Why Atlas Air has become tempting takeover target for investors

Unconfirmed reports that Apollo Global Management is in advanced talks with Atlas Air Worldwide Holdings to take the freighter airline private provides the latest example of private capital flowing into the air cargo space. It’s a trend that accelerated during the COVID-19 crisis as aircraft became essential for delivering critical medical goods and supporting an explosion in online buying.

Top private equity firms sitting on hundreds of billions of dollars are looking to deploy their uninvested cash. They increasingly view pure cargo airlines and aircraft as good investment vehicles because of structural conditions supporting the sector’s long-term, consistent growth.

Fund managers are rushing to buy public companies and delist them because the sell-off in stocks has reduced valuations and made investments less risky, according to Yahoo! Finance. 

The Wall Street Journal reported Monday that Apollo (NYSE: APO) is negotiating to acquire Atlas Air (NASDAQ: AAWW), the largest operator of Boeing 747 freighters, and Reuters later said it learned of the pending deal from a source. Neither story provided any specifics, and the Journal gave itself plenty of wiggle room over a transaction materializing, saying “a deal could come soon assuming talks do not fall apart.”

A Bloomberg report Tuesday evening, citing unnamed sources, said Apollo Global Management has agreed to buy Atlas for $3.2 billion, or $102.50 per share. 

News of a possible Atlas sale comes ahead of Friday’s earnings report. In the first quarter, Atlas Air produced better than expected adjusted earnings of $88.8 million ($2.99 per share) and record revenue for the period of more than $1 billion. 

Atlas Air last year posted a record $4 billion in revenue and $1.1 billion in adjusted earnings before interest, taxes, depreciation and amortization.

The speculation offers an opportunity to examine the rationale behind a potential investment in Atlas Air, which operates 103 aircraft under a variety of long-term contracts and short charter arrangements for Amazon (NASDAQ: AMZN), express carriers like FedEx (NYSE: FDX) and UPS (NYSE: UPS), and the U.S. government. It also  operates Polar Air Cargo, with DHL Express as a joint venture partner, offers white-label passenger service to airlines, the government and sports teams, and owns an aircraft leasing business.

If consummated, it would be the second largest airline deal in terms of aircraft since Alaska Airlines (NASDAQ: ALK) bought Virgin America in 2016, according to a research note by Christopher Stathoulopoulos at Susquehanna Financial Group.

Atlas Air’s stock price has soared 46% since its 16-month low of $59.04 on July 6, including 16% this week. It is up 86% in the past three years after closing Tuesday at $87.37, giving the company a market capitalization of $2.5 billion.

Equity analysts who follow the company estimate a potential purchase price for Atlas of between $2.7 billion and $4.2 billion, based on enterprise value and financial performance. There aren’t good comparisons for price setting because passenger airlines are a different market, there haven’t been any air cargo acquisitions in several years and the two most recent ones — including Atlas’ purchase of Southern Air in 2016 — were substantially smaller. But the estimates align with Bloomberg’s report.

According to Zacks Investment Research, Atlas’ forward price/earnings ratio is 4.2 versus an industry average of 14.3, meaning it is trading at a discount to its airline peers. 

Apollo Global is a massive buyout fund with about $513 billion in assets under management, according to its website. 

Atlas gets finances clicking

Investor interest in Apollo spiked over the past two and a half years. CEO John Dietrich took the reins at the start of the pandemic and put the company on a strong financial footing — stabilizing previously volatile earnings, increasing cash flow and paying off debt. A key decision was shifting more business to dedicated transport for large customers that leased aircraft and crews under multiyear contracts and in the process diversifying its strategic partnerships and limiting exposure to fluctuations in demand.

Atlas now provides scheduled cargo service for a roster of blue-chip logistics providers, as well as retailers and manufacturers, including freight forwarding giant Kuehne + Nagel, DSV, Flexport, Ceva Logistics, DB Schenker, Geodis, Alibaba’s logistics arm Cainiao, Chinese express delivery company SF Group, Spanish apparel firm Inditex and HP.

Management has also aggressively reinvested profits in expanding and modernizing the fleet and an accelerated share repurchase program this year. Atlas is scheduled to receive four production 747-8 freighters from Boeing (NYSE: BA) this year and placed an order in January for four Boeing 777 cargo jets. It also is buying 747s as they roll off leases to retain capacity. And it has a new five-year pilot contract  that offers labor certainty, although pilots were unhappy with the outcome determined through mediation.  

More financial investors entered the air cargo sector prior to the pandemic because of the upward trendline in e-commerce sales, which heavily depend on aircraft for express delivery, as well as cross-border trade. The pandemic broke supply chains, disrupted normal trade flows and wiped out passenger flights relied on for half the global cargo capacity, sending air cargo rates through the roof and putting a premium on freighter aircraft. 

Freight rates have eased this year but remain more than double what they were in 2019.

Demand for freighters remains extremely high with shippers converting to air because of overcrowded ocean shipping, the loss of large freighter fleets based in Russia because of the Ukraine war and COVID restrictions in China that continue to limit access by widebody international passenger carriers. And as airlines shift to more point-to-point flying with newer, long-range single-aisle jets instead of widebodies, there will be more opportunities for freight, experts say. 

Widespread flight cancellations and flight delays at U.S. and European airports also highlight the inherent unpredictability of belly freight – another reason freighter operators are filling their aircraft.

The twin trends of relentless e-commerce growth and rising reliability issues at passenger airlines could partially future-proof all-cargo carriers, many logistics professionals now say. 

Since mid-2020, a large amount of investment capital has gone into leasing companies that are purchasing used passenger aircraft and sending them to repair facilities to be converted into full-time freighters.

With so much free cash-flow generation, Wall Street wondered more whether Atlas would make an acquisition — perhaps for an airline with narrow-gauge aircraft or a maintenance repair and overhaul specialist — rather than being acquired itself, Stathoulopoulos said in an interview. 

The only change in ownership that seemed a possibility was Amazon potentially exercising additional warrants to purchase shares in the company. Instead, Amazon has been decreasing its stake in Atlas. Last year, Amazon sold off nearly 80% of its Atlas holding and now only owns 1% of the company, down from 5%. By contrast, Amazon controls nearly 20% of rival Air Transport Services Group (NASDAQ: ATSG), which also provides outsourced air transport services. 

Amazon has shown more interest in ATSG after becoming frustrated with Atlas in 2019 over service issues related to the unresolved pilot contract and transferring two leased aircraft to ATSG’s fleet.

Stathoulopoulos said it’s unclear how a change in Atlas’ ownership might affect its transportation services agreement with Amazon. 

A deal for Atlas would extend Apollo’s interests in the aviation industry. It owned Sun Country Airlines (NASDAQ: SNCY), a leisure passenger airline that also operates a handful of 737 package freighters for Amazon until taking it public last year. In 2019, it bought PK AirFinance from GE Capital, and on Friday funds controlled by Apollo invested $512 million in an Air France operating affiliate that owns a pool of spare engines dedicated to the airline’s engineering and maintenance activities.

Click here for more FreightWaves/American Shipper stories by Eric Kulisch.

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Source: freightwaves - Why Atlas Air has become tempting takeover target for investors
Editor: Eric Kulisch