Avation (AVAP) - ATR Fleet Sale

[Carcosa]

Avation (AVAP) is a relatively small aircraft leasing company based in Singapore and listed in the UK. They are however the world's second largest lessor of ATR72 aircraft. In more recent times they have started to expand into the A320 fleet but in aircraft numbers this is very small, but highly valuable business.

On 26th October there was an unsolicited approach from an unspecified company to purchase Avation's current ATR fleet (22 aircraft). Avation have indicated they would only be interested in selling this fleet at a substantial premium to book value. Any sale would be subject to shareholder approval.

As to why someone would be open to the idea of buying a fleet above NBV is open for discussion for another day but there are some good potential reasons out there to do so. (I had hoped it might even lead to a take-over of the company but that's perhaps too far of a reach).

Since three weeks has passed without Avation indicating that the deal is not going forward I am left with the impression that the unsolicited approach has, indeed, got some merit so I thought I would take a look at what I foresee as potential outcomes.

I have chosen a 15% and 20% premium to NBV for at end of year 2017.

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      ATR72-500 (6 aircraft)          $78,305,027
     ATR72-600 (16 aircraft)         $251,607,425
                              -------------------
       Current Estimated NBV         $329,912,452
 
  Est Outstanding Loan (76%)         $250,733,463
          Balance (Net Cash)          $79,178,988
 
             Assumed Premium                  15%           20%
 
                  Sale Price         $379,399,320  $395,894,942
            Outstanding Loan         $250,733,463  $250,733,463
 
                        Cash         $128,665,856  $145,161,479
          (Exceptional gain)          $49,486,868   $65,982,490
 
                  Cash/Share                $2.18         $2.46
Cash/Share (Sterling @ 1.25)                £1.75         £1.97


So 175p - 197p/share in cash arising from this sale (that equates to a substantial exceptional gain of 83p to 112p/share)

But where does that leave the remaining business which is principally the Airbus aircraft? On an annualised run rate I get:

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Remaining Business
                         Annual Run Rate
Lease Revenue                $40,678,400
Other Income                  $1,000,000
Depreciation               $(17,944,411)
Loss/Gain on a/c Sales                $0
Admin                       $(9,000,000)
Other Expenses                $(125,000)
Operating Profit (EBIT)      $14,608,989
 
Finance Income                  $500,000
Finance Expense            $(11,877,237)
GMTN Expense                $(8,300,000)
Total Finance Expenses     $(19,677,237)
 
PBT                         $(5,068,248)
 
Total Profit (Loss)         $(4,510,740)
 
Shares in Issue               58,928,336
EPS ($)                           -$0.08
Exchange rate                      £1.25
EPS (£)                          (£0.06)

So clearly this is not good! However, the admin expenses are $2-$4m too high for the size of the fleet but cutting admin is something that will be very difficult to do as the fleet is re-grown because it would be better to hang on to the experienced staff for 1-3 years than let them go and try to re-hire.

The other aspect is that with the new capital from selling the ATR fleet, cost of finance may come down significantly (although whether the cost of the GMTN notes can be reduced is unknown to me).

Also, the older Airbus aircraft may well be sold realising a gain of $4-$6m

The other aspect is how will the sale affect Avations ability to raise additional finance given that their risk profile is significantly higher (small number of customers with expensive ticket items; so any failure to maintain lease payments would be very serious for Avation).

So in reality I would expect a small profitable operation from the remaining fleet because Avation have lost their critical mass.

Overall then:

If it comes to a shareholder vote I would need to have some guidance on:
Profitability of remaining fleet
How quickly and what aircraft types Avation could rebuild fleet size
How the capital would be deployed

Meanwhile, I can see significant upside if the ATR sale goes through but would not be too unhappy to see it fail; although not liking the share price reaction!

Carcosa

[Carcosa]

Since three weeks has passed without Avation indicating that the deal is not going forward I am left with the impression that the unsolicited approach has, indeed, got some merit

Avation have appointed a financial adviser to assist in the evaluation of an expression of interest for the purchase of its current portfolio of ATR turbo prop aircraft. RNS so it would appear the approach to acquire the ATR fleet is indeed possible because one would have had to assume that three weeks since the approach the general terms of an agreement have been outlined and accepted.

Carcosa

[simoan]

Meanwhile, I can see significant upside if the ATR sale goes through but would not be too unhappy to see it fail; although not liking the share price reaction!

Carcosa

Hi Carcosa,

I have held Avation for a while now waiting for the value of the ATR leases to out, but must admit I did not see it coming this way, or so soon. Like you I am not clear of the value of what will be left should the ATR sale go ahead or where the share price would end up. Do you think there's any chance the company could be wound up and the cash returned to shareholders at some point?

Thanks for sharing your analysis and thoughts BTW.

All the best, Si

[Carcosa]

Do you think there's any chance the company could be wound up and the cash returned to shareholders at some point?

Greetings Si,

I do not see that happening. This is an opportunity to redeploy those funds to rapidly re-grow the fleet again; that was what Avation told me upon my enquiry anyway!

What has passed my mind is for this mysterious company to make an offer for Avation, then dispose of the Airbus aircraft if they just want the ATR's. At the same time they would get access to financial markets in the UK and have a ready supply of future ATR's. However, we just don't know who this company is that wants the ATR's and their reasons for so doing, let alone their future plans. All somewhat mysterious.

There are numerous options for what AVAP could do with the cash; perhaps that is also why they have engaged a financial advisor. If they used it all to pay down loans then their annual finance expenses would be cut from $20m to $14m post ATR sale which falls straight through to the bottom line. Obviously there are numerous combinations some of which may improve their credit rating and therefore able to access finance at a cheaper rate. This sort of thing is way beyond my understanding so I hope Avation provides us with a complete presentation on what life could be like post ATR's.

Have been a holder of Avation for since 2014 and saw them as my real long term hold. Now, am not so sure!

Carcosa

[jackdaww]

recommended by simon thompson of investors chronicle .

not simple enough for me .

[Carcosa]

Today Avation issued a IMS and trading update RNS which I thought I would review.

...will continue this growth during the remainder of the current period with a further two new Airbus A321 jets to VietJet Air scheduled for delivery before 31 December 2016. As scale and diversification are delivered into our aircraft fleet, we will strive to lower the cost of debt, which improves the profitability of our existing leasing business and enables Avation to be more competitive in our mission to attract new airline customers.

Well, I don't think Airbus are likely to deliver the second aircraft before years' end but if they do, then fine. They are basically saying the bigger the fleet the lower the cost of debt, so if the ATR fleet disappears then cost of debt will go up as I alluded to in an earlier post. Also I mentioned that the smaller the fleet the more difficult it is to raise finance, so Avation seem to be confirming this.

We continue to deliver economies of scale as the proportion of administration expense to fleet value continues to decline. We are pleased to report that Avation has a skilled and experienced team in place and a platform that can support further growth in fleet assets.

Again, as I surmised in an earlier post, with the ATR fleet disposed of admin costs are going to be a relative high proportion of costs but need to keep the team together for the future. Operationally this is what is likely to kill any operational profits

The unexpired revenue for the 22 [ATR] aircraft is in excess of $305 million as at 1 November 2016

That practically pays off 90% of the loan book and, IMO. is pretty much guaranteed. So at the end of the current leases Avation would theoretically own the aircraft with no debt/loan to pay for years to come. You can see why a large premium would be wanted to give up that income. By the time the aircraft are scrapped Avation may have made >50% over book value in returns and have the asset around on which to leverage new finance at a lower cost for additional aircraft. But of course there is a time element to all of that; so what would an acceptable 'premium' be?

Avation remains committed to the ATR turboprop aircraft type. Avation is not currently proposing to divest itself of its future order and delivery options for further ATR aircraft which would allow Avation to rebuild a turboprop portfolio.

"Should a sale of the portfolio be concluded, the Board would consider a dividend for part of the proceeds from the profit on the sale of the portfolio assets to shareholders immediately following conclusion of the transaction. Avation would then seek to reinvest the remainder of the proceeds into replacement aircraft assets that would rebuild the fleet and add further diversification and new airline customers.

As expected Avation would intend to regrow the fleet but I was not expecting a special dividend; although in hindsight I should have.

If the ATR sale goes through then the share price should increase substantially in response. But I still feel that as a 'Buy and Forget' investment such a deal is not in shareholder's interests.

Carcosa

[simoan]

Today Avation issued a IMS and trading update RNS which I thought I would review.

As expected Avation would intend to regrow the fleet but I was not expecting a special dividend; although in hindsight I should have.

If the ATR sale goes through then the share price should increase substantially in response. But I still feel that as a 'Buy and Forget' investment such a deal is not in shareholder's interests.

Carcosa

Hi Carcosa,

I was hoping for a good AGM update on the ATR sale today. The approach they are taking all sounds sensible but admit I was not expecting a special dividend either, should the sale go ahead. I'm not sure this entirely makes sense and was hoping they could put the sale proceeds to better use to regrow the fleet following the disposal - I don't mind special dividends where the funds are truly excess to the company's requirements but in such a capital intensive business is this the case here? Of course, they also announced future dividends will be paid in USD.

Like you I was hoping to hold AVAP for the next 2-3-years at least as the ATR fleet revenues rolled in and further ATR options were exercised but it looks like that may no longer be the case. Surely there must be larger leasing companies running the rule over the whole company in light of the proposed ATR sale?

All the best, Si

[Carcosa]

Firstly, some 'housekeeping': A321-211SL, VietJetAir (MSN 7427) had it's first flight last Monday so I would expect delivery in 10-14 days from now. The second aircraft (MSN 7454) is scheduled for third week December but I would not be too surprised that slips into January.

The two ATR deliveries by year end (mentioned in the AR) are, I suspect not going to happen but an RNS will be out about that in a couple of weeks if Avation cannot secure a customer.

Had a good telephone call with Avation today and got the feeling/intention of what management are hoping to do in the very near future (nothing 'sensitive' etc was discussed). It certainly changed my opinion and expectation of things going forward.

I did not pick up the significance if a sentence in the RNS:

The size of the portfolio makes it an attractive acquisition for a range of both strategic industry and financial investors

They have, since the initial approach, had numerous enquiries from other aircraft leasing companies and asset finance houses around the world with credible expressions of interest and NDA's are being signed accordingly. Part of the remit of Avation's financial adviser is to prepare the documentation for these companies; hence we are in something of a bidding war. If a non leasing company wins out then Avation would certainly be open to continuing asset administration. The initial expression of interest was from an existing leasing company.

Current thoughts that the special dividend would be a very large percentage of the profit return. I would guess that would be in the region of $20-$30m (~33p/share).

Given that Avation is trading at around 0.6 NTAV any buyout of the company would probably have to be well north of 300p/share

Life after ATR fleet sale (this is what really interested me). The intent is something which I found a huge surprise. Although they had previously stated they would regrow the fleet it was something I imagined would take 3-5 years. However they will regrow the fleet within a month by buying a portfolio of currently leased narrowbody jet aircraft (I imagine that really means A320/B737's) and I certainly had the impression several portfolio's had already been identified.

As a result of the above I actually bought more shares this morning. The risk, is of course, that no deal materialises.

Carcosa

[simoan]

I did not pick up the significance if a sentence in the RNS:

The size of the portfolio makes it an attractive acquisition for a range of both strategic industry and financial investors

They have, since the initial approach, had numerous enquiries from other aircraft leasing companies and asset finance houses around the world with credible expressions of interest and NDA's are being signed accordingly. Part of the remit of Avation's financial adviser is to prepare the documentation for these companies; hence we are in something of a bidding war. If a non leasing company wins out then Avation would certainly be open to continuing asset administration. The initial expression of interest was from an existing leasing company.

Current thoughts that the special dividend would be a very large percentage of the profit return. I would guess that would be in the region of $20-$30m (~33p/share).

Given that Avation is trading at around 0.6 NTAV any buyout of the company would probably have to be well north of 300p/share

Life after ATR fleet sale (this is what really interested me). The intent is something which I found a huge surprise. Although they had previously stated they would regrow the fleet it was something I imagined would take 3-5 years. However they will regrow the fleet within a month by buying a portfolio of currently leased narrowbody jet aircraft (I imagine that really means A320/B737's) and I certainly had the impression several portfolio's had already been identified.

As a result of the above I actually bought more shares this morning. The risk, is of course, that no deal materialises.
Carcosa

Hi Carcosa,

Very interesting, particularly the information on how quickly they plan to regrow the fleet - a month, blimey! The only trouble in these kind of situations is that the seller of the planes will be only too aware they have a cashed up buyer with the money burning a hole in their pocket. It's a nice problem to have but does not exactly make price negotiation easy! I'm also surprised by the size of the special dividend and personally would rather they re-invested the funds in growing the business somehow.

I think you've probably made a good call in buying more under the circumstances, it looks a decent risk/reward given that there are now multiple interested parties and there seems a good chance the ATR sale will go ahead. I think I've probably got enough AVAP for now and will hold but would revisit that were the price to pull back on no further news.

All the best, Si

[Carcosa]

Hello Si,

The only trouble in these kind of situations is that the seller of the planes will be only too aware they have a cashed up buyer with the money burning a hole in their pocket.

I would have taken that view as well except I was informed there are several aircraft portfolio's that are already in the market prior to the ATR sale announcement. I would not be surprised that when Avation announce the particulars of the ATR deal to be voted upon that they will also advise they have a replacement portfolio fleet already lined up.

As regards the special dividend, I surmise that is due to level of the premium expected for the fleet sale. In my earlier illustration I used a level of 15-20% which I thought was a bit racy; perhaps not!

One reason given for the rapid fleet re-growth would be to reduce risk. Also, the question I raised earlier regarding raising new finance (access and cost) is that when it comes to narrow-bodied jets the cost of capital is less than with ATR's.

It's all sounding somewhat more exciting should the ATR sale come to fruition. It also potentially suggests Avation will try to do a similar 'trick' in the future because if they have several enquiries about the fleet sale then it suggests there is a market out there to use their knowledge of the industry to create aircraft portfolio's to be sold off. No doubt that is a reflection on general commercial aviation dynamics and the current low interest rate world we live in.

It would also demonstrate to investors just how much value Avation can unlock and hopefully, going forward, the share price will track much closer (if not above) NAV. My view has always been that Avation should be listed in America, or possibly Hong Kong, where leasing companies are better received in terms of share price and understanding.

As regards my top up share purchase today, I will look a mug if this ATR sale does not materialise. One wonders how long it will take to agree... 2 months???

Carcosa

[simoan]

The only trouble in these kind of situations is that the seller of the planes will be only too aware they have a cashed up buyer with the money burning a hole in their pocket.

I would have taken that view as well except I was informed there are several aircraft portfolio's that are already in the market prior to the ATR sale announcement. I would not be surprised that when Avation announce the particulars of the ATR deal to be voted upon that they will also advise they have a replacement portfolio fleet already lined up.

This is really interesting and it seems the fog is now clearing about what a post sale Avation may look like, so thanks for passing on this information. It's at this point that you have to back the management to get the best price for the ATR's and re-invest the proceeds in a way that grows the company more quickly than without the ATR sale. I'm happy to do this from what I have seen to date and Jeff Chatfield has plenty of skin in the game.

It would also demonstrate to investors just how much value Avation can unlock and hopefully, going forward, the share price will track much closer (if not above) NAV. My view has always been that Avation should be listed in America, or possibly Hong Kong, where leasing companies are better received in terms of share price and understanding.

As regards my top up share purchase today, I will look a mug if this ATR sale does not materialise. One wonders how long it will take to agree... 2 months???

It would be nice to see the value out here, and the ATR sale seems to be the best way to realise it in the short-term. I don't believe you'll look a mug even if the ATR sale falls through... yes the share price will likely spike down but it doesn't look expensive here, even if you assume the company moves forward with leasing the current ATR and A320 options it has available to it. Personally, I've no view on the timescale for the sale process but hope it is resolved one way or another soon. However, if it gets into a competitive bid situation it could roll on for months.

All the best, Si

[Carcosa]

Not ATR related but...

VietJetAir, (MSN 7427) had it's third flight today at Airbus. That typically means delivery within the next 2-5 days. Avation have previously indicated this aircraft would not be sold upon completion.

Carcosa

[jackdaww]

simon thompson in this weeks IC advises buying at 195 , forward p/e still only 7 .

[Carcosa]

Vietjet's latest delivery is scheduled to be delivered today, A321-211SL, Regn, VN-A685 (MSN 7427), after a short delay requiring an additional test flight. So expect an RNS today or perhaps tomorrow. Of course, in the great scheme of things it matters nothing but often we get a little share price action of a penny or so.

As I mentioned before, the next and final Airbus delivery (for Avation) is scheduled to be before year's end but I still maintain this will slip to early 2017. We also have some sort of announcement regarding two ATR's but clearly the real news is related to the ATR fleet sale and a potential change of emphasis in what Avation willa actually do in the future, i.e. become creators of small fleets of aircraft to be sold as a portfolio to finance companies. If Avation can demonstrate they are able to do this then the share price must reflect NBV or above; which would relate to a share price of around 260p; although I may be somewhat generous with that target.

As regards the Simon Thompson pick, I cannot comment because I am not a subscriber to the IC but I am aware he has been bullish on Avation for quite some time. I maintain that P/E valuations are inappropriate for Avation... but that hardly matters if everyone else values it that way!

Carcosa

[simoan]

As regards the Simon Thompson pick, I cannot comment because I am not a subscriber to the IC but I am aware he has been bullish on Avation for quite some time. I maintain that P/E valuations are inappropriate for Avation... but that hardly matters if everyone else values it that way!

Carcosa

Hi Carcosa,

FWIW I agree that P/E is very misleading as a method for valuing Avation as with any asset play e.g. Oil & Gas, Property. I don't take any notice of the IC either and several times have sold into share price spikes caused by their buy recommendations!

All the best, Si

[Carcosa]

Although I rarely pay attention to buy/sell data it seems to me that someone has bought 20,000 shares throughout the day today in blocks or round numbered shares eg 3000, 2000 etc. Thanks for putting the share price up by 6p! That's a lot of money for most people to risk at this stage unless you are an 'insider'! Or it could be just bo**ocks...

Meanwhile the last Avation/Vietjet aircraft (MSN 7454) to be delivered had it's first flight today. So it could be a late December delivery, unfortunately.

Carcosa

[Carcosa]

Iran to land first Airbus jet within weeks under sanctions pact.

Hopefully the ATR order will not be too far behind; pushing up the value of Avation's options and ATR valuation in general.

Carcosa

[Carcosa]

Avation released this RNS announcing the disposal of the Fokker F100 fleet around NBV.

These aircraft were up for lease renewal mid 2017. Hard to estimate the NBV but on the low side I reckon they are worth, collectively, around $4.25m and generating around $5 -7m annual revenue. However the Fokker fleet is the one part of the Avation portfolio that I have questionable valuations in my finance model.

Finding new homes for these particular aircraft may prove to be very difficult so getting rid of them now (or more likely Skywest giving Avation no choice in the matter, as they hold all the cards) is a reasonable outcome. Lost high margin, but relatively small income, business though.

Hopefully we should have a couple more RNS's from Avation before the year is out; The A320 delivery to Vietjet and something about the next two ATR's referred to in their AR

Carcosa

[muckshifter]

Thanks for your posts here Carcosa. I never managed to attend any of their public presentations, which, together with the fact that the link to their website on Stocko doesn't work, kept me out of the shares until your recent explanations.

As I still haven't found the company website, what effect do you think rising interest rates will have on Avation? My expectation is that it would be beneficial in terms of future income as leases expire, without increasing the rates paid on long term borrowings to finance currently owned aircraft, so I would be grateful for your opinion on that.
Regards.

[Carcosa]

Hi muckshifter.

Avation's website went offline for a couple of days but is back up now.

Avation's financial model means that there are several important financial metrics which are in effect fixed for the duration of lease terms, and do not require the close attention and management time that other financing companies typically dedicate to them. Key amongst them are currency risk (all leasing and financing is in USD) and interest rates; The large majority of borrowing costs are fixed for the duration of the leases to which they relate. The long duration of the typical Avation lease also means that refinancing is not a regular requirement (although the group has taken advantage of its growing scale to renegotiate some arrangements at more attractive rates over recent years).

So Avation mitigates the risk posed by a sharp rise in interest rates by borrowing over the term of the lease, rather than over two or three years and constantly refinancing. That way it always knows it will receive more in lease payments than the financing cost payments.

The Iran deal is something that Avation would not get involved with (other than perhaps selling production slots) because it cannot be financed via US Dollars and also Iran is yet to be part of an international convention related to aircraft ownership and debt recovery.

Rising interest rates are not really an issue at these ultra low values. What is of more importance is aircraft valuation (for example the effect of the new A320 NEO's affecting residual valuation of other A320's and the main competitor aircraft the B737), passenger demand driving supply and fuel costs although for short haul aircraft (ATR's and F100's) fuel is not a large percentage of the overall cost but does become an issue for wide-bodied aircraft. One aircraft thst is on trouble regarding valuations is the A380; hence companies like DORIC have come up with innovative financing options (basically forming a listed company specific to one aircraft so the shareholders take all the risk and not the parent company).

Another factor is Avation's credit rating as that affects the cost of capital. I suspect their continuing desire to maintain a young fleet and dispose of aircraft (such as the last Vietjet A320 aircraft) is partly driven by that. In fact their latest ratings have improved but I do wonder if that will be maintained going forward if the ATR fleet is disposed of.

Anyway, provided industry demand continues to exist for commercial aircraft - and there is huge continuing demand - and airlines can make a long term profit then irrespective of likely interest rates in the medium term then leasing business will continue as is. It also has a beneficial effect on Avation's second and third leasing rounds because generally speaking after the initial lease period is up the aircraft has been paid for so years 12-25 are essentially 100% pure profit and (in theory) Avation could lease them out independent of whatever the interest rate is doing. In those circumstances having high interest rate environment means significantly higher profits over the life of the aircraft and also higher residual value.

However no leasing business really works with individual aircraft in isolation like that but the above does somewhat demonstrate potential positives.

What I am more excited about is the implications of the ATR fleet sale. If, as Avation says, they have had several enquirers from within and outside the industry because they see benefits in owning a portfolio of aircraft then that changes the nature of Avation's business model. They will become a company that acquires a portfolio of disparate assets (individual aircraft from around the world) below NAV that are then sold on as a 'package' at NBV or above. This could be a new niche in the leasing world. Remember Avation are, I think, the third or fourth smallest commercial aircraft leasing company in the world out of about 30 such companies.

If you have any specific queries I suggest you contact the Finance Director, Richard Wolanski directly and if you have a range of queries he is very amenable to having a chat over the phone.

Carcosa