Half-term Report Card - II

Cybergun announced today that it had signed agreements with its banks extending the maturities of its term loans. The agreements will be signed this month. It has also sold two noncore subsidiaries, SMK Sportsmarketing (rifles) and I2G (video games), for €5 million in cash and a possible extra €1.3 million in contingent consideration. Separately, it will issue 4.7 million new shares at €1 each, effectively doubling the share count.

The upshot of all this is that the liquidity risk is reduced. €34.7 million in bank debt will now come due in smaller installments spread out over a 6 year period; €9 million in bond maturities over the next year (€6 in July, €3 next February) seem to be well covered by cash on hand, subsidiary sales, and the equity raise (~€ 15 million) before accounting for any cash flows generated by the businesses as it continues to work down its inventory to normal levels.

The prices of the 8% bonds and the equity have therefore both risen a bit – by 32% and 25% respectively.

The 8% bonds have been altogether de-risked, in my view, and the yield to maturity at the current price is about 25%.

The equity is more troublesome: if one thinks the underlying business deserves an enterprise multiple of greater than 7x, the shares are quite good value; if one doesn’t, they are uninteresting. The equity raise appears to be already quite well subscribed.

Disclosure: I am long the bonds and the equity

Half-term Report Card - I

Six months in, a quick round up of developments. I am lagging the S&P 500 by 7.5%, the International Small Cap Index by 9.6%, and my own picks by 23.4%.

I’ll start with a review of Hawaiian Holdings.

Hawaiian has reported its 2012 results. The last five years have seen its franchise stress tested: fuel prices have ranged from $1.93 to $4.67 per gallon; the domestic market has fallen into, and has come half-out of, a recession; its major international market, Japan, has suffered a nuclear event causing a calamitous drop in the number of Japanese visitors to Hawaii; the yen has appreciated and depreciated against the dollar, and so on.

And still the franchise remains intact, as it was bound to: it’s a low cost airline with full service amenities; it’s a toll road to a honeymoon, anniversary, and once-in-a-lifetime destination; it’s the transport network for residents who need to hop from island to island to get to meetings, to shop, and to visit relatives; and it’s the network into which all other airlines carrying passengers and cargo venturing beyond O’ahu must feed their traffic.   

The strategic control point of Hawaiian’s franchise is its monopoly position in interisland transportation and significant events are those that threaten that position, including end-runs. In that light, 2012 saw some US carriers increase their direct flights to Maui in an attempt to circumvent that control. Hawaiian responded in an appropriate way, creating a hub in Maui and flooding it with excess capacity. It was, in hindsight, a bit overdone but a sign, nevertheless of competence at work in the executive offices: the integrity of the inter-island monopoly matters, everything else is mere noise.

These are the last five years (you will remember that Hawaiian's fortunes were transformed when Aloha Airlines was liquidated in 2008):

It is a bigger, better diversified, more efficient airline than it was a year ago, and it is still the lowest cost and best performing scheduled passenger service airline in the United States.

There had been some indications that Southwest was considering entering the West Coast-to-Hawaii market. I had thought that unlikely since that market is probably the most brutally competitive market in the United States, a market in which one has to price an available seat mile at 7.5 cents just to break even. Only Hawaiian and Alaska Air Group, both favored with high margin regional monopolies (Alaskan in the Pacific Northwest, Hawaiian in the Islands), could and would compete effectively there. And, in fact, it now seems that Southwest has turned its attention to other, softer markets. 

What, in any case, is Hawaiian worth?

We know the rate at which its net operating assets will grow over the next two years and, since we know that its margins and asset turns are increasing as it grows, applying the past average ROIC to those assets implies a degree of welcome conservatism.

The above implies an expansion of the various market multiples currently accorded to Hawaiian.

At a constant total enterprise multiple (TEV/EBITDAR, where TEV = EV + Capitalized Operating Leases + Pension Liability – Cash – NOLs), Hawaiian’s share price should follow a progression that looks something like this:

When an intrinsic valuation is so much higher than the current market price it doesn’t hurt to do a sanity check by comparing one’s valuation to the market’s valuation of other, “similar” businesses.

Therefore:

The market clearly doesn’t agree with the above rather smug review. It's not that it hates airlines as a group; it just really doesn’t like Hawaiian. 

I’ll be adding to my position as price and cash availability permit.

Dsclosure: I long Hawaiian Holdings