On June 13, 2013, Seeking Alpha author Richard Pearson wrote an article on Erickson Air-Crane (EAC). Mr. Pearson disclosed he was short EAC shares. The article caused a big sell-off in EAC shares and also caused short interest to rise on a stock with 3mm shares in the public float. I would like to address some of the points from Mr. Pearson's article.
1) "Evergreen has received a going concern letter from its auditor. It was in default on its debt. It was not even paying its accounts payable to such an extent that suppliers began withholding parts and Evergreen was unable to maintain its aircraft."
Response - Evergreen (EHI) was owned by their parent company Evergreen International Aviation (EIA). EIA owned numerous other divisions: See Page F-7
Evergreen International Aviation, Inc.
Evergreen International Airlines, Inc.
Evergreen Aviation Ground Logistics Enterprise, Inc.
Evergreen Trade, Inc.
Evergreen Agriculture Enterprise, Inc.
Evergreen Defense and Security Services, Inc.
Evergreen Maintenance Center, Inc.; through the date of disposal (May 27, 2011)
So I pose the question, was Evergreen Helicopters performing poorly and as a result not paying their bills and had a going concern, or was the parent in trouble and needed cash so they sold EHI to EAC? Well, we already knew that EHI did approximately $200mm in revenue and approximately 25% EBITDA margins. When you look at page F-4 of the same financial statements that Mr. Pearson referenced you see that EHI did do those numbers and in addition they had $17 million in net income. But the real part of the story that was not included in Mr. Pearson's article was on page F-6 on the cash flow statement. EHI transferred $57mm of cash to what I assume to be their struggling parent! On page F-7 there is a narrative given for this transfer back to the parent. This is from an SEC filing. Without that payment, EHI would have generated cash of $56mm, which I would discount by $20mm for the increase in A/P. So EHI was and is very profitable and generating great free cash flow but they had to transfer cash to their parent (who sold them to EAC I'm guessing because they obviously needed the money) instead of paying their own bills.
2) "But in fact, the situation was set to get far worse for struggling Evergreen, given that over 60% of its revenues come from DOD contracts in Afghanistan. The U.S. has already announced that the pullout from Afghanistan is set to accelerate and troop levels will be further reduced by 50% in the next year."
Response - Mr. Pearson failed to note that EAC has already publicly responded to this question several times. Here is EAC's CEO Udo Rieder's response from the Q1 Conference call:
"So I would like to address some of the obvious questions about this portion of our revenues. First regarding sequestration, it's important to understand that the majority of the work which is for logistic supports for oversea deployments it's funded through the overseas contingency operation vehicle and is not subject to sequestration. Second approximately 65% of Evergreens total revenues are related to work that we do in Afghanistan.
We have good visibility on this work for the remainder of 2013 and we have growing expectation that the work remain brisk in 2014. I know that our business is not directly related to troop levels this include support for special operations which are likely to remain longer than most deployment and support for reconstruction work which also should persist for some years."
Additionally, here is an article that states this type of work will be needed in Afghanistan for years or decades to come and is not tied to troop levels.
"The individual pay and contractor company revenues are lucrative, substantially above the civil rate in the U.S., reflecting operational costs and risks. Last year six civil helicopter companies-AAR Airlift, Canadian Helicopters, Columbia Helicopters, Construction Helicopters, Evergreen Helicopters and Vertical De Aviacion-received $417.9 million for their work in Afghanistan. This year that amount is expected to grow to $783.2 million, according to the Pentagon. A combination of new construction projects and the draw-down are keeping the rotors spinning. The new facilities are being custom built for forces anticipated to remain after next year, and they are likely to require civilian airlift support for years, if not decades, to come."
Lastly, there has been no mention of the massive increase in backlog for EAC. From page 43 of the same SEC filing:
"Our backlog as of December 31, 2012 was $178.8 million, of which $69.6 million was attributable to signed contracts and $109.2 million was attributable to anticipated exercises of customer extension options. We had total backlog of $213.8 million as of December 31, 2011, of which $106.0 million was from signed contracts and $107.8 million was from anticipated exercises of customer extension options. On a combined pro forma basis, we had approximately $894.5 million of backlog as of December 31, 2012, comprised of approximately $178.8 million, $445.7 million and $270.0 million from EAC, EHI, and Air Amazonia, respectively. Our $894.5 million of combined backlog consists of $293.7 million from signed contracts and $600.8 million from anticipated exercises of customer extension options."
Additionally, this link from a week ago shows that EHI just outbid three other companies to win $10mm contract in Hawaii.
As far as the debt levels of the EAC combined companies post acquisition, they are in line with comps in the industry and EAC has stated they will generate $40mm free cash flow on a sustainable basis, excluding one time acquisition charges this year.
3) "With respect to the distressed Evergreen acquisition, Erickson disclosed the following:
- lack of experience in these business segments
- lack of experience with these types of aircraft
- lack of experience in these geographic regions (Middle East, South America and Africa)
- NO experience with Department of Defense customers and projects"
Response - That is why you keep the key leaders from EHI on board as part of the acquisition. Mergers and Acquisitions 101 here -- I'm shocked this was used as a slam on the company. Is EAC the first company to make an acquisition in another geography or business other than their core business?
4) "The reason for the rise is that the stock benefited greatly from a strong fire season in late 2012. As a result, the company actually turned a meaningful profit in one quarter out of the past five."
Response - Yes, fire fighting is seasonal so prior to the acquisitions EAC made most of their money in the quarter that fire fighting was strongest. This is often referred to as "seasonality" and is common for many companies (again Business 101 here). Additionally, fire season is unfortunately very strong this year also.
5) ZM wants to sell all of their shares. ZM is an equity fund. Equity funds are usually in the business to invest money in early to mid stage companies, build them up to sell and make a profit and then do it again. They are typically not long term holders. Also, it is not uncommon for funds to invest in similar companies (Like EAC and EHI) and then combine them to sell or take them public (roll up). Lastly, a shelf filing is a flexible arrangement and with this S-3 they have two years to sell the shares. With this amount of shares, I would say ZM would need to find strong institutional buyers that saw the future value in this company.
6) If EAC were to sell 4mm new shares at some point, keep in mind that it would eliminate 8.25% interest debt if they used it to retire debt. This would be close to neutral on and EPS basis. If they used it for an acquisition, I would like to believe that it would be an accretive one. However I have updated my numbers assuming they sell 4mm new shares and compared them to industry comps:
So I will now update my numbers and price targets compared to similar companies, based on the guidance from EAC.
- Bristow Group, Inc. (BRS) has a market cap of $2.3 billion + $900 million of debt less $200m cash divided by $294 million of EBITDA = 10.02 EBITDA multiple.
- Seacor Holdings Inc. (CKH) has a market cap of $1.5 billion + $678 million of debt less $340m cash divided by $211 million of EBITDA = 8.7 EBITDA multiple.
- Air Methods Corp. (AIRM) has a market cap of $1.4 billion + $663 million of debt divided by $233 million of EBITDA = 8.9 EBITDA multiple.
- PHI Inc. (PHII) has a market cap of $511 million + $379 million of debt less $49 m of cash divided by $119 million of EBITDA = 7.1 EBITDA multiple.
If I take the mid-point of the EAC 2013 pro forma guidance of $112.5 million and conservatively assume no growth in Air Amazonia so I add $12.5mm of EBITDA they expect from that acquisition we have $125mm of EBITDA:
$125 million of EBITDA X 8 - $400 million of debt + $84mm of cash (assumes they sell at $21 closing price) = $684 million divided by 17.7 million shares outstanding (added 4m new shares) = $38.64 per share.
$125 million of EBITDA X 10 - $400 million of debt + $84mm of cash (assumes they sell at $21 closing price) = $934 million divided by 17.7 million shares outstanding (added 4m new shares) = $52.77 per share.
The average EBITDA multiple of the 4 similar companies is 8.7. That would imply a valuation of $43.59 per share with 4m new shares issued.
Risk - Clearly EAC needs to execute on their business and successfully integrate these acquisitions in the process. This would enable them to pay down the debt and continue to grow the business. ZM selling their shares does not create dilution, but they need to find buyers in strong hands.
Lastly, short interest is currently 17% of the approximate 3m float, so any momentum could ignite a very strong short squeeze. The numbers clearly show EAC as undervalued, and if ZM successfully sells shares, that only confirms this. The 17% is of the last measure and I would guess that shot up much higher after the short article last week.