Skip the Air Lease IPO, Aercap Holdings Offers Better Value

Includes: AER, AIG, AYR, FLY, GE
by: Stone Fox Capital

Air Lease (AL) should IPO on Monday and immediately become the leading independent airplane leasing company in the public markets. Quick! Name another public airplane leasing company? Today, the leading companies ILFC (part of AIG (NYSE:AIG)) and Commercial Aviation Services (part of GE (NYSE:GE)) are small parts of mega corporations. This has left the few existing independent public leasing companies underfollowed and in most cases undervalued, leaving opportunities for nimble investors.

Airplane leasing has become increasing popular and profitable because it offers an attractive value proposition: Flexibility in fleet composition, favorable financial characteristics, access to superior equipment and delivery positions, and elimination of residual value considerations. Here's a great quote from the AL IPO roadshow: "Airlines need our new airplane positions in good times and our balance sheet in bad times."

AL expects to raise as much as $700M at the mid point price of $26.50 per share, but don't be surprised if institutions bid up the shares based on the industry leading management.

AL has an impressive management team and will likely receive a premium valuation for the sector. The CEO Steve Udvar-Hazy is long considered the pioneer and expert in the industry. He was the founder of ILFC (taking it public in 1983) and built that into an industry powerhouse. He also brought along several senior executives from that team. Naturally, all this history led me to check the age of the management team: Hazy is 65 years old, so that should be taken into consideration when valuing this company at a premium based on management.

As a young company, AL will have an advantage in the sector with an extremely young aircraft fleet. The more modern the better in this industry. One of the biggest advantages these days of a young fleet is that they are more fuel efficient than planes from 10 or 20 years ago. This provides a competitive advantage with oil prices above $100. As of now AL only has a fleet of 49 airplanes, but it expects to reach roughly 100 by year end, mainly via new purchases of Airbus and Boeing (NYSE:BA) planes.

AL will likely trade at a premium to current public companies with its valuation reaching 1.4 - 1.5 times net tangible book value, depending on the final offering price.

Aercap Holdings (NYSE:AER) provides the nearest comparative public airplane lessor. AER has roughly 350 planes and a market cap of nearly $2.2B. Analysts expect AER to have $1.32B in leasing revenue and $1.82 earnings per share for 2011. Like AL, AER was aggressive during the financial crisis. It snapped up Genesis Lease and secured a significant new plane order book when others cut back on orders.

Several other small leasing companies are public, including Aircastle (NYSE:AYR) and FLY Leasing (NYSE:FLY) but neither reaches the $1B market cap threshold. All three companies should benefit from a new focus on the industry, but we'd expect that AER would garner the biggest benefit due to its size and growth plan. AER, like AL, doesn't pay a dividend so all of the earnings can be plowed back into buying more planes.

The road show video is worth a view for anybody interested in a quick overview of AL or the sector. And the prospectus provides a wealth of information about airplane leasing including a lot of the risks. Some of the main risks are rising interest rates and a shift in demand away from Boeing or Airbus planes to planes possibly made in China or Russia.

Still, as compelling as the management team is at AL, it doesn't warrant paying more than top dollar for this stock. AER did just as well during the crisis and now, if anything, it is about to be discovered. It might never trade at the same book value ratio, but it definitely has more upside, especially for anybody buying the IPO in the open market.

Via Reuters:

Air Lease is coming at a generous premium to public peers AerCap Holdings NV (AER.N), Aircastle Ltd (AYR.N) and Fly Leasing Ltd (FLY.N) -- roughly 1.5 times book value, compared with their average of 0.8 times to 0.9 times, according to IFR, a Thomson Reuters service.

Disclosure: I am long AER.