A Short Memo on Avation Plc. (LSE:AVAP)
A small aircraft lessor mistakenly valued as a going concern.
Market Capitalization: £85m
Avation is a small aircraft lessor and is the only one of its kind in the London Stock Exchange. Before Covid-19 the company’s fleet peaked at close to 50 aircrafts. Nowadays, however, the fleet has been reduced to 35 planes because of a series of sales of unused planes as they emerged from the pandemic. Therefore, Avation is now a sub-scale aircraft lessor with a significant maturity wall in FY27 and unadvantageous access to financing. Perhaps for these reasons it trades at half of book value. However, Avation holds a very timely, valuable fleet and other assets as well as a new compelling majority shareholders. The natural path for $AVAP is to sell itself to a bigger lessor or in parts. Jeff, the CEO, has considered this in the past and may revisit this alternative.
Their fleet consists of the following:
1 Boeing 777-300ER
1 Airbus A330-300
6 Airbus A321-200
2 Airbus A320-200
5 Airbus A220-300
16 ATR 72-600
4 ATR 72-500
Additionally the company holds 28 purchase rights and is currently expecting orders for 2 ATR 72-600. The rights are specially valuable these days because Avation negotiated in the past an inflation price escalation limit with ATR which is lower than the realized aircraft inflation and increased demand doe ATR 72-600 has caused a surge in their market values. Previously the company has made “millions” from these spreads and Jeff has expressed in recent investor calls that he is open to do the same this time. In 2023 they sold one of their oldest ATRs for a 15% premium to book value and Jeff added “it's a very very good market to sell aircraft.”
The rights are non-transferable. However, there are ways to bypass this provision. In the past, Avation has ordered the plane and entered into a contract with another party to transfer it immediately when the aircraft is received. Hence, monetizing the rights. Also the rights must be exercised at least 18 months in advance, but I believe it is possible to negotiate earlier slots.
The aviation industry has a shortage of planes majorly driven by order cancelations to OEMs during the pandemic. As such, manufactures are struggling to meet demand and market prices for aircrafts have drastically increased. This is specially true for widebodies and surely varies by plane model.
ATR prices and lease rates have likewise increased and there are additional reasons to believe values will remain high at least in the short term. Bombardier in 2021 stop manufacturing the only competing aircraft to the ATR 72-600, the CRJ900, and now ATR has to replace that volume with an already lower than historical production capacity as they emerge from the pandemic. ATR targets to produce 40 aircrafts this year and 80 by the second half of the decade, which is closer to the levels they produced in the past. In March of last year, Soeren Ferre, who used work at AerCap and Airbus and is now the CCO at Avation, stated that in the first half of FY22 there was an oversupply of ATRs as there had not been a full recovery from covid. However, domestic traffic has increased drastically compared to international and Soeren argues there is now a shortage of ATRs. He continues saying that these days they are getting 2 calls per week looking for ATRs and that the replacement cycle and other manufacturers ceasing production are driving a shortage of new aircrafts. He lastly adds lease rates increased 20% in the past 6-8 months from 60-65k to middle 80k. Further demonstrating the current robust demand for the airplane model, last year all the received strategic enquiries received were about the ATR72-600.
Other airplane models like the A220 are also very valuable today. The company owns 5 of them.
“But yeah, (..) the valuation [has] gone up, I would say that all of our A220s are certainly worth more than what we paid for them. Does it make selling them in the track of proposition? Well, they're really good assets, probably best investment in the world at the moment in that sector.” - Jeff
As shown above, the opportunity in Avation dissipates if the purchase rights are excluded from the balance sheet. The company then seems to be close to fairly valued. Other substantially higher quality lessors like AerCap and Air Lease deservingly trade closer to book value. Bigger competitors have access to substantially cheaper financing, better fleet, and other scale benefits. The market implies the purchase rights have no value and will expire worthless as Avation would have to almost double their their fleet size in the current unfavorable environment. However, the market is not giving any value to the new majority shareholders at Rangeley Capital and Jeremy Raper who own 25% of the company and could crystallize the valuable fleet and rights in the short to medium term. The group acquired the shares from former majority shareholder Oceanwood Capital for substantially bellow the current share price.
Jeremy has expressed ways Avation could monetize its assets in this ideal time. The investment strategy of these fellows would suggest that they are not hopping to passively own an aircraft lessor, but rather push for a liquidity event. Unloading the share in the market would be a hassle for them and all shareholders given low liquidity. As such, they must intend to exit through a full sale. Jeremy has emphasized he intents to maximize value for all owners, so it would be devastating for his record if he decimated all minorities by selling their stake in the open market and pushing the price downward for at least many months. I trust they have a solid plan.
Jeff owns 18% of Avation and already tried to sell the company before the pandemic but the strategic review stopped because of the virus. Now that the fleet has shrunk significantly and access to reasonably priced financing is at risk, it is a perfect time to reconsider monetizing their timely valuable assets. After the new shareholders acquired their stake, it was coincidentally revealed in the AGM that the company was approached by a broker during the summer about the possibility of a takeover offer. The CEO has expressed many times that they are open for a sale at the right price, so the new shareholders don’t have to impose directionally conflicting proposals.
Subscale lessors are typically acquired by bigger ones because of their structural cheaper financing advantage and even Jeff has emphasized this point in a Bloomberg interview last year.
“so you'll see more consolidation and I I'm shocked that we're not seeing more investment grade lessors. Not just by the sub investment great ones, because it's an obvious trade, right? It's, you know, you've got a lower cost of funds, therefore, you're gonna make more money.”
Another quote from the same interview:
“the investment grade (…) should be buying everything they can because clearly, the supply channel issues, the aircraft deliveries are not going to go away in the next few years, so they should be grabbing as much existing aircraft as they can, as they can finance at a reasonable price, you know, we're looking at a lot of trading opportunities, you've made a fortune out of literally trading aircrafts”
He has also highlighted their troubling access to accessible financing markets.
“the cost of financing, what we have found is we are not an investment grade company, we are bellow that. So the unsecure market the bonds are very expensive.” He added that the bank market for this time is “still” viable.
Avation’s unsecured bonds are rated CCC- and mature in FY27, while their secured bonds are B-. Contrarily, higher quality competitors like AerCap and Air Lease are rated BBB. 95% of the debt is fully hedged or fixed rate.
I think there is a strong rationale for selling Avation. The company is in a weak competitive position and coincidently holds assets which would be substantially more valuable in a sale than what the market will maybe ever pay for Avation. Furthermore, the company has historically targeted new aircrafts but the pandemic further worsen their position. The average age of their fleet almost doubled from 3.4 years in 2019 to now 6.4 years. I believe this furthers adds to the logic for selling the company now.
As aforementioned, Avation has a significant maturity wall in FY27. Specifically, their unsecured notes will mature and the company will have to refinance or explore other options beforehand. According to Jeff the unsecured market is not viable now because it is too expensive, so the company has limited options. He expects refinance in the near future “once rates stabilize”, if they do. Regardless, the company will likely end with a not-cheaper cost of financing. There are still alternatives that could lead a cheaper refinancing like green loans and a lower LTV ratio driven by the increase in market value of the fleets.
In a monetization event shareholders could double their money. In the meantime the stock is trading assuming the company will remain publicly listed in perpetuity and seems to ignore tailwinds in the industry. The long term position of the company has worsen, though, given the issues highlighted before. So the current share price ignores any value the new shareholder may provide and optionality with the purchase rights.
In addition to looking at the balance sheet, it is evident an acquirer with scale would materialize substantial savings by quickly looking at the P&L. Bellow are 2 expenses where a portion of them would flow to earnings for a prospective acquirer. (1) Overhead and (2) legal expenses. The biggest saving would surely come from refinancing, which could save an additional ~$20m/year. Avation currently spends ~$60m/year on interest payment. An investment grade lessor could likely refinance at rate 200bs less than Avation’s ~6.5% weighted average rate. Therefore it is hard for the company to be sold for less than the book value, or 50% more than today’s stock price, if it is broken down into pieces even using very punishing assumptions.
Main Risks
I am concerned about the duration of this investment given that the purchase rights cannot be transfered. However, I think the new shareholder are not planning to use the traditional methods to monetize them. They would need to wait years until all the rights are fulfilled and sold, so I expect them to use a quicker method.
I am also unsure how much the company could make from the rights. Avation doesn’t disclose the specific price for which they can buy the ATR72-600s. They are accounted using Black Scholes. Hence, the rights could be worth more or less. Also, given the company owns more than half of the ATR production capacity in purchase rights, will they be forced to receive lower rates from some of the rights because the planes wont be received in 2 years? I do not know if the Avation can realistically exercise all of the rights to be receive all aircrafts in the next 18 months.
Note that the fleet is accounted using fair value accounting and are stated 7% above cost and impairments. I am less concerned about this because the company has already sold an old ATR72-600 for 15% more than book value.
Keep in mind this company besides being of inferior quality than other bigger competitors it it still more levered which adds another layer of risk.
Sorry for the unusual descending order in the x axis!
I like this opportunity and have a position in it. The market is attributing no value to the new shareholders, which I believe will imminently lead to a liquidity event. Even if they are surprisingly passive, the company is trading for a reasonable valuation and has many tailwinds and other events that could incentivize Jeff to reconsider alternative options. This includes the current attractive aircraft valuations in the industry and the maturity wall in 2027. If he was in the processes of selling the company before Covid-19 when some have said that ATR lease rates were in “distress”, it seems reasonable to consider it now again.