Finding Value Where Others Don’t See It
A closer look at Air Lease's (AL) balance sheet
GAAP accounting turns most assets into expenses over time. For example, today’s Inventory is tomorrow’s Cost of Goods Sold when Revenues are recognized. Buildings and Equipment become Depreciation over several years. GAAP also records assets at the Lower of Cost or Market. Thus, if the market value increases, a company cannot write it up. But if the market value declines, it may have to write it down. As a result, it can be possible to find companies with considerable assets that are being carried at a discount to real value. We want to look at Air Lease Corp. (AL) for areas that could indicate the company is trading below its real value. Keep in mind two condition must exist to find meaningful value: 1)The item must be something others have yet to recognize, and 2) the market must believe there is something wrong with the company.
A good place to start is with some history. We titled this article after a chapter in one of our favorite Business History books – “The 50 Best (and Worst) Business Deals of All Time” by Michael Craig. That Chapter discusses KKR’s takeover of Safeway and even the purchase of Alaska from Russia among other deals. One of the lessons is that some assets have inherent value regardless of accounting rules requiring depreciation or a market going crazy for unrelated reasons.
Other examples include -- T. Boone Pickens observing how as oil prices were sliding from 1980 highs into 1983-86 – no one wanted to invest. In fact, he started takeover battles at Gulf Oil and Phillips Petroleum based on his belief that the assets had inherent value that Wall Street was underpricing. In his words, it was cheaper to buy oil on the stock market than drill for it in Texas.
Harold Simmons, a friend of Pickens, observed that airlines in the 1970s were under heavy regulation. Airlines couldn’t fly just anywhere – several could only fly within a single state and routes and times had to be approved by the FAA. Fares were also regulated and several oil shocks had squeezed profits. On the income statements, these looked like some sorry businesses. But Simmons could see deregulation was starting which could result in more flights and many airlines would want greater economies of scale and route capacity to grab market share. The problem was – no one could create new airplanes overnight to feed that demand. He noticed that despite the ugly financial statements, there were airlines with planes worth more than the market value of these companies. Simmons bought some airline stocks and PSA management actually paid Simmons off with planes for his shares. PSA booked a gain on the trade and Simmons leased the same planes back to PSA for a nice profit too.
We believe a similar situation may be at play with Air Lease (AL). Let’s take a closer look: