I have worked overseas for 20 years working with 30+ airlines all over the world on strategy and now back in Canada I have found it difficult to find out how well Canadian airlines do financially and why more consolidation has not happened. With some M&A (mergers and acquisitions) experience and airline privatizations behind me, I am a keen aviation observer of such activities around the world.
In this article you will be introduced to the best regional airlines in Canada, an investment company doing very well buying regional airlines and how they do it as well as some insight into how they are valued.
With only a handful of Canadian operators being public it is difficult to really see how well Canadian airlines are run outside of Air Canada, Air Transat, Jazz/Chorus and West Jet. I like to benchmark airlines and do reality checks on how they are doing in relation to competitors and other similar operators, and I look at helicopter and fixed wing charter operators as well, when the information is available.
In Canada we have many what I consider really interesting medium sized airlines (>$20m in Revenue/Year) that have great potential for expansion and future growth in their markets :
- Pacific Coastal Airlines (Saab 340’s, Beech 1900C scheds and float charters) in B.C.
- Hawkair Aviation (DHC-8’s) scheds to YVR
- North Cariboo Air (DHC-8, BAe 146, King Air’s, Beech 1900’s)
- Central Mountain Air (Tier III Air Canada Connector with Beech 1900D’s and charters).
- Air North (B737’s and HS748’s), connects Yukon to BC and AB.
- Canadian North (DHC-8, B737’s) connects NWT, Nunavit to the south.
- Westwind Aviation (ATR-42, Beech 1900’s, BAe J31’s) serves SK and Nunavut.
- Calm Air (ATR-42/72, Saab 340’s, Do328Jet’s) ses MB and Nunavut.
- Bearskin Airlines (Metro 23/III’s, Saab 340) serves mostly Northern Ontario.
- Perimeter (Metro III/II, DHC-8’s) serves Northern Manitoba.
- First Air (B767F, ATR-42’s, L-100-30 Hercules) serves the North.
- Air Creebec (DHC-8’s, EMB-110’s, HS 748’s, B1900’s) serves Quebec
- Wasaya Airways (HS748, B1900’s) serves Northern Ontario.
- Air Inuit (DHC-8’s, DHC-6, Kind Airs, B737’s) serves mainly Northern Quebec
- Sky Regional (Q400, EJet175, CPA with Air Canada)
- Jazz/Chorus (DHC-8’s, CRJ’s, Q400’s, CPA with Air Canada)
- Air Georgian (Tier III Air Canada Connector with Beech 1900D’s and exec jet charters).
The above list includes several airlines now fully or majority owned by First Nation Corporations or Bands and these are underlined, above. I will write about some of these airlines in soon to be released articles. Most of the First Nation owners of these airlines are not well known corporate names, but companies like Creeco (Air Creebec), Makivik (First Air), Inuvialuit Development Corp. (Canadian North) and Vuntut Development Corp. (Air North) are today big players in the Canadian airline scene, once you get below the Air Canada and WestJet level of size.
As we all know the airline business is tough, and globally margins are very thin, globally EBIT (earnings before interest and taxes) margin for 2012 was 2.1%, with Net Profit up to $US 6.7 billion.
North America actually lead the way in 2012 with an EBIT margin of 3.4% and Net Income expected at $US 2.4 billion, while EBIT margins for the rest of the world were:
- Africa at 0.3%
- Latin America at 2.4%
- Middle East at 2.7%
- Asia Pacific at 2.9%
- Europe 0.6%
There are many small regional airlines across Canada, it is a very fragmented industry and I am surprised there has not been more merger & acquisition activity to consolidate the industry, especially given the profitability some of these private operators have. I think it is because many of these regional airlines are run conservatively, not wanting to go outside their area of comfort. Many were started by pilots and slowly grew and grew and the owners saw no reason for acquisitions as a means of business growth.
I look over at Alaska, where the airplane is key to so many communities and where given the geography of the State, there are dozens and dozens of operators, from Cessna 185’s on floats, DHC-6 Twin Otters, Hercules transports to B737-800’s, just like here in Canada.
Today, after a great deal of consolidation through acquisitions, $120 million a year ERA Alaska (Discovery Channel fame from “Flying Wild Alaska”) is run by CEO John Hajdukovich who in 1974 bought a small operator named Frontier Flying Service (est. 1950).
Then the company started to expand and acquire other operators in various regions of Alaska:
- 2005 buys Cape Smyth Air Service (est. 1975).
- 2006 buys Hageland Aviation (est. 1981), James Tweeto comes on board as COO.
- 2009 buys ERA (est. 1948) and company renamed Frontier Alaska Group.
- 2010 buys Artic Circle Air and company renamed ERA Alaska.
Today ERA Alaska operates 74 aircraft of 7 different types to 97 communities in Alaska :
- 11 x Beech 1900C/D
- 8 x DHC-6 Twin Otters
- 20 x Cessna 207’s
- 9 x Cessna 208A/B Caravans
- 1 x Cessna 185
- 8 x Piper PA-31-350 Chieftains
- 4 x Cessna 406 Caravan II’s
Now back to why I write this article, I found 2 public companies in Canada that have gone out and made substantial acquisitions in Canadian aviation companies. While the two investment companies differ in their strategy and outlook, a closer examination will reveal which of the two has a better aviation strategy in place, which will reveal itself in the financial performance and stock valuation of each individual company. Business is ultimately about the strategy you choose, and unfortunately few really understand strategy and its implication of future growth and profitability.
Today, I will look at Exchange Income Corporation (www.exchangeincomecorp.ca) whose shares trade on the Toronto Stock Exchange (TSX: EIF). The company is based in Winnipeg, Manitoba, and was established in 2002 and is run by its CEO/President Mr. Mike Pyle a highly experienced executive and financial expert that has been with the company since it was established in 2002 and started its business acquisitions in 2004.
Today Exchange Income Corporation (EIC) is active in two segments, aviation and specialty manufacturing, and since 2004 it has made 13 acquisitions for a total sum of $CDN 281 million in both aviation and manufacturing. In aviation EIC acquired some very big names in the Manitoba aviation community, companies founded by local aviation legends. A quick history of EIC’s aviation acquisitions is as follows (all prices are CDN$ values) :
May 2004 acquires Perimeter Airlines of Winnipeg, MB from its founder Mr. William Wehrle and family for $17.2 million. Today operates 29 turboprops (Metro II, Metro III and DHC-8’s) on scheduled and charter services in Manitoba.
April 2005 EIC acquires bankrupt Skyward Aviation for some of its assets like hangars and cargo terminal. Company does not exist anymore.
July 2005 EIC acquires Keewatin Air of Winnipeg, MB from Mr. Frank Robert May for around $15.0 million. Today has 13 turboprops and jets (Beech 1900C’s, King Air 200’s, PC-12 and Lear 35’s) mostly in and out of Nunavut from Manitoba and Air Ambulance services.
April 2009 EIC acquires Calm Air International of Thompson, MB from the family of the late Mr. Carl Arnold Lawrence Morberg (his initials came to Calm, hence the name Calm Air) for $59 million. Today operates scheduled services in Manitoba and Nunavut with 19 turboprops and jets (ATR-72, ATR-42, HS748, Saab 340B, Dornier 328-Jet). The airline is the first to use the 32 passenger D0328Jet in Canada, operates 2 for the Nunavut Government for medical flights and the two ATR-72-200’s are carrying fuel to remote communities in NW Ontario.
July 2009 EIC acquires HMY Airways Inc. of Vancouver, B.C. an airline started in 2002 by Dr. David Ting Kwok Ho, later renamed to Harmony Airways (3 x B757-200, 1 x CRJ), shut down April, 2007. Just the name was acquired to be used as a shell company.
January 2011 EIC acquires Bearskin Airlines of Sious Lookout, Ontario for $32.5 million from Mr. Harvey Friesen and brother Cliff Friesen. Today the airline operates 15 turboprops, 14 being the Metro 23’s and one Saab 340B has been leased in from EIC owned Calm Air, synergy at work.
February, 2012 EIC acquires Custom Helicopters of Winnipeg, MB for $29 million. The company operates 24 helicopters throughout Manitoba and Nunavut and apparently eyeing Air Ambulance work in the province, again synergy at work.
A very impressive acquisition spree by EIC and I am sure more aviation acquisitions will be forthcoming. The interesting thing about EIC is that it is very disciplined and so far has made M&A work, when many in the financial industry question whether or not Mergers & Acquisitions work. Well they do, and can bring substantial shareholder returns if you do your homework and don’t lose sight of your objective. As EIC says in its 2011 Annual Report, “Spotting opportunity for growth is easy, BUT finding the right acquisition is hard, discipline matters.”
In 2011, EIC’s 5 Aviation holdings (Perimeter Airlines, Keewatin Air, Calm Air International, Bearskin Airlines and Custom Helicopters) combined to produce $CDN 274.3 million in revenue (or 53.8% of EIC’s total Revenue of $CDN 510.3 million) and an EBIT (earnings before interest and tax) of $CDN 57.1 million for a very impressive EBITDA margin of 20.8% ! and many experts and industry veterans say you can’t make money in aviation ? sure you can ! just need to pick the right company and have a real viable strategy in place with good people to lead it from start to finish.
Through acquisitions EIC has grown its 2 core business segments with some very impressive numbers during the past 5 years (2007-2011) that few companies can match, especially the CAGR (compound annual growth rate):
- Revenue grown from $106.0 million to $510.0 million, or 36.9% 5 year CAGR.
- EBITDA grown from $15.3 million to $74.8 million, or 37.4% 5 year CAGR.
- Net Income grown from $7.6 million to $20.7 million, or 22.2% 5 year CAGR.
For this interested the stock trades on TSX as EIF and was trading around $12.00 in 3Q 2009 and today it is trading at $27.59 a 130% increase in just 10 quarters. While 2011 the company paid out $1.605 dividend per share, a yield of 6.3% while share price increased 44% and combined with dividends the total investment return was 53.1%, wow !
Through Acquisitions EIC grew its aviation business, lots of opportunities out there but you need to follow certain rules that EIC sticks to.
- RIGHT VALUE. Never pay more than a company is worth-NEVER. Past performance is a good indicator of Revenue, Cash Flow and EBITDA that one can expect from acquisition. I will touch on this a further down.
- NICHE MARKETS. Want limited competition, strong barriers to entry and a market that does not fluctuate with every change in global markets, so that Cash Flows are strong to support commitments to stakeholders.
- STRONG MANAGEMENT. Run subsidiaries autonomously and make sure key executives have long term contracts to stay. That is good BUT markets change and when you have people in places like Thompson, MB for years running an operation with no new talent coming in, myopia settles in and new ideas and ways of doing things gets lost in the old saying “if it ain’t broke, why fix it ?” This management myopia has brought down many airlines that once did really well but tunnel vision blinded them and new competition, markets, know-how, technologies were ignored and companies went bust, the list of great Canadian airlines gone bust is endless (ie. Wardair, Canadian, Transair, Nordair, Nationair, Worldways, Great Lakes, Air Toronto, Canada 3000, JetsGo, Roots Air, Odyssey, Skyservice, NWT Air, Zoom, Time Air, Lamb Air, Air Manitoba, City Express, EPA, Air BC, etc.).
- PLAN for GROWTH. Target companies must also have a plan to grow and retain its competitive advantage, and here in the case of EIC they are able to bring new capital for CAPEX and synergies to help each company with its individual problems, which ALL companies have, the only difference is the degree of the problems, companies that are successful one day DO NOT always remain successful. Successful companies remain vigilant, always alert for warning signs and they react quickly when problems arise, some ignore the problem and usually go bust within a short period. My experience is that airline failures are due to poor management, not paying attention to the world around you and not addressing problems quick enough.
Lastly, I want to touch on corporate valuations, this is a large topic, but for this article I want to discuss how EIC values its aviation companies, thanks to it being a public company more information is available than usual as most Canadian small/medium operators are private companies, it is impossible to find out what companies have paid to acquire other companies.
I think it will give some people an idea of what their company is worth or how much they should expect to pay for a company, though valuation in EIC case is a little different in that the companies they bought retain the previous owners or executives or give shares of EIC in part exchange to keep everyone motivated to drive EBITDA higher and higher.
Now, EIC bases its purchase price on a multiple of historic and sustainable EBITDA and proud to say it never paid more than a 5x multiple on EBITDA for any acquisition.
There are many ways to value a business and I will leave that for a future article, but I want to show what EIC paid for some of its acquisitions. The on an best data given is on Calm Air International in 2009, where we know that in 1st 9 months of 2008 Calm Air had revenues of $63 million and EBITDA of $11.7 million or a margin of 18.57%.
On an annual basis interpolating 9 months into 12 months, 2008 would have been shown around $84 million in revenue, $15.59 million in EBITDA on a margin of 18.57%, which compares well to 2007 figure of Revenue of $70 million, EBITDA of $ 13.9 million for a margin of 19.85%.
Using 2008 estimated numbers, since $59 million was paid to acquire Calm Air International and EBITDA was $15.59 we get an EBITDA 3.78 multiple and a Price to Revenue multiple of 0.7 or $0.70 for every $1 of revenue. This is a good indication of how investors value a regional airline today.
When EIC bought Bearskin Airlines in 2011 we were given 2009 revenue of $47 million, 2010 revenue of $50 million and 2011 revenue of $54 million and EBITDA of $9 million or 16.6%. So seeing that Bearskin was bought in 2011, EIC used 2010 numbers, and if I use 2011 margin of 16.6% on 2010 revenue, I get EBITDA of $8.3m in 2010 (estimated).
So EIC paid $32.5 million for Bearskin, that is a EBITDA multiple of 3.91 slightly higher than for Calm Air and Price to Revenue of 0.65 slightly lower than for Calm Air.
So we have learned that EIC values the regional airlines in the range of 3.7-3.91 EBITDA multiple and 0.65 to 0.70 Price to Revenue multiple , a good indicator for me know, and hopefully some of you out there looking for a quick valuation. Remember, value is in the eye of the beholder and some have paid too much for a company and then lost it all.
With Custom Helicopters acquisition only a price of $29 million was given with a note that multiples were in range of previous deals. So working backwards, if we assume a 3.7 EBITDA multiple valuation, than Custom Helicopter had roughly an EBITDA of around $7.84 million in 2010 and Revenue would have been around $44.6 million using a Price to Revenue ratio of 0.65. and a roughly a EBITDA of 17.6%.
One of the reasons for using EBITDA rather than EBIT or Net Income is that when you compare companies across the world which have different capital structures as well as different tax rates and depreciation schedules, it makes sense to adjust for all these differences. EBITDA is an easy way to adjust for this and compare such companies. EBITDA valuation multiple is a common choice in valuing businesses using the market-based valuation methods. The multiples are ratios that are statistically derived from recent comparable business sales.
Today we got an insight into the Canadian regional airline market, looked at how a successful aviation investment company makes money with airplanes and how valuations are done in the aviation industry today.
Thank you for reading my Blog, till next time.
I always welcome some feedback.