Thursday, March 21, 2013

First Aviation, a catalyst wrapped in a mystery

Luck is often described as where preparation meets opportunity.  I'd like to consider myself lucky with my First Aviation Services (FAVS) investment, but it's really too early to know.  I prefer simple investments if possible, they're easier to understand, and eliminate opportunity for mistakes.  But often opportunities lies in hard to understand or complicated situations, First Aviation Services qualifies as both.

Sometimes I get emails asking where I find my ideas, some readers believe I have a secret source for finding undervalued ideas.  Unfortunately I don't, I just do simple things often enough that I eventually become lucky.  Wednesday I was browsing the OTCMarkets.com website and noticed on the front page under that a OTC - Limited Information company had sold a division.  I clicked the news link and noticed that the stock hadn't traded any shares, and the price was unchanged.  I smelled opportunity.

After reading the news release I started to realize why there was no quick market reaction to the divesture news.  The release had no price information, and it was difficult to understand exactly what was being sold.  Beyond that the company never broke out any historical sales information making it even harder to guess what the specific division might be worth.  I took this as a challenge, with the company selling for less than half of book value, and for less than NCAV I realized there might be considerable value with the company selling a division.

The history

Before estimating what the Aerospace Products International (API) division might be worth we need to go back a little in time and look at how the company became what they are today.  In some cases history is important, with First Aviation understanding their history is vital.

First Aviation is an aviation company, they specialize in parts supply and repair.  The company is really three independent subsidiaries, Aerospace Products International (API), a parts and service distributor.  Piedmont Propulsion (PPS) the last remnant of Piedmont Airlines, they specialize in aircraft overhaul and maintenance based out of their North Carolina location.  The third subsidiary is Aerospace Turbine Rotables (AeTR), which designs and manufacturers aviation components such as landing gear, wheels, brakes, and other components for propeller aircraft.

When most people think of propeller aircraft they think of recreation aircraft, it's worth noting that First Aviation's market is mainly turboprops and smaller corporate propeller aircraft.  They are not selling parts to the recreation flyer, but rather airlines and companies with corporate aircraft.  The company recently was certified to work on the Bombardier Dash-8 turboprop (Q400).

Up until 2009 the company was only the Aerospace Products International division.  Towards the end of 2009 they entered into a transformative transaction, from which we can extrapolate details regarding the division sold.

In 2009 the company entered into a transaction with a company familiar to most readers TAT Technologies (TATT).  TAT purchased $750k worth of First Aviation preferred shares, and 288,333 shares of class B non-voting stock.  In exchange for the investment First Aviation received Piedmont Propulsion.  The transaction is a little unusual but at this point it's still straightforward.  Here are where things get strange, simultaneously as the company entered into the transaction with TAT they also entered into another one with Kelly Aerospace.  The company used the TAT investment as guarantee for a loan to purchase the AeTR division from Kelly.

Let me recap the last paragraph if your head is spinning.  First Aviation purchased PPS from TAT, but didn't pay right away.  Instead they issued new stock and preferred shares to TAT that have to be held for five years.  Then they took that equity injection and used it to guarantee a loan to purchase AeTR from Kelly Aerospace.  The end result of the financial engineering is First Aviation before March 20th.

The terms of the deal in 2009 provided a balance sheet for PPS, AeTR, and API.  From that balance sheet here are the equity values for each division:
API is on the left, PPS in the middle, and AeTR on the right.

At the time of the merger API had a book value of $13m, PPS of $7.9m and AeTR of $4.8m, keep in mind that API is what's being sold currently.  When I looked at this stock First Aviation had a market cap of $8m.

The results haven't been all that great since the 2009 merger, demand fell off 59% over the past three years and the company went from profitable operations to reporting losses.  Additionally the company discovered that PPS's results were overstated at the time of the merger.  The company thought they were buying a profitable company but were stuck with a loss making division instead.  The current management has been in fire fighting mode but their efforts have been successful with the company reporting profits the past two years.

So what is Aerospace Products worth?

Given everything above the task is to consider what is API worth, and at the current price (or the price I paid) is it a savvy buy?

Before looking at what API is worth I want to highlight why this is worth a reasonable speculation.  The company was trading below NCAV meaning that my investment was protected by liquid tangible assets.  Even with the complicated capital structure, and the outstanding debt if the company were to sell all of their current assets the amount received would have been greater than the level I invested in.  From that foundation I knew that my investment was protected and that most likely whatever value the company receives for API is greater than what I paid.

My starting point was the equity amount for API from 2009, which was $13m.  The company hasn't performed up to expectations since then, and assets have been depreciated over the past four years.  After considering that I thought that API had to be worth at least $6-8m.  I speculated that the company would receive at least 50% of it's marketcap in cash from this deal.  And given that the company will continue to own the two most profitable divisions after the sale things were looking up.

The company's book value is $23 per share, and it was trading at $9 when I purchased shares.  I estimated at $9 and below NCAV I had a hard time going wrong buying.  The company is probably worth book value, but this transaction will at least help unlock some of that value.

The company has been paying down debt at a rapid pace and I would presume proceeds from the sale would be used to pay down more debt thereby increasing book value.  Investors will own a company with a vastly improved balance sheet, and will continue to own the remaining two profitable divisions and hold a small equity interest in API.  The purchaser of API is a private equity group from Cleveland Ohio that specializes in aviation turnarounds.  If they are successful the equity interest that First Aviation holds could become increasingly valuable.

Of interest to likely no one but myself is that the private equity firm buying API is located one street away from Ancora Advisors, the fund that has purchased an activist stake in Solitron and is pushing for a $1.50-2.00 p/s dividend.

In the end I picked up a small position in First Aviation, I'm now patiently awaiting updated financials showing what the company will look like post-sale, and what the price of the sale was.  It's worth noting I've contacted the CFO asking when we might expect to see the updated financials and I'm still awaiting a response.

Talk to Nate about First Aviation

Disclosure: Long First Aviation

13 comments:

  1. Nate - nice find. I agree with you that there is no secret to finding interesting opportunities. Takes discipline and a sharp eye.

    I'm intrigued by the opportunity (also noticed that FAVS price rose from $9 to $11 already). How concerned were you about the $3m note provided by the CEO to the company July 2012, and the detachable warrants for 107k shares at a strike at $7?

    FAVS price at the time was around $5. In hindsight, seems like a GREAT deal for the CEO, but not such a great deal for shareholders. Do you think this says anything about possibility of future dilution to shareholders, which would in-turn affect the margin of safety?

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    1. Sorry for the slow response..

      I saw the note when I was reading their reports, I'm split on it. Part of me is glad that the CEO is willing to contribute cash, but part of me is also concerned that he got a really nice deal. If I remember correctly these guys aren't making a ton of money, I think the CEO makes $190k.

      I'm not sure if the investment was a cautious sign of faith in the company, or they needed the cash at the time.

      What I'm really impressed with is the current management's team's focus and desire on cleaning up the balance sheet. They're delevering fast and getting rid of API the one marginally profitable division. I don't know where things go from here, but I'm happy to wait.

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    2. Turns out First Equity is the main investor in FAVS. The manager of First Equity is also the Chairman and CEO of FAVS. Despite the close ties (and even shared offices) between the two companies, I believe management is capable, and probably fair and ethical.

      First Equity's corporate presentation is quite impressive: http://www.firstequity.com/uploads/FEG_overview.pdf

      I'm relatively new to your blog and the value / special situation community. Look forward to sharing ideas and analysis with you...

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    3. Thanks for the link, very interesting indeed. I think this is a fascinating story, I originally purchased on a safe speculative basis, but the more I research the more I like this.

      The company sold API for $16.9m, they're delevering, and they have a management team in place that knows about value creation, and isn't afraid to sell off divisions. At $10 this is almost a no-brainer investment, there's a tangible 50% upside at an absolute minimum, plus whatever operational changes the management can put in place.

      Glad you found me, thanks for the insightful comments, hope you'll continue to contribute!

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    4. Agreed - I occasionally post at undertherockstocks.tumblr.com and @undertherock3 on Twitter. Have a great weekend.

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    5. Nate - I've been looking out for 2012 financials from FAVS to verify the API sale price. Did you get the $16.9m figure from the company (that would be a pretty nice return for the business)? Any other indication from the company on what the uses of cash may be after $4.2m debt is paid (acquisition, buyback, dividend, etc)?

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    6. The sale price is public but hidden…guess it's time to expose it. Since TATT owns such a large stake in FAVS they filed an 8-k regarding the sale. In the 8-k they have the sale price ($16.9m) and note that $15.9m of the sale proceeds will be used to pay down debt.

      I tried to contact the CFO but have heard nothing back.

      I have no idea what things look like going forward. I want to see what assets they end up divesting with API and how the business looks once this is done. I like that debt is paid down and they're left with profitable divisions as well. I think this is an all around good transaction.

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    7. Nice find, truly looking under the rocks ;) to find this info. The explanation of the $11.5 write-down raises some questions about what book value of the remaining business will be. Will be answered when they publish the 2012 report. But, you're right, the net result is that the business will be better positioned and should give management liquidity for value-creating (hopefuly shareholder friendly) moves.

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  2. Great work Nate, and congrats. The question I have for you is whether you put enough money in it to make it worth your time?

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    1. The position is roughly 1%, and based on the $16.9m sale price against my $9m purchase mcap I think this is probably worth $25-30m. In other words about 2.5x what I paid.

      I like to think of research time value, I probably spent two to three hours researching this. If I get 2.5x on my investment the value of my time spent researching expressed at an hourly rate will be close to 50x what I make at my day job.

      Granted I won't retire on this sale lots of returns like this over the years does add up, that's always the goal!

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  3. Rule 1 : Follow the Gurus
    rule 2 : if Mr. Market serves you at "cheaper than Guru's buy price" , take it

    1. You seem to be a guru at this ....

    2. Part a.
    the market is close to where you bought
    http://investing.money.msn.com/investments/stock-cash-flow/?symbol=FAVS

    2. Part b... will it get well below where you bought ?? hmm then it MAY be worth my 1% or so ....


    TIA
    Regards

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  4. The report is out now....First Aviation Reports Profitable First Quarter 2013....what is your read now?? Thanks

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  5. FAVS just announced a going-private transaction through a reverse stock split. Minority shareholders are going to be cashed out at $8.40/share. Do you still have a position in this?

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