Doric Nimrod Air Three (DNA3)

[Laughton]

To many errors on my part. Guess I'm having a bad week!

Don't sweat it. I , for one, appreciate all your detailed commentary.

[Carcosa]

Current situation is that Elliott Investment Management now own:

11.25% of DNA2 (7 aircraft) from 11 Oct 2022
14.08% of DNA3 (4 aircraft) from 16 Sept 2022

In the grand scheme of things the purchases are insignificant for Elliot Investment Management. Can only speculate as to their rationale for buying but from the U.S. tax point of view, aircraft investment can be structured in the form of asset-backed securities that qualify as debt with no U.S. withholding tax on the income. There is also an element of inflation protection in an A380 asset.

It will be interesting to see if Elliot Investment Management will continue to acquire Doric shares but as a PI I see it as an academic exercise that holds little or no influence over the final exit strategy for PI's. However should one of the larger shareholders be a willing/forced seller it does appear that Elliot is a willing buyer.

[Carcosa]

Given recent dividends, share price and exchange rate changes I thought that I would say very conservative shareholders in DNA2 and DNA3 should be aware that my financial model suggests that no further profit is likely if you consider there is no value in the scrap value of the aircraft.

If on the other hand you take solace that Emirates/Doric have already agreed to buy one A380 (DNA1) for $30m in December 2022 and one aircraft from DNA2 is being returned to Doric with a cash redelivery payment of US$12m (plus/minus scrap value) then its not unreasonable to assume DNA aircraft are worth at least $10m and up to $30m depending on whether the aircraft are being returned from lease or transitioning to Emirates ownership. In that case there remains a considerable profit to be made.

[Laughton]

Thanks Carcosa.

Can I just check my figures - because I think I've gone wrong somewhere?

If we take mid value of $20M per aircraft and there are 4 aircraft, plus a cash pile of $10M giving total of $90M. There are 220M shares and using an exchange rate of 1.17 that gives a mid price value per share of 35p.

IfI use that as the final value per share I come up with an IRR of 6.81%

If planes valued at $0 each I make IRR a big negative
If planes valued at $10M each I make IRR minus 5%
If planes valued at $20M each I make IRR 6.81%
If planes valued at $30M each I make IRR 15+%

Do those numbers seem right? Or mabe you don't feel using IRR the right way to value these?

[Carcosa]

By the time I finished typing and submitted a long reply I had been logged out of TLF and lost everything! Anyway, here's a second attempt...

Can I just check my figures - because I think I've gone wrong somewhere?

Calculating IRR using the future dividends and the assumptions you have used, I get broadly the same numbers as you, within a couple of percent. However I am not sure IRR is appropriate measure because it generally assumes the dividend is re-invested which I think most investors would shy away from.

Similarly with calculating NPV it is highly dependent on the assumed discount rate.

Using IRR or NPV makes sense for a business when planning for large capital projects over a long period of time with variable cash flows.

For an investor applying a discount rate is different to that of a business which is trying to mitigate risk for a project.

So lets assume you want to calculate the NPV of DNA3, what discount rate would you use? Well, will a dollar today be worth more or less than a dollar in October 2025? Interest rates are going up but inflation is also powering ahead. On the other hand some commentators think inflation will fall dramatically in a few months time. And what of the asset itself? Inflation may make an A380 more valuable than would otherwise be the case, and if fuel prices drop considerably by 2025 then the aircraft will also be worth more to Emirates. So NPV can be pretty much whatever you want it to be.

All I am trying to say is that I agree with your IRR calculation and if that is one of the tools that you use for deciding on an investment that allows you to sleep well at night then continue using it. For me however I believe I can model the total returns against a range of scenarios (which may or may not prove accurate) and using that method I too can sleep at night.

My earlier post today was made toward those investors who are highly cautious. Essentially it is my belief the investment has reached a 'gate' whereby should the worst case scenario occur i.e.the aircraft being scrapped for nothing and with minimal redelivery conditions met then it's time to consider exiting sometime in H1/23.

[Carcosa]

Emirates announced last week that all of their A380s have returned to service.

Also, I sold about 65% of my holding in DNA3 and used the majority of proceeds to buy DNA2.

As a result of a meaningful share price divergence between DNA2 and DNA3, my financial model shows minimal upside for DNA3 should Emirates not buy some of the aircraft post lease around 2025. An unlikely event IMO but possible. Also I would think it more likely for Emirates to buy DNA2 aircraft than DNA3.



I was selling blocks of 20,000 shares (during auction) over a number of days and I found I could sell 0.5 to 1.0p more than the offer price! I have no idea why this should be but selling around 5% above the bid price was a pleasant surprise. A conspiracy theorist could have a fun time with this info

[Carcosa]

Investors may recall that Emirates agreed to buy DNA1's only A380 (MSN 016) for £25.30 million in preference to returning the aircraft at under half-life condition and for $12 million at the end of December.

From a bit of research I found this: MSN 016 is a very early production aircraft, with weight and performance limitations, and it was 18 months old at
initial delivery prior to the twelve year lease, having participated in the A380 test flying campaigns.

Therefore, all else being equal (for example compare hours & cycles of DNA3 aircraft with DNA1, acquisition costs, specific warranties, exchange rates etc) logic would dictate there would be more value in DNA3 aircraft at end of lease than DNA1/MSN 016 provided the airline wants to maintain operating DNA3 aircraft.

Logic would also dictate that should Emirates retrofit the cabins for DNA2/3 aircraft then it would be safe to assume they are going to continue operating the aircraft post lease. However simply because they may not be upgraded does not imply they will scrap the aircraft either.

So far Emirates have only announced two aircraft and interestingly they are both relatively young aircraft; MSN 240, A6-EUW and MSN 264, A6-EVM are 6 and 3 years old respectively. It would make sense to refurbish the newer rather than older aircraft for several reasons, e.g. you want your best performing aircraft on your primary highest margin routes.

By 23 May 2024, all 67 A380s earmarked for the retrofit programme will be back in service

[Carcosa]

Correction: Emirates plan to return all A380's into service by end of 2023 and not as per my post dated 26 Nov 2022.

Interims
Following publication of DNA's Interims, the net cash levels of DNA1/2/3 are notably higher than estimated. I had been using £1.0m £25m and £10m respectively. However I believe most of that increase is due to USD/GBP exchange rates at the reporting time. However DNA1's cash level does appear materially improved and some improvement for DNA2 & 3. Nevertheless some additional improvement can be expected due to increased bank interest rates for cash in deposit. All of these changes are not material for shareholders other than those holding DNA1, but pleasing to see.

A380 Transfer to Emirates
DNA1's only aircraft should have completed its ownership transfer to Emirates on 16 December for £25.3m look out for an RNS on Monday (?) about that. I suspect DNA1 shareholders will be pleased with what looks like a bumper cash balance on the books. It also looks like the winding up and return of cash to shareholders will be complete mid 2023. Looking forward to seeing the details.

Hopefully by mid 2023 we should have news from Emirates about what they intend to do with the next Doric aircraft coming off lease. (There may also be other leasing companies doing the same thing with Emirates too).

Wing Spar Cracks
I note that some reports of aircraft delayed in being returned to service due to wing box cracks being discovered are doing the rounds. Just a couple of notes about that. Firstly it looks like they are repairable & long term issue and secondly such cracks were also found a few years ago. All repair costs (and service interruption costs) are bourn by Emirates (with claims to Airbus too). In the unlikely event of the aircraft have to be permanently withdrawn from service then it would be normal practice that Emirates/DNA would make a claim Warranty with Airbus; which are likely to be materially higher than the current value of the aircraft.

Other News
In other news the Boeing 777X flight testing has halted following a significant issue with the General Electric GE9X engines. This aircraft is now 5 years late.

The A350/Qatar dispute looks like it will take all of 2023 to resolve via the courts. My personal view is that Emirates do want these aircraft ASAP and will not delay deliveries but use the court case for better financial terms.

Bottom line is that Emirates will get all A380's back to service for a few more years. Rest of the world A380 fleet are returning to service considerably faster than many predicted only 12 months ago which should help arreat current aircraft valuations.

Links for Interims:
DNA1
DNA2
DNA3

[abtan]

Hi Carcosa

Thanks as always for sharing your insights.

I hold DNA2 and read the interim report.

One thing that stood out was that the $12m return fee to be paid by Emirates was only mentioned for 2 of the 7 aircraft.
Would you expect a similar minimum fee for the other 5 aircraft? I was surprised by this omission.

---

Based on the figures from the interims I am now assuming the following (figures are for the period end date, i.e. Sep 30th 2022):

- Future rental income: £116m
- Future lease + capital repayments: £49m
- Cash on balance sheet = £30m

Within the next 1.5 years I therefore expect profit from rentals of c.£97m = $115m (1).
Current Market Cap = $197m

---

ENDGAME SCENARIO 1:
- 7 aircraft.
- Emirates paying $12m to return x2 aircraft - DNA2 CAN STILL SELL IT FROM HERE
- Let's assume minimum $20m per aircraft = $140m
+ rental profit (1) $115m
= $255m
- Current Market Cap = $197m
- Minimum upside = +29%

---

ENDGAME SCENARIO 2:
- If $30m per aircraft = $210m
+ rental profit (1) $115m
= $325m
Upside = +65%

---

In conclusion, I would therefore expect upside in the next 18-24 months to be between 29% and 65%.

I'd be interested in hearing thoughts on the above.

Cheers
A

[Carcosa]

Nice post.

The two aircraft where they have signed the side letter for half life return conditions are MSN 077 due end lease 14 October 2023 and MSN 090 due end lease 2 December 2023. The next aircraft due off lease are MSN105/6/7 due October 2024 so I would not expect any future announcements regarding half life return cash payments until March or April 2023. I would imagine Emirates would want their future 12/18 month liabilities to be definitive where possible as they are probably saving themselves ~$15m - $25m per aircraft in liabilities with these side letters.

Us shareholders were told some time ago that a side letter was given to Emirates suggesting the $12m figure for all Doric aircraft. It is possible future cash payments for half-life return conditions will be marginally higher than the $12m due to inflation as I would expect some clause along those lines to have been included in the side letter and subsequent agreement.

Should be noted that given the tone of Emirates desire to keep A380's that, in fact, the aircraft will be bought by Emirates. The half life return cash return is an option for Emirates and not a definitive outcome. The $12m provides us shareholders some element of certainty regarding minimum cash return as a base line figure.

The question then arises as to how much money Doric can obtain from scrapping the aircraft.

There is no way whatsoever that Doric will be able to sell the aircraft to anyone other than Emirates. Given the demand for A380's now I would hazard a guess the selling price would be north of $30m/aircraft especially as MSN 016 was an ex-flight test aircraft. However Doric do not have any pricing power so $30m seems a reasonable base-line figure for all sales.

As you probably know the accounting standards do not provide a 'true' picture as discussed in the DNA reports.

There has been significant swings in the exchange rate since September which affects everything! For example they state that he value of the borrowings has decreased by £26 Million due to the 17.7 percent movement in the Sterling / US dollar exchange rate for the period from 1.3138 at 31 March 2022 to 1.117 at 30 September 2022. Well to a some extent that has reversed at todays exchange rate as has the net cash.

Net debt is $53m.

My scenarios are:
Aircraft not sold, 7%
x2 Aircraft returned and the rest sold, 35%
All Aircraft Sold, 52%

My assumptions
Scrap Value $5m
Half Life $12
Sale Price $30m
Cash GBP26.3m
USD/GBP 1.22

I think we are basically in agreement that there remains good value in DNA2 and worse case probable scenario still provides limited upside. More than that depends on our assumptions. Given potential market volatility in H2/23 DNA2 is not a bad place to be!

[abtan]

Thanks Carcosa

If Emirates are the only potential buyers of the aircraft, I wonder whether a fee closer to the half-life + scrap value (=$17m) is therefore more realistic?

In any case, the downside does indeed look minimal from here.

Fingers crossed.

A

[Carcosa]

If Emirates are the only potential buyers of the aircraft, I wonder whether a fee closer to the half-life + scrap value (=$17m) is therefore more realistic?

On first looks it's understandable why someone may think that but in reality that is not the case.

Any seriously unserviceable aircraft is worth considerably less than a serviceable aircraft, and an unserviceable aircraft with no revenue earning potential is practically worthless. That is why some restaurant owners (especially in [url=shorturl.at/euzPR]Thailand[/url] can get a Tristar/B747 for a few thousands of dollars because there remains no commercial value in operating the aircraft (also the high value engines and often the undercarriage are usually not found in these 'cafes').

The valuation actually depends upon the economic value of the future revenues rather than the pure scrap metal/parts value.

Hence DNA1's only A380 (MSN 016) was sold for £25.30m (~$30m) which was an ex-flight test aircraft with relatively poor airframe performance (heavier, less aerodynamically efficient). So using $30m as a baseline sale price seems reasonable to me.

For reference here is a link regarding the various types of valuations used in the aircraft industry and you can see why Doric moved to a 'Soft' valuation a couple of years ago. However, even those soft valuations appear markedly out of step with the real world. New Appraisal valuations are scheduled for H1/23.

[Carcosa]

Engine Valuation

Anyone who has been following Doric for the past few months and years should by now have a very good understanding of what the investment is all about; the potential future rewards and the potential risks.

The following analysis and views are very much detail oriented and are provided for interest. It should not really affect an investors decision to buy/hold/sell Doric shares because its impact on the rationale for investing is minimal.

This is an attempt to look at likely engine valuations for the Doric A380's. However I am having to use the Rolls-Royce Trent 900 valuations as a proxy for the Engine Alliance GP7000 as fitted to the Doric A380's aircraft. This is because I cannot find sufficient data for the EA engine.

Given that both the Trent 900 and GP7000's are unique to the A380's, share very very few parts with other engine types and the overall economics are pretty much the same plus the A380 market share is roughly equal (although within Emirates the ratio of EA/RR is 3:1) I would expect there to be minimal differences between the two engines in terms of valuations although the EA engines may be worth a tad more to Emirates because they have more EA engines than RR.

Using data supplied from the reputable http://www.airfinancejournal.com/magazine (Which I suspect gets a lot of its data from iba.aero) I have compiled the following data.

Code: Select all

Year   Fair Market   Base Value   QEC
2017     14.9           14.9      0.6
2018     14.5           14.9      0.6
2019     11.5           12.25     0.6
2021      5.7            8.55     0.6
2022      3.8            3.8      0.6

What can be seen is the engine valuations were in free-fall from 2018 and a significant divergence between base and fair values occurred during the pandemic. Interesting to note that the Base and Fair market values have converged and the QEC valuation has remained the same for many years. The 2022 data was published mid-year just as the A380's were returning to service so I would hope the decline in valuations has halted, if not possibly reversed by the time 2023 data is published. Fair market valuation fell from $14.9m in 2017 to $3.8m in 2022.

It should be noted that these valuations are of serviceable engines; not scrap. I would expect scrap value to be around 50% of the current $3.8m i.e. around $2m

However the QEC items (Quick Engine Change Items which are the hardware and components needed to quickly build up a provisioned spare engine to a service-ready condition, typically air start motors, Hydraulic pumps, Generators etc which are high value items that can be transferred between unserviceable and serviceable spare engines) are valued at $0.6m and even in a scrap situation will be worth say 75% of the QEC value, say $0.45m

That totals somewhere around $9.4m per ship set.

Additionally, landing gear, Auxiliary Power Unit and Line Replaceable Units will also have some value although largely dependent upon the general market at the time.

Maintenance Costs

Some other numbers that might be of interest are maintenance costs. This would be a key cost input into what drives Emirates decisions as to which aircraft to lease, buy and scrap

As the engines get older and accumulate flights (cycles) the Life Limited Parts (LLP's) need to be changed, these are mostly the big heavy rotating discs that the blades attach to. Currently new LLP's cost $11.15m per engine. This is on top of average overhaul costs of $8.1m per shop visit per engine.

The Mean time between overhaul is 30,000 hours and with a cycle ratio of 8.8 hours that equates to about 3400 flights. Unfortunately I do not have Emirates flight data including utilisation at hand but as a guess I reckon that equates to a planned engine change every 6-7 years or so with a complete LLP change every 10-12 years. (It's a little more complicated than that because its advisable to stagger engine times across the wing and LLP lives relate to multiple parts with several of those parts having different life cycles declared and many engine repairs/overhauls are unscheduled due to various reasons such as modification upgrades, quality issues, performance deterioration etc).

Anyway, bottom line is that under the terms of the lease agreement the engines must have at least the bulk of one shop visit life remaining on them. That means an expenditure of $8m-$15m per engine (say $50m for a shipset).

However there are a couple of wrinkles in this. All the above is based on what is called "Time and Material' and whilst its the traditional way of operating an airline it's not how modern airlines work. They will have entered into a side agreement with the engine manufacturers whereby Emirates would have been paying a monthly fee from day one to the engine supplier with a guarantee that no matter how many shop visits are made Emirates will only pay the same flat rate per month (or hour). These payments are often broadly split into two parts. One is to cover the 'ordinary' shop visits and the other is to pay for the LLP's. Due to the high cost of LLP's airlines will often not pay the LLP portion of the monthly rate because a) damned expensive and b) by their very nature the payments can be planned for years ahead so may as well use the cash flow for immediate operations where they will get a return on the cash.

The other wrinkle in all of this is the fact that there are no second-hand customers for the A380. So even if DNA hold Emirates feet to the fire and insist of full return conditions - which could cost Emirates $100m or more, all that would happen is that Doric get a pristine aircraft that is effectively worthless on the open market.

Hence these 'half life' + cash return conditions are equitable for all concerned; including to some extent the engine manufacturers who may have been paid for LLPs (although no doubt Emirates would negotiate to get some or all of that cash back one way or another).

Without knowing the specifics of what the engine life remaining is for all Doric aircraft at end of lease, whether engine ownership can be transferred between Doric airframes it is impossible to accurately assess the value of each airframe. For example if one airframe at end of lease has pristine overhauled engines versus another with end of life engines then the former will be worth more.

We also do not know the contents of the Doric side letter it terms of its breadth and conditions.

So apart from awaiting further news from Doric (and possibly other Lessors) regarding the fate of the next A380's coming off lease, the http://www.airfinancejournal.com mid year edition should provide some further valuation data points. Am cautiously optimistic we may have reached the valuation bottom and may see valuations experience some modest increases although that may not be reflected until the Doric March 2024 revaluations for A380.

[Carcosa]

DNA was written about in the Wall Street Journal on 3rd January 2023 (January 4, 2023, print edition) in which they noted Elliott Management, invested 11% and 14% in DNA2 and DNA3 respectively.

Additionally they wrote:

If Emirates needs its A380s, the companies it leases them from should probably be better valued. Even after DNA’s deal, the share prices of its sister vehicles imply residual values of roughly $15 million for each A380 they own. That isn’t much if you consider that the companies will get $12 million a plane just to take them back in used condition rather than fully refurbished under the terms of their leases...

...If Emirates returns the jets, scrap value should easily cover the $3 million a plane nominally at risk. Much more likely, it will negotiate with the planes’ owners to extend the leases or buy the planes, opening up the prospect of better returns. Richard Evans, co-founder of Texas-based hedge fund Mara River Capital, which owns shares in DNA3, points out the favorable skew of an investment with a floor under potential losses and an improving likelihood of gains.

[moorfield]

Thanks for your analysis here Carcosa, really interesting stuff.

[Laughton]

Yes, I'm another that takes note.

[Carcosa]

We now have some useful information arising from DNA1 which can be used as a guide for DNA2/3

Doric are expecting DNA1 redemption to occur around 3 February 2023 at or around a price of 60.67 pence per Ordinary Share and with payment on 10 February 2023. That is less than two months from the sale receipts of the aircraft to shareholders getting their cash. I would therefore think that a similar timescale would be reasonable should Emirates buy all of DNA2/3 aircraft; But quite a while longer should any aircraft in those DNA fleets not be sold and they are scrapped, which is what I expect to actually occur.

DNA1
Shares in Issue: 42,450,000
Expected Redemption Price: 60.67p
Shareholder's Total Return: £25,754,415
Aircraft Cash Receipts: £25,300,000
Balance (Cash): £454,415
(Plus a dividend To Be Paid of 2.25p/share)

I had a previous cash estimate of £1.0m for DNA1 (£25m and £10m for DNA2 and 3 respectively). The shortfall is equivalent to about 1p/share. I can only hope the final redemption price is a little bit higher than currently envisaged to keep me honest!

In theory if you can buy DNA1 at less than 62.9p/share which some investors appear to be doing, you 'should' end up in profit in five weeks.

[Laughton]

A bit of coverage in The Times today:

www.thetimes.co.uk/article/daf1ce82-94f ... 9ed1d8d7d3

[Carcosa]

Over the last few weeks I have been selling my DNA3 shares and now have fully disposed of my holding.

On July 18th, 2020 I started this thread with my views regarding DNA3, following a suggestion from a reader from the Avation plc board, in which I identified the key elements for investing in DNA3:

1) Emirates would continue to pay their lease charges
2) No secondary market for the aircraft
3) Residual value which I then estimated to be $15m compared to the then claimed $60m
4) An estimated total return of almost 100%
and shortly followed up with a suggestion that a half-life payment of $10m would seem reasonable (we actually got $12m/aircraft)

Well today from that 35p share price we now have a sp of 56p and a total dividend of 12 x 2.0625 = 24.75p giving a total return of 130%, exceeding my expectations. In actual fact the lowest share price I obtained was 32p give a 152% return.

I have now sold out of DNA3 because the current share price is factoring in an assumption that many of the aircraft are going to be bought by Emirates at a price similar that achieved by DNA1.

It should be noted that the DNA1 aircraft was bought for spares only. Not revenue service.

The risk is that Emirates purchase of DNA3 aircraft may or may not happen and if it does there is no guarantee that $30m/aircraft will be achieved. It is quite feasible that some or all aircraft will be re-leased as per the existing contract. It is a certainty that any new lease rate would be against the end of lease value of the aircraft meaning that for the entire 4 aircraft fleet it could represent a potential income to shareholders of about 3.75p/year. (0.9p/qtr). However there would not be any immediate half-life payments, and a good chance that come end of the lease extension the aircraft would be scrapped as replacement Boeing/Airbus aircraft finally get delivered. Scrap value at that point would likely be lower and half life payments would reflect that.

From Emirates point of view they would place priority on the later delivered A380's compared to the Doric aircraft because newer aircraft would probably require less maintenance expenditure.

Also, should Emirates/Doric announce a lease extension then I would expect investors would sell DNA3 shares leading to a greater capital loss than the potential income could replace. Of course, if such a thing was to happen then it could make investing in DNA3 attractive once again!

There is also the question as to what Doric would want to do with the aircraft/company. It would not be unreasonable to think they would want to divest the aircraft and wind the company down.

So overall there are too many variables i.e. risk, going forward. Having said that, the hype generated by commentators surrounding the A380 could push the shareprice well above book value in the coming months.

As someone on TMF used to say, leave something for the other guy...

I still have a few shares in DNA2 which I see as being marginally more valuable but will look to sell those shares in the coming weeks and months.

[Laughton]

Thanks for all your input on this over the past couple of years Carcosa. I've followed you with a sale of half my holding today but MMs seemingly not keen to offer an online price and best I could do phoning my broker was 54p.

Still a nice increase on the 36p I paid in July 2020 considering the very nice dividends received.

Maybe Friday isn't the best day to sell so will have another go for the balance on Monday/Tuesday. As the saying nearly goes "every penny helps".

I hope that you might alight on another great prospect and decide to share it here.