Description

Mesaba Airlines (MAIR) is a regional airline in the Northwest system. This one sells at a 10% premium to tangible book value with no long term debt (although there are leases). The reason for this is that MAIR is a busted takeover and risk arbs were left holding the bag. Northwest and MAIR announced a buyout for $13/share in November 2000. In June, due to the terms accepted by Northwest as a result of the pilots strike, and due to some pressure from antitrust, the deal fell through and the price cratered from 12 to sub 9 dollars per share. It has since stabilized at 9-9.20 in the past 8 weeks. There is ample supply on the sell side as the arbs (and probably Northwest) are now distributing the stock back to the public near tangible book value.

During the period from the initial announcement until it blew up in June of this year, approximately 76% of MAIR common changed hands. Since the deal blew up on June 18, approximately 50% of MAIR common has traded. Therefore supply is likely to be exhausted in the next 1-3 months. Once the risk arb supply is exhausted, I believe that MAIR will begin to move up to a price more in-line with its peers. I looked at 10 comps, including SKYW, ACAI, HA, FRNT, MESA, ALK, MEH. As a group they sell at an average of 2.8 times tangible book value, 9.6 times peak cash flow, with an average LTD/Equity ratio of 0.6. At the current bid of 9.20, MAIR is selling at 1.1 times tangible book, 5.8 times cash flow, and has no long term debt, and over $5/share in cash. Positive cash flow. 12-16 dollars per share seems like a reasonable target in the next year, barring any major catastrophe.

In addition to a cheap valuation, MAIR has been one of the better performers among the regional airlines in the last economic cycle. It is paid by Northwest for providing capacity, so their cash flow is not as dependent on loads as other airlines. It primarily competes with Express Air, a subsidiary of Northwest, hence the antitrust concerns. But although MAIR is in this strange position of being both in business with and in competition with Northwest, it does have a near monopoly on a number of regional airports feeding into Minneapolis, and is likely to do well in the next economic cycle. They are negotiating with Northwest for more routes.

MAIR's fleet is modern, costs seem well controlled, and they claim to have fuel costs fully hedged for the next several years. Mike Burry did a bit of a write-up on MAIR on msn.com a month or so back. You can find it on moneycentral.msn.com

MAIR has sold as high as 25 in the peak part of its cycle in 1998, and as low as 8.75 recently after the Northwest deal went bad. The regional airlines have actually been one of the stronger groups in the S&P smallcap index this year so MAIR's valuation is well out of line with its peers. Therefore, this might also make a good paired trade.

Problems. Obviously, there is excess supply in the common stock. There is a short term risk that the remaining supply will just get dumped willy nilly on the market for tax reasons cratering the price. But the distribution seems pretty far along at this point, and the bid has firmed a bit since July. Of course, the economy could also crater into a serious slowdown, which would undoubtably effect MAIR as well as every other airline. But that risk could probably be laid off by pairing this with a short on another airline.

If you want a large block, the sellers seem willing to sell larger blocks at 9-9.10, whereas the current bid/ask for smaller blocks has been in the 9.20-9.25 region the past two weeks.

Catalyst

A merger with Northwest Air failed in June. Since that time risk arbs have been redistributing MAIR common back to the public. No matter how you slice it, at the current bid MAIR has one of the cheapest valuations in the industry, and one of the better balance sheets, even when you adjust for leases. Once the risk arb community is done selling, the price will be free to seek a level higher than tangible book value, more in line with its peers and its own history.