Aerocentury Internalizes Management - ACY
I have another interesting idea in the aircraft leasing industry: Aerocentury Corp.
Aerocentury is a tiny aircraft lessor headquartered in California. The company owns 25 aircraft, all smaller regional jets and turboprops, plus one engine. Aerocentury focuses on aircraft worth $10-25 million and attempts to lease them for periods of 3-7 years. Lessees tend to be small regional airlines worldwide.
Aerocentury's operating history is lackluster. Over its 21 year corporate existence, the company has always struggled to earn its cost of capital. The company's profits have been wildly inconsistent year-to-year, with periods of strong results followed by mis-steps and losses. The company has occasionally had leases go bad, and recently suffered after buying a few aircraft for which demand proved elusive. But the biggest reason that Aerocentury has always struggled to earn sufficient profits is its relationship with Jetfleet Management Corp. Jetfleet is responsible for managing leasing activities for Aerocentury, and gets paid handsomely for the task. From 2013 through 2016, management fees paid to Jetfleet amounted to nearly 28% of Aerocentury's total operating lease income. Jetfleet is controlled by Aerocentury's largest shareholder.
This onerous external management structure and the resulting depressed profitability is likely the reason that Aerocentury trades at such a gigantic discount to its asset value. At $16.80, Aerocentury is priced at 50% of book value. (And this is after a pretty decent upward move in the stock. For much of 2017 and before, shares traded at under 35% of book value.) However, the company is in the process of unwinding this structure.
Aerocentury is in the process of buying Jetfleet and fully internalizing its management. The company will pay Jetfleet's owners $3.5 million in cash and 129,286 shares of Aerocentury stock. This is a good deal for Aerocentury. At $16.80, the purchase price for Jetfleet works out to $5.7 million, which is 3.4x Jetfleet's estimated 2017 operating income. The company estimates Jetfleet's 2019 operating income will be $2.0 million. Assuming a 30% tax rate for Aerocentury, this would add 91 cents per share to Aerocentury's annual net income. The resulting increase in profitability might convince investors to value Aerocentury shares closer to book value.
The successful completion of the acquisition is not in question with Jetfleet's controlling shareholder in favor. The transaction has taken a little longer than expected. Aerocentury had not expected to bring the issue to a shareholder vote, but was ultimately required to do so by law. That accomplished, the acquisition should be completed this year. Integration risk is minimal, given the existing close relationship.
Internalizing management will unquestionably benefit Aerocentury's profits and clean up the company's principal-agency conflicts. However, investors should still view the company with a skeptical eye given its history of poor results (even after adjusting for Jetfleet's fees) and its operating model. As I mentioned before, Aerocentury's lessees are regional airlines worldwide. Many of these are not "investment-grade" carriers and there is a risk of non-performance. The airline industry is cyclical and these carriers are at the end of the whip, feeling the effects of fuel costs, local recessions, and other headwinds most acutely. Aerocentury is also feeling the effects of rising interest rates, paying much more than before to finance its fleet. The company lends long and borrows short, so spreads will be compressed until leases reprice at the end of their terms.
Aerocentury is ultimately not for me, but more enterprising readers may find the company's shares too cheap to resist.
Alluvial Capital Management, LLC does not hold shares of Aerocentury Corp. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.
Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.