|Shares Out. (in M):||81||P/E||0||0|
|Market Cap (in $M):||35||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0||0|
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CHC Group is one of only two global commercial helicopter operators that provides crew transportation to the offshore oil and gas (O&G) industry as well as Search and Rescue (SAR) and Emergency Medical Services (EMS) to various government agencies. The market's current aversion to CHC Group can be summarized by its:
· exposure to the crash in oil prices and overall pessimism on the future of the offshore O&G industry
· historical inability to generate free cash flow or even earn its cost of capital
· highly leveraged balance sheet and additional off balance sheet debt in the form of operating leases
· management’s unwillingness to provide any form of forward guidance
· bankruptcy fears
CHC equity is a very assymetric way to capitalize on the current dislocation in oil related stocks without needing to have a particularly strong view on the near to medium term direction of oil prices. Alternatively CHC debt is a bet on the ongoing utility and earnings power of its newly refreshed fleet and its duopolistic position in an industry that functions as a crucial cog in the offshore oil complex. CHC’s only global peer, Bristow Group, has also demonstrated the inherent strength and resiliency of the underlying business through prior cycles and Bristow’s success (and historical market valuation) shows the potential for what CHC can achieve with a strengthened balance sheet, a new management team, access to cheaper financing, and a drastically more accommodative leasing environment.
CHC currently has an adjusted enterprise value of ~$3bn which is slightly below the $3.1bn third party valuation of its helicopter fleet. This suggests that the market is assigning no value to its network of 70 bases in over 20 countries, its future and existing contracts and customer relationships with offshore O&G firms, its portfolio of operating certificates to operate in jurisdictions all around the world, its long term SAR and EMS contracts with various commercial and government entities, its industry position in a global duopoly, its long term safety record, and its entire Heli-One Maintenance, Repair, and Overhaul (MRO) business.
The investment thesis and variant view is that:
· CHC will survive this downturn and it's longer term prospects and fundamental business have not been permanently impaired by the near to medium term challenges in offshore Exploration and Production (E&P)
· PE firm Clayton, Dubilier & Rice’s preferred equity investment along with its expertise in helping CHC secure alternative sources of cheaper financing like the recently signed ABL facility will provide ample liquidity to ride out this downturn
· The unprecedented amount of capital and competition that has entered the helicopter leasing market in recent years will aid in CHC’s ongoing discussions with its operating lessors and allow for increased flexibility with its leasing obligations
· The low to no growth macro environment will focus CHC’s new management team primarily on lowering its fixed costs and improving its capital efficiency as opposed to the prior management teams unbalanced and uneconomic drive to increase EBITDAR
· The majority of CHC’s legacy aircraft write-downs have been incurred and new tech aircraft now represent 85% of CHC’s total fleet value – the earnings power of this next generation fleet should more than support CHC’s fixed charge obligations
· There is additional liquidity optionality in the potential future divestiture of the MRO business
CHC Group began in 1987 when former CEO Craig Dobbin merged three Helicopter operators with his own company, Sealand Helicopters, to form Canadian Helicopters whose parent company was renamed CHC Helicopter Corporation. Dobbin grew CHC through a series of acquisitions in the 1990's and 2000's to become the largest global provider of helicopter transportation.
· In 2008, CHC was acquired by First Reserve, a PE firm exclusively focused on the energy industry, in an all-cash transaction for an aggregate consideration of CAD$1.5 billion which implied an adjusted enterprise value of CAD$3.7 billion making it the largest-ever buyout in the oilfield services industry at the time. This valued CHC at over 11x FY2008 EBITDAR (currently trades for <6x) and included $800mm of debt and $1.4 billion in lease adjusted debt.
· In 2010, First Reserve chose William Amelio, the former CEO of Lenovo Group to replace retiring CEO Sylvain Allard.
· In January 2014, CHC returned to the public markets in a poorly received $310mm IPO. CHC initially expected to sell 29.4mm shares for $16-18 but later reduced the range to $12-14 and ultimately priced 31mm shares at $10/share.
· In August 2014, CHC announced that CD&R would invest up to $600mm in a convertible preferred share private placement. The preferred shares are convertible at $7.50 and will accrue PIK dividends at 8.5% for the first two years with CHC's option to pay cash afterwards. CD&R will have a ~54% ownership position in CHC Group on an as-converted, pro-forma basis with First Reserve retaining ~29%, on a pro-forma basis (~57% of outstanding ordinary shares).
· In February 2015, CD&R replaced CEO William Amelio with Karl Fessenden, a former exec at GE Energy and GE Aviation
· In May 2015, CHC announced that CFO Joan Hooper would be succeeded by Lee Eckert, another former exec from GE
· In Jun 2015, CHC entered into an ABL facility that provides for an asset-based revolving credit facility (that is nearly 70% cheaper than leasing) of up to $145mm with the ability to be increased to $405mm
CHC is one of only two global commercial helicopter operators that provide crew transportation to the offshore oil and gas industry. This is CHC's primary business and it derived 81% of its revenues in FY 2015 from O&G crew transport. Helicopter Services, which includes O&G transport as well as search and rescue (SAR) and Emergency Medical Services (EMS) comprised 90% of revenues with the remaining 10% coming from its maintenance, repair, and overhaul business (Heli-One). CHC is globally diversified and has a network of approximately 70 basis across 6 continents with a presence in over 20 countries, which is more than any other commercial helicopter service provider in the world. CHC operates the world's largest fleet of 233 heavy and medium helicopters with a focus on deepwater and ultra-deepwater markets. CHC's Heli-One business is also the only global independent non-OEM provider of MRO services.
CHC's business has obviously be affected by the recent downturn in oil prices but the majority of CHC's O&G revenue comes from 4-5yr contracts tied to customers’ offshore production operations which have stable long-term transportation requirements. Their primary competitor Bristow Group has described their businesses as being more similar to an infrastructure play and their services as a part of the critical "people pipeline" that is the lifeblood of the industry. Approximately 75-78% of the flying revenue in CHC's Helicopter Services segment was attributable to fixed monthly charges (stable contractual revenue that is earned regardless of flying hours) for the fiscal years ended April 30, 2013, 2014 and 2015.
The remaining exploration related O&G transportation revenue derived from transportation to and from offshore drilling rigs has and will continue to experience pressure as customers reduce and delay their capex plans. This will eventually become an area of growth again as exploration inevitably moves further and further offshore – Bristow is projecting this downturn to last between 18-24 months.
Safety is of the utmost importance in this industry and historically global O&G firms relied on a patchwork of fragmented operators that only had limited national or regional footprints to satisfy their global requirements. This resulted in greater complexity and costs, lower efficiency, and most importantly was more dangerous as these operator's safety records could vary widely. As the industry consolidated, CHC and BRS have implemented uniform best practices that have enabled them to operate at industry leading safety records which will continue to support the rationale for their preference amongst all the major O&G firms.
Bristow is CHC's only global peer and primary competitor in the heavy and medium aircraft space and the two companies form an effective duopoly and dominate the global competitive landscape. High barriers to entry exist due to:
· the massive capital requirements associated with building a fleet of large helicopters,
· the difficulty in establishing an efficient global supply chain,
· the historically scarce supply of helicopters limited by large backlogs at only three major OEMs,
· the need to demonstrate a long and consistent safety record to satisfy strict safety regulations,
· the various licenses and operating certificates that must be secured and maintained to operate helicopters across multiple jurisdictions
· the high 90%+ contract retention enjoyed by incumbents and CHC's 50%+ win rate on new contracts(77% win rate on contract tenders for FYE 2014)
Heli-One (Maintenance, Repair and Overhaul)
Heli-One operates MRO services for both CHC's own fleet and third party customers. Excluding OEMs, Heli-One is the largest provider of these services. Heli-One has three owned facilities in British Columbia (80k sq ft), Norway (215k sq ft), and Poland (65k sq ft) – and has a total of 500k sq ft of facilities that it operates out of. The party line has been that Heli-One enables CHC to manage their supply chain and maintain their fleet more efficiently leading to higher availability of their aircraft and a reduction in overall cost of maintenance.
Although CHC no longer provides the segment assets employed in the business due to a change in internal reporting structure, we can see that prior to the restatement Heli-One’s 2014 segment assets were $770mm and we can estimate based on the previously disclosed 2014 depreciation expense that the rotables alone were worth nearly $350mm. The problem is that the business generated only 22mm, 29mm and 14mm of EBITDAR in 2015, 2014 and 2013, respectively. (To be fair, the internal realignment changed the way that revenue was recognized between Heli-Services and Heli-One.) In addition, the business requires rotables to be constantly refreshed with segment capex of 130mm and 141mm in 2014 and 2013. I believe this division is a prime example of prior management’s lack of discipline (or complete incompetence) with respect to capital efficiency. I assume they viewed it as a potential strategic differentiator that might allow CHC to win additional business in a tight market which would increase EBITDAR growth (a primary metric of their compensation). It’s not hard to imagine a scenario where this business is divested in favor of delevering the balance sheet by the new management team who is focused on stabilizing the business and generating FCF.
Helicopter transportation is the most efficient and often the only viable form of transportation due to the increasing distance from shore of the platforms and environmental conditions offshore. O&G customers will increasingly require complex transportation and logistics services that can only be served by the types of advanced heavy and medium technology helicopters that make up the majority of CHC's fleet. These new aircraft are favored by customers due to their "greater range, passenger capacity, comfort, enhanced passenger safety systems and ability to fly under a variety of conditions." Regulatory bodies are also increasing their scrutiny of regular crew rotations which will increase the number and frequency of flights to and from offshore facilities. Helicopter service is an irreplaceable part of offshore O&G exploration and production and makes up only 4-7% of operator rig expenses.
Despite the near to medium term headwinds in the offshore O&G industry, the fact remains that over the long term firms must continue to go further and further offshore in order to replace reserves and grow production. This is affirmed by Douglas-Westwood which forecasts offshore helicopter services spending to rise more than 25% to $25Bn for the 2015-2019 period compared to the preceding 5 year period as “the installed base of manned production infrastructure continues to increase, as does the fleet of offshore rigs and specialist installation and support vessels.” DW concedes that E&Ps are “currently focused on costs through their supply chain and this is expected to impact renewal rates and new contracts over the next two years” and they anticipate “lower than previously-expected levels of drilling and seismic activity [and] a delay in the sanctioning of some new offshore production infrastructure.” However, DW is still only projecting a 4-7% drop in expectations for the next three years vs. expectations from a year ago as “the majority of demand will arise from ongoing production phase support” which ,as previously mentioned, is relatively resilient to oil prices.
Historically, the demand for new commercial medium and heavy helicopters has outpaced supply. The recent turmoil has slightly elevated aircraft availability in the near term per BRS management comments on recent earnings calls but the favorable supply and demand dynamics are likely to persist as there are only three major suppliers of large aircraft (Sikorsky, AugustaWestland, Eurocopter) and they have historically been very disciplined in their production and delivery schedules. None of them have indicated that they intend to ramp up production to fill their large order backlogs – on the contrary, CHC and other operators have made favorable comments on the OEMs willingness to be flexible in deferring deliveries and/or upfront capital commitments.
Risks and Mitigants
· Safety incidents/Helicopter Suspensions: CHC continues to have one of the best safety records in the industry and there have been no issues with the EC225 following the extensive investigation and heavily scrutinized modifications that were completed in the middle of 2013. BRS suffered a recent accident and has been punished because of it.
· Controlled Company: Minority shareholders will have no say in the strategic direction of the company as CHC is effectively controlled by CD&R with their majority ownership in the form of convertible preferred stock but long term interests are aligned and minority shareholders have representation from First Reserve representatives on the board who will watch out for the interests of common shareholders. Also CD&R has a pristine reputation for revitalizing businesses and their modus operandi has always been focused on actual operational improvements rather than financial engineering.
liquidity from selling mro business?
more transactions like abl facility to lower cost of capital
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