding company and that the debt at each subsidiary is non-recourse.  There are no parent guarantees or cross-collateralization agreements whatsoever.  So in a bearish scenario where business jet activity continues to decline and Airport Services ultimately has to file for bankruptcy, this will have absolutely no effect on the remaining energy businesses.  The company used to have a fifth business of operating parking lots at airports, but the combination of high leverage and the economic downturn led the business to file for bankruptcy in 2009.  The important takeaway here is that the company was able to walk away from the business with no liabilities whatsoever to the holding company or to the remaining subsidiaries.  Per the company, the project/non-recourse debt structure used at airport parking is the one used at all the other subsidiaries.  I would like to emphasize that I view the probability of Airport Services of being a zero as extremely unlikely, given the FCF it generates and its ability to delever before its 2014 maturity.  But even if that did happen, I believe the energy businesses are worth more than the current share price.    

The other way to look at MIC's valuation is by analyzing the combined FCF of the businesses, and the stock looks equally as attractive on this basis.  I have them generating $2.82 and $3.52 of FCF per share in 2010 and 2011, implying P/FCF multiples of 5.1x and 4.1x.  Please note that I am deducting only maintenance capex in my FCF calculations.  The only division where total capex is materially higher than maintenance capex is in IMTT, where there remain a significant amount of high-return growth projects.  It's also important to note that the company hardly pays any taxes and won't pay any until at least 2013.  To be conservative, if I fully-tax my 2010 and 2011 numbers, I get to $2.29 and $2.78 of FCF per share in 2010 and 2011, or P/FCF multiples of 6.3x and 5.2x.  Applying a conservative 10x multiple on my fully-taxed 2011 FCF gets you to my target price of $28.  And in the unlikely hypothetical scenario where Airport Services is a zero, I get fully-taxed FCF per share for the energy businesses of $1.26 in 2011, or 10.7x - I believe this to be quite an attractive multiple to be paying for the energy businesses, and this is with Airport Services being a zero.

Company Description

Bulk Liquid Storage Terminals (or IMTT)

MIC's most significant holding is a 50% equity interest in the company that owns International-Matex Tank Terminals ("IMTT").  I believe it is a gem of a business.  According to MIC's website, "IMTT is an industry leader in the handling and storage of bulk liquid products. IMTT owns and operates ten terminals in the US and operates two additional facilities in Canada . The terminals handle petroleum (crude oil and refined), chemical, and vegetable and animal oil products for customers including refiners, commodities traders and specialty chemical manufacturers. Customers retain ownership of the bulk liquids, as well as responsibility for insuring those products. IMTT is the lessor of its more than 40 million barrels of storage capacity.  In addition to stability of revenue and cash flow driven by long-term contracts and strong demand, IMTT has the capacity to grow both organically and via acquisition. Complementing these attributes, we have invested in a substantial number of growth projects and expect these to strengthen the cash flows of the business."

Simply stated, IMTT owns storage tanks, primarily situated in New York Harbor (Bayonne, NJ) and in Louisiana.  Both are prime locations and benefit from enormous barriers to entry.  For example, the Northeast is the second largest refined product consumption market in the world but has no refining capacity.  The only way to bring refined product in is by ship, the most effective way is by the largest ship possible, and IMTT has the deepest dock in NY harbor.  Because of these factors, there is a very favorable supply/demand balance.  Contracts typically last 3 to 5 years, and due to the favorable supply/demand balance and their strategic positioning, IMTT has been able to raise prices 20-25% when the contracts renew (subsequent years of the contract have inflation escalators).  The Company's guidance for 2010 is for organic price increases in the high single digits, and for operating expenses to grow in-line with inflation.  The high single digits estimate makes sense if you think about the following:  25% of the revenue (average contract of 4 years) gets 22.5% pricing lift and the remaining 75% gets a pricing lift in-line with inflation.  In addition to the organic growth in rental rates, recently completed expansion projects should add another $12 mm of EBITDA to 2010.  Using these assumptions, I get to $181 mm of EBITDA in 2010 and $198 mm in 2011 (I use slightly lower revenue growth in 2011).  IMTT also has a small Oil Mop business which participates in environmental clean-up activity in the Gulf.  The results are small in relation to the storage terminals business, but the business should generate a meaningful amount of profit in 2010 due to their participation in the most recent BP/Transocean oil spill.

The closest public comp is a company called Vopak, which trades in the Netherlands.  Their terminals are all international, mainly in Europe and Asia.  They trade at ~9.2x forward EBITDA.  In addition, there was a recent M&A transaction, where MISC Berhad (Petronas' Malaysia shipping unit) agreed to purchase a 50% in Vitol's bulk liquid storage and terminal business.  There are a lot of adjustments you need to make regarding future capex commitments, but based on rough math, the transaction implies a value for MIC's share of IMTT at $14-15/share.  That would be ~10x my 2011 EBITDA estimate for IMTT.      

Gas Production and Distribution

MIC's gas business, ("TGC" or "Gas") is a producer and distributor of synthetic natural gas (SNG) and a distributor of propane gas on the six major islands of Hawaii. Gas owns and operates an SNG plant and more than 1,000 miles of pipeline serving approximately 35,500 utility customers (businesses and households). The business serves an additional 33,000 non-utility customers via on-site propane tanks or portable gas cylinders.  The Gas Company operates the only gas utility in the Hawaiian islands and the state's largest propane distribution business. Customers are served by TGC's more than 300 employees. The Gas Company has served the needs of Hawaiian consumers for more than 100 years.

The drivers of growth in this business are demographic and economic expansion in the state of Hawaii and shifts of end users between gas and other energy sources and competitors.  While the weak economy does not help, the business has proven to be very resilient.  The example that the company often gives is that the tiki torches and the pools must still be heated regardless of what the hotel occupancies are.  In fact, Gas was able to grow EBITDA in 2009 from $27 mm to $36 mm.  Part of the increase was due to a rate increase ($8 mm annual benefit, goes straight to EBITDA/FCF) granted by the Hawaii Public Utility Commission for the regulated side of the business, contributing ~ $4 mm of the increase.  The remaining $4 mm benefit will be captured in 2010. 

District Energy

MIC's District Energy business produces chilled water that is distributed via underground pipelines in downtown Chicago to high-rise buildings for use in air conditioning and process cooling systems. The business also operates a site-specific operation that supplies both cooling and heating services to three customers in Las Vegas, Nevada. MIC sold a 49.99% (non-controlling) interest in the business in December 2009 to John Hancock in order to help address an upcoming maturity of debt at the holding company.  The holdco debt has since been repaid and there is no debt remaining at the holdco.  In terms of  valuation, Hancock paid $30 mm for 49.99% of District Energy (~11x EBITDA), illustrating the resiliency and recurring-nature of the cash flows.

District Energy is a relatively small part of the Company's NAV.  The business generates roughly $6 mm of FCF per year, with little requirement for reinvestment.  For the SOTP, I assumed our 50% stake is valued equal to what Hancock paid.

Airport Services

MIC also owns Atlantic Aviation.  Atlantic Aviation owns and operates a network of fixed-base operations (FBO) that primarily provide fuel, terminal services, and aircraft hangar services to owners and operators of private (general aviation) jet aircraft at 68 airports and one heliport in the U.S. The network is the largest of its type in the U.S. air transportation industry.  In my view, this business provides very attractive upside optionality to the current stock price.

FBO's make most of their money on fueling, and the company manages the operation to earn a fixed dollar margin per gallon of fuel sold.  Even during the most recent downturn, the company did a very good job of holding the line on the dollar margin.  This is confirmed by looking at their gross profit trends, which has strongly correlated with the overall general aviation takeoffs/landings trends.  (You shouldn't look at revenue for this comparison since revenue will be directly affected by the price of fuel, whereas gross profit captures just the margin that they earn).  They also make money on ancillary services, such as parking fees and de-icing services.  The FBO facilities operate pursuant to long-term leases from airport authorities and local government agencies; their existing leases have a weighted average remaining length of 18 years.  Based on my channel checks, rarely has a lease in the industry gone out for re-bid.  The common practice is to renew for another 20-30 years several years before the lease termination. In 33 of their 72 facilities, they are the sole FBO operating at the airport, so if you land at one of those airports and need to re-fuel, you need to go to Atlantic.  The best comp for Atlantic would be Signature Flight Support, which is owned by BBA Aviation (trades on LSE).  Signature is the 2^nd largest network of FBOs in the U.S. and also operates FBOs internationally.  Signature accounts for ~40% of BBA Aviation's EBIT; the remainder comes from aircraft engine repair & overhaul services.  BBA currently trades at ~9x EBITDA. 

Airport Services is the result of several large acquisitions in an attempt to consolidate the fragmented FBO industry within the U.S.  They paid aggressive multiples and over-levered themselves, and when the downturn hit in mid 2008, they found themselves with a highly leveraged capital structure and declining EBITDA.  According to FAA data (described below), business jet takeoffs/landings declined 11% in 2008 and another 20% in 2009.  In February 2009, the company amended the Airport Services credit agreement to relax the financial covenants, namely Debt/EBITDA.  The Debt/LTM EBITDA covenant is currently 8.0x, steps down to 7.5x for the March 2011 quarter, 6.75x for the March 2012 quarter, 6.0x for the March 2013 quarter, and 5.0x for the March 2014 quarter.  As of March 31, 2010, total debt was $838.5 million and LTM EBITDA was $112 million, or 7.4x leverage.  They are already below the covenant level for 2011 when the covenant steps down to 7.5x, EBITDA is improving and they will pay down ~$60 mm of debt through FCF over the next year.  For the March 2010 quarter, EBITDA grew 7% YOY, marking the first YOY increase since the June 2008 quarter.  In addition to a streamlined cost structure, recent activity trends have been very promising, confirming what several industry contacts believe to be a bottoming of the cycle (see below). 

The FAA reports monthly business jet activity (takeoffs/landings) at:  http://aspm.faa.gov/apmd/sys/bj-intro.asp.  This is a great way to monitor utilization trends, and the FAA data correlates very well with the takeoffs/landings at Airport Services, which in turn correlates well with Airport Services gross profit.  The following chart just lays out the FAA quarterly growth/(declines) over the recent prior periods.  The key trend to notice is the stabilization of activity in Q4 and the very encouraging pick-up in the early months of 2010.  Business jet activity has been strongly correlated with the level of corporate profits, so as companies' profitability recovers from the downturn, it is not surprising to see the recovery in business jet utilization.

During the downturn, the company has taken aggressive action to take out costs, taking out $27 mm from their overall operating expenses.  As stated above, EBITDA has begun to grow YOY.  In my base case, I have gross profit increasing 4% in 2010 and 7% in 2011.  With the more cost structure, that translates into EBITDA growth of 10% and 13%.  And assuming all FCF is used to pay down debt, I get to Debt/LTM EBITDA of 6.6x at the end of 2010 and 5.3x at the end of 2011.  Even if you assume zero growth between 2011 and 2014, the company will be able to delever to 3.5x by 2014 (their debt maturity).  I should also note that their credit agreement mandates that all excess FCF be used to pay down debt until their leverage ratio is under 6.0x, at which point they can distribute up to 50% of excess FCF to holdco.  At 5.5x and below, they can distribute 100% of excess FCF to holdco.  I see them getting below 6.0x towards the back half of 2011, and that could serve as a catalyst as the Company will have more FCF at their disposal to either distribute or re-invest. 

Capitalization

FCF and Valuation

2010 FCF:

2011 FCF:

Keep in mind that the Company is not a federal tax payer (due to NOLs) and does not plan to be one until at least 2013.  And the Company is working on ways to extend/preserve their non-tax status.  But I think it's important to view what FCF would look like if it's fully-taxed.  The way I did that was to basically start with EBITDA, use D&A found in the income statement and work my way down the P&L.  In reality, the taxes paid would be less than my estimate because there are favorable depreciation tax attributes in some of the businesses, primarily IMTT.  As you can see from the above tables, the stock still is extremely attractive when viewed on a fully-taxed FCF basis, and keep in mind they won't be paying these taxes for the next 3 years. 

In terms of getting access to the FCF, we will need to wait a bit to get full access.  At Airport Services, the credit agreement mandates that 100% of excess FCF be used to pay down debt until leverage gets below 6x.  At that point, the Company gets access to 50% and when leverage falls below 5.5x, the Company gets access to 100%.  I see them falling below 6x some time in the back half of 2011.  At IMTT, the division is still finding very attractive investment opportunities for their FCF;  given the quality of their business, that's something I welcome.  For Gas Production & Distribution and District Energy, there are few reinvement opportunities so we should be able to get access to that FCF. 

SOTP

Notes on the SOTP:  I am using my 2011 EBITDA estimates for all divisions.  For Airport Services, I am using my forecasted debt balance at the end of this year to calculate equity value.  Other adjustments I make:  I burden equity value for one year's worth of holdco admin expenses and I credit the FCF that should be flowing up to holdco this year.  It excludes FCF from Airport Services (which will be used to pay down debt) and FCF from IMTT (being used to reinvest in the business), and also assumes some of the remaining FCF from Gas and District Energy is kept at the respective divisions to increase cash balances. 

Catalysts:

Further deleveraging at Airport Services:  all FCF at Airport Services is currently being used to pay down debt.  Once Debt/EBITDA falls below 6x, Airport Services is able to flow up 50% of FCF to the Company.  I see that happening in the back half of 2011.  At that point, the Company will have significantly more FCF at their disposal for dividends, share repurchases, reinvestment.

Catalyst

Catalysts:

Further deleveraging at Airport Services:  all FCF at Airport Services is currently being used to pay down debt.  Once Debt/EBITDA falls below 6x, Airport Services is able to flow up 50% of FCF to the Company.  I see that happening in the back half of 2011.  At that point, the Company will have significantly more FCF at their disposal for dividends, share repurchases, reinvestment.