AerCap Holdings (AER) is an aircraft leasing company incorporated in the Netherlands. Having absorbed a competitor, Genesis Lease, in 2009-10, on top of an ambitious growth strategy maintained through the crisis, AER is now the largest independent aviation lessor by assets, leading other U.S.-listed companies such as AirCastle (AYR) and Fly Leasing (FLY). The sector, however, remains dominated by ILFC and GE Capital Aviation Solutions, units of AIG and GE, respectively. (Following a successful IPO earlier this year, remarkably valued Air Lease Corp (AL) has still not reached a critical mass, most of its assets having been just ordered.)
I refer you to one of AER's recent presentations for a summary look into the company. There is an apparent bullish case to be made based solely on its financials. It is indeed not only trading below its March 31 book value of over $15, but it also claims that its assets are worth around $1 billion more than its carrying value. There is potentially upwards of $6 per share embedded liquidation value not showing on the balance sheet. AER earned close to or more than $2 per share in each of the last four years and is estimated to earn $1.81 per share in 2011. Analysts have been upgrading the stock and raising estimates. What's the matter then?
Rougemont, an SA contributor, recently included AER in an interesting list of companies (s)he considers undervalued and that would bounce back in the second half of the year. I agree with the suggestion but not the offered rationale – that AER, based in Europe, is currently affected by the European debt crisis and is somehow bound to jump back to its book value. AER, together with the other listed aircraft lessors and, one could add, many other listed specialty finance vehicles, has been trading below book value since the financial crisis showed how lack of liquidity can affect long-term leveraged assets. Instead, I want to focus on how the AER CEO succession story may present an opportunity to enhance the stock's appeal to investors.
Ex-CEO Heinemann: Impressive results but some distrust
Outgoing CEO Klaus Heinemann had led AER since 2003, well before its acquisition by Cerberus and its subsequent 2006 IPO. Under his stewardship as a listed company since 2006, AER, committed to an aggressive growth policy with no dividends or buybacks, more than doubled its revenues and assets, and almost tripled its shareholders' equity. Nevertheless, AER's share price is almost 40% less than the $23 IPO debut – and this single fact only shows investors' change of appetite and the new normal.
Though articulate and poised, Heinemann failed to convince investors over the last couple of years to fully trust AER's embedded asset and lease values. At the same time, perhaps constrained by AER's large contracted order book, he did not take advantage of the singular GFC opportunity to buy back shares or debt at what he acknowledged were ridiculously mispriced levels. Even though in successive quarters AER management clearly stated its intention to look into the matter, frustratingly, there was purportedly never enough free cash for more than a toe dip -- and that wouldn't do for it.
Heinemann's public pronouncements about AER's undervaluation also were at odds with the price paid for the amalgamation of Genesis (1 for 1 share, or 29% of AER at the time, at a 45% premium over the Genesis ADS price). These pronouncements also rang a bit hollow later in 2010, in view of the price paid to Waha Capital, an AbuDhabi investment company, to buy out the remaining half of its AerVenture joint venture (which controls 65 new A320 aircraft), some additional Waha encumbered aircraft and $105 million cash: 20% of the new AER/Genesis. In both cases, some analysts pointed out that AER was handing out purportedly undervalued shares but receiving fully valued assets. Heinemann offered credible arguments supporting the strategic fairness of either deal, which remain perhaps ultimately unconvincing. But it is true that at least the Waha transaction may result in other, difficult to quantify benefits in the future.
Heinemann exited at the AER 2011 AGM this May. At 60, he had the option to retire under his contract. In a well-prepared succession process, he handed the reins to 38-year-old Aengus Kelly.
New CEO Kelly and possible near-term catalysts
Kelly has been with AER's predecessors since 1998. Having been the group treasurer, more recently he was overseeing the U.S. operations of AER, which also include the parts and engines business AeroTurbine, based in Miami, FL (which has grown impressively). He is put in charge at a time when AER's major CapEx has been completed and operating cash-flow from leases becomes increasingly significant, interest rates remain low, competitors and airlines look to renew fleets -- but also as the world economy remains unstable. Kelly is faced with the dilemma of pausing and reassessing AER's strategy or continuing with growth.
There seems to be little competitive advantage for AER if Kelly continues with an aggressive growth strategy, when the likes of GECAS, struggling ILFC, newcomer AL and the airlines themselves all now have their sights on new orders. I believe it is a great opportunity to see how much cash the business can throw off with the current stable asset base and prepare for a new downturn; in fact, his sole thought should be on how to get ready for such a downturn.
The simplest thing Kelly can do in the short term to encourage investors is to announce a firm authorization for management to buy back shares, thus indicating that management believes in the valuations it offers to investors. In the next conference call, together with another set of good results, he should articulate clearly a vision for the company: Limited growth only in the U.S., China, parts and engines – areas he knows well – but no swashbuckling forward orders; a repurchase authorization; paying back some debt (as also obliged by certain of the AER securitizations); and preparing for another down cycle.
AER has presented in at least five major investor conferences over the last couple of months and was on the road in the U.S. at the end of June, with no visible real impact on the share price (despite renewed analyst coverage). I hope this relates more to the dire state of the world economy and not on the message that Kelly is presenting. I have entered AER again recently in anticipation of a rational new CEO decision to show that there exists tangible value in this franchise.