ACE Aviation ACE.A (TSX) W
September 11, 2006 - 2:06pm EST by
ladera838
2006 2007
Price: 31.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,750 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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  • Potential IPO
  • Canada
  • Transportation
  • Sum Of The Parts (SOTP)
  • Airline

Description

ACE Aviation (ACE) is a significantly undervalued asset play, with catalysts already in motion to eliminate the asset discount over the next six months.  An investment of $31 in one share of ACE today should result in distributions of $25 (in units of its publicly traded Jazz and Aeroplan subsidiaries) over the next six months, publicly traded shares in Air Canada worth $15-25.  Expressed differently, a net outlay of $6 over the next six months gets you Air Canada shares worth $15-25.

 

ACE is the parent holding company of various transportation and related service companies and partnerships including: Air Canada, AC Cargo, ACGHS, Touram (Air Canada Vacations), and ACTS.  In addition, ACE owns 79.7% of Jazz Air and 75.3% of Aeroplan.

 

ACE is traded under the ticker ACE.A (for foreign investors) on the Toronto Stock Exchange (TSX), but its ADRs are easily tradeable in the U.S. under ACEAF through both full-service and discount brokers.  Jazz and Aeroplan also trade on the TSX.

 

After I wrote ACE up, I realized that it had previously been written up by roch801 in December 2004 under ACEAF (in fact, I had asked a follow-up question!).  However, roch801’s focus was on Air Canada, while my focus is on all the assets of ACE.

 

All analysis below is in Canadian dollars, which currently trade at approximately US$1 = C$1.12

 

Please note that I currently have a long position in ACE, but this may change at any time.

 

BACKGROUND

 

In early 2003, Air Canada's revenues were severely impacted by: (i) the advent of the Iraq war; (ii) the SARS outbreak; and (iii) the rapid expansion of WestJet and other low-cost carriers. New directives requiring Air Canada to file new actuarial valuations of its ten registered pension plans and to make retroactive current service contributions to eight of those plans in respect of 2002 were the last straw, pushing Air Canada into bankruptcy.

 

On September 30, 2004, ACE's predecessor corporation and its now wholly-owned subsidiary, Air Canada, and other subsidiaries, emerged from creditor protection.

 

BUSINESS

 

In terms of the airline industry in general, ahab931 does a great job making a positive case for the future performance of legacy carriers in his recommendation of United Airlines (UAUA) and the thread that follows.  I will discuss the specific investment opportunity at ACE.

 

ACE operates as a holding company for its various subsidiaries, with the explicitly stated goal of maximizing the value of each of these subsidiaries.

 

ACE's businesses are operated as four reportable segments which include: (i) Transportation services; (ii) Jazz; (iii) Aeroplan; and (iv) ACTS

 

(i)  Transportation services:

 

Transportation services includes Air Canada, AC Cargo, Ground Handling and AC Vacations.

 

Air Canada:

 

Air Canada is Canada's largest domestic and international full-service airline and the largest provider of scheduled passenger services in the domestic market, the transborder market and each of the Canada-Europe, Canada-Pacific, Canada-Caribbean/Central America and Canada-South America markets. According to OAG data in 2005, Air Canada ranked as the 14th largest carrier in the world, based on ASMs.

 

ACE currently owns 100% of Air Canada, but is exploring an IPO in late 2006.

 

Cargo Services:

 

AC Cargo LP and Air Canada provide Cargo Services on domestic, transborder and international passenger flights and with dedicated all-cargo freighter aircraft. AC Cargo LP and Air Canada are Canada's largest providers of air cargo services as measured by cargo capacity. Combined, AC Cargo LP and Air Canada provide direct Cargo Services to over 200 Canadian and international destinations and have sales representatives in over 50 countries.

 

Ground Handling Services:

 

ACGHS LP (and its United States subsidiary, ACGHS US Inc.) and Air Canada provide Ground Handling Services to numerous airlines, including major foreign airlines at Canadian and international airports. These services include passenger check-in, gate management, baggage and cargo handling and processing, as well as aircraft ramp services.

 

Touram LP / Air Canada Vacations:

 

Touram LP conducts business under the trade names Air Canada Vacations. Air Canada Vacations is a major Canadian tour operator, offering a variety of leisure vacation package options which include air transportation supplied by Air Canada and its Star Alliance® partners, hotel accommodations, cruises, Aeroplan Miles and airport transfer/car rentals to popular destinations. Netair, a national consolidator that sells surplus seat inventory aboard Air Canada exclusively to travel agents, is another division of Touram LP.

 

 (ii)  Jazz (JAZ on the TSX):

 

Jazz, the Corporation's regional carrier, provides service to lower density markets and to higher density markets at off-peak times throughout Canada and to certain destinations in the United States, and forms an integral part of Air Canada's domestic and transborder market strategy. Jazz's regional network connects passengers and provides valuable traffic feed to Air Canada's mainline routes.

 

On February 2, 2006, Jazz Air Income Fund completed its IPO; ACE holds a 79.7% ownership interest in Jazz.

 

 

Based on OAG data, as measured by ASMs, ACE estimates that it provides approximately 61% of the Canadian airline industry's overall domestic scheduled capacity, 42% of the overall transborder scheduled capacity, and 46% of the overall scheduled international capacity between Canada and Europe and Canada and Asia.

 

 

(iii)  Aeroplan (AER on the TSX):

 

The Aeroplan Program is one of Canada's longest standing loyalty programs, founded in 1984 by Air Canada, to manage the airline's frequent flyer program.   Aeroplan provides its commercial partners with loyalty marketing services to attract and retain customers and stimulate demand for these partners' products and services.

 

On June 29, 2005, Aeroplan Income Fund completed its IPO; ACE currently holds a 75.5% ownership interest in Aeroplan

 

(iv)  ACTS (AC Technical Services):

 

ACTS LP is a full service MRO (Maintenance, repair and overhaul) organization that competes on a global basis, with major maintenance facilities in Montreal, Vancouver, Winnipeg and Toronto.  ACTS provides MRO services for Air Canada and over 100 other customers worldwide.  ACTS has the ability to significantly increase its business volume with its current infrastructure and facilities. ACE's strategy is to continue to leverage ACTS LP's unused capacity by developing relationships with third party customers, especially American carriers that have recently started to outsource their maintenance work.

 

A monetization of ACTS is expected in early 2007, probably through a sale.

 

 

ANALYSIS

 

Based on various analyst reports, we have the following estimates (in C$ millions):

 

 

2006

 

2007

 

Transportation EBITDAR

 $        1,000

 

 $       1,140

 

Jazz EBITDA

               170

 

             170

 

Aeroplan EBITDA

               220

 

             220

 

ACTS EBITDA

                 40

 

                90

 

ACE EBITDAR

           1,430

 

          1,620

 

 

 

 

 

 

Transportation services includes Air Canada, AC Cargo, Ground Handling and AC Vacations.

 

 

 

 

 

Also, as of June 30, 2006 (in C$ millions),

 

 

 

 

 

 

 

 

 

 

Cash

 

Debt

Net debt

Transportation

 $        2,214

 

 $       3,502

 $     1,288

Jazz

               110

 

             115

                5

Aeroplan

               498

 

                   -

          (498)

ACTS

                    -

 

                   -

                 -

ACE convertible debt

 

 

             247

           247

ACE total

           2,822

 

          3,864

        1,042

ACE convertible preferred

 

 

             157

 

ACE total debt + convertible preferred

 

 

          4,021

 

 

 

 

 

 

Transportation Operating Leases (7 x $660 rent) capitalized

 

                2,640

 

Transportation Net debt

 

 

 

        3,928

 

 

 

 

 

 

 

 

 

 

Valuation

 

 

 

 

 

 

 

 

 

In C$ millions, except per share amounts

2006

 

2007

 

 

 

 

 

 

Air Canada

 

 

 

 

EV @ 5.5 x EBITDAR

$5,510

 

$6,300

 

Net debt

          (3,928)

 

        (3,928)

 

Equity value to ACE

$1,582

-

$2,372

 

Value per ACE share

$13.07

 

$19.60

 

 

 

 

 

 

Jazz

 

 

 

 

Jazz share price

$9

 

 

 

# units owned by ACE (79.7% = 99.4)

99.4

 

 

 

Equity value to ACE

$894.6

 

 

 

Value per ACE share

$7.39

 

 

 

 

 

 

 

 

Aeroplan

 

 

 

 

Aeroplan share price

$14

 

 

 

# units owned by ACE (75.3% x 200)

150

 

 

 

Equity value to ACE

$2,100.0

 

 

 

Value per ACE share

$17.36

 

 

 

 

 

 

 

 

ACTS

 

 

 

 

EV @ 6.5 x EBITDA

 $           250

 

 $          580

 

Net debt

                    -

 

                   -

 

Equity value to ACE

               250

 -

             580

 

Value per ACE share

$2.07

 

$4.79

 

 

 

 

 

 

Total ACE equity value

 $        4,827

 -

 $       5,947

 

Options proceeds (3.35 million @ $23.87)

80

-

80

 

Net ACE equity value

4,907

-

6,027

 

 

 

 

 

 

Fully diluted ACE shares (millions)

               121

 

 

 

 

 

 

 

 

Per share ACE equity value

 $        40.55

 -

 $       49.81

 

 

 

Note that if ACTS is sold, the cash proceeds would probably end up on the balance sheet of Transportation services, leading to a $2-5 increase in its value per ACE share.

 

The multiple for Transportation services is justified below in Valuation Metrics.  Analyst reports use 6.5x for ACTS, but in any case, it is a small piece of the pie.

 

 

TAXES

 

ACE has pre-tax NOLs of approximately $6 billion.  The company plans to leave Air Canada with half those NOLs post-spinoff, so the remaining $3 billion in NOLs should allow for a tax-efficient spin-off of Jazz and Aeroplan and the sale of ACTS. 

 

While distributions of units in JAZ and AER are made on a tax-free basis to Canadian shareholders, U.S. non-"qualified purchasers"of ACE will be paid the cash proceeds by selling off the relevant JAZ and AER units, which will be conducted on an orderly basis by ACE.

 

 

VALUATION METRICS

 

EV/EBITDAR of 5.5x for Air Canada seems reasonable versus the comparables:

 

 

TTM EV/EBITDAR

American Airlines

7.3x

 

Continental Airlines

8.5x

 

British Airways

4.3x

 

United Airlines

9.2x

 

US Airways Group

9.7x

 

Alaska Air

10.7x

 

Average

8.3x

 

 

Note that the multiples for the comps are somewhat overstated, given the airlines are likely to improve 2006 EBITDAR versus TTM, with likely significant improvements for United and US Airways, having recently emerged from bankruptcy.  Also note that Air Canada will retain $3 billion of NOLs as an independent company.

 

RISKS

 

The risks associated with investing in airlines are well known.  The company provides a comprehensive set of risks on pages 60-67 of its 2005 Annual Report (available at http://www.aceaviation.com/en/investors/documents/2005_ar.pdf)

 

One can mitigate the risk here via arbitraging the basis of your future Air Canada and AC Technical Services stock down to C$6 by buying ACE and shorting JAZ and AER as shown below:

 

Purchase ACE

 $              31

 

 

Short 0.82 shares JAZ

                  (7)

 

 

Short 1.24 shares AER

               (17)

 

 

 

                   6

 

 

 

 

 

 

As shown above, this stub should trade for

 $              14

-

 $            26

providing a total return on the stub of

125%

-

311%

 

 

 

Catalyst

According to the earnings press release on August 11, 2006,

“The Board has identified the following initiatives, market conditions permitting, to create further value:
• Launching of an initial public offering (IPO) of a minority stake in Air Canada in late 2006;
• Commencing a process in late 2006 to monetize ACTS;
• Pursuing opportunities that realize the value of its investment in Aeroplan and Jazz.”

On August 31, management announced that ACE has received court approval for a $2 billion capital reduction (which should allow the spin-off of significant parts of its Jazz and Aeroplan ownership).

On August 31, management filed a proxy statement to seek approval at an October 5 special meeting to distribute additional Aeroplan shares to ACE shareholders.

As part of ACE’s emergence from bankruptcy in September 2004, Cerberus invested $250 million in 5% PIK ACE preferred stock, convertible into 10.22 million ACE shares on 12/31/2005, and has three board seats.
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