© Piotr Trojanowski atlas
© Piotr Trojanowski

One of the most recurring questions at Loadstar Towers in recent weeks has been whether a takeover of Atlas Air by Amazon could be on the cards.

In the short term, such an outcome is not written in stone but it is not far-fetched, either. Why?

Market whispers, the close relationship between the two, the pilots’ background story, as well as the lessor’s cost structure, all give substance to the idea that by 2020 Atlas could have a new owner.

 

 

Agree to disagree

“When you embark on a strategy, you need an end game,” an Atlas insider recently told us, referring to the management’s decision to effectively stall labour negotiations. “I can’t imagine what the advantage is.”

The peculiar case of Atlas management and its increasingly poor relationship with its pilots is indeed confusing – unless, that is, it turns out to be a strategy that allows its executives to cash in big time via a smart trade sale to a key client, Amazon.

Atlas claims to be sticking to the letter of the law in its contract with its pilots, arguing that the specific process laid out must be adhered to. This is a painful path for the pilots, less so for the company, given where its stock trades, and one that looks likely to result at least in part in arbitration rather than a comprehensive agreement negotiated by both parties.

Chief executive Bill Flynn told The Loadstar: “We would actually agree on most parts of the contract. Both sides would want to reach a consensual agreement on most sections. Neither side wants a third party making the decisions.”

Which begs the question why the carrier formally insists on sticking to a clause that the pilots claim could mean that no CBA is agreed before 2021 – that’s a long time of pilot protests, pilot shortages and ill feelings.

Mr Flynn added that 2021 was a date he “did not recognise”, but declined to say when he thought the CBA would be finalised.

So, what is Atlas’s plan?

Perhaps it is as simple as not wanting to increase labour costs any time soon – as shown later in this post, additional costs would not look good on the books. But the books don’t tell the whole story.

On the side

There is a mystery over the financials at Titan, a formerly small Irish leasing company, now the 13th largest freighter lessor, which is home to Atlas’ dry leasing business. It’s interesting, for example, that it has a Cayman Islands arm – in fact, Atlas has four subsidiaries in the Cayman Islands and two in the British Virgin Islands. No doubt they are synergic and efficient financing centres, but the accounts aren’t quite as transparent as they might first seem.

Then there are the financials at Polar, the joint-venture with DHL, which are also – unusually – unavailable.

“Pilot expenses versus total expenses are just a sliver. A decent contract would not put Atlas out of business,” said one source.

(However, on a larger scale, additional labour costs would be less appealing to Amazon, and certainly would dilute the multiples at which Atlas could be sold.)

“But it’s hard to track the money,” added the source. “There could be some financial manipulation. The indications are they have a lot of money.”

What is certain is that managers have proved to have many funding options, as cash inlays from financing prove, so why continue along a course which upsets the workforce and risks putting the business through labour shortages for potentially three more years?

In June alone, 300 flights had to be covered by pilots on their days off, according to one source. A flight from Anchorage – one of Atlas’ biggest hubs – was said to have had to wait some 14 hours for crew. This situation is not likely to improve in times of pilot shortages. One could argue that in fact this is precisely the time to invest in an increasingly rare resource – as FedEx, for example, appears to be doing.

But is there something Atlas Air (AAWW) management knows, that others don’t?

There is, of course, talk that Amazon, keen to offer delivery services rivalling FedEx, will buy Atlas and ATSG. Both would be an easy bite, after all, for a company of Amazon’s size, and several sources say it’s a likelihood.

Low-looking labour costs would clearly make Atlas appear a better acquisition target, and no doubt management would pocket hefty bonuses while kicking the labour problem into the long grass. Amazon has a track record with trade unions.

To investors, though, Atlas is making the right noises about its labour ‘negotiations’, according to one source.

“They say the right things publicly, but stonewall the pilots privately. They are not only not negotiating, but they are not presenting viable offers.”

Mr Flynn, however, counters that Atlas is “able to recruit pilots”; “our goal is to reach a CBA”; “investors are happy with the progress and growth”; and “we are negotiating with our pilots, routinely and regularly meeting.”

Funny that nothing has been achieved, then.

What’s not funny, for the pilots, is the budget Atlas has allocated to their services as a percentage of total operating expenses, particularly compared with its smaller rival, ATSG.

We wish

What is frustrating for the entire workforce, excluding top management, is that in a recent presentation to investors, Atlas showed a great deal of confidence in its business plan and prospects. 2017 was truly a great year financially, which reflected on shareholder value, given a stock that has appreciated over 30% in the past 12 month, recording solid rise since April. Thank Amazon for that.

It hit a record of $75.29 on June 12, and even the latest volatility has had little impact on its share value, which still holds onto about $71.

AAWW vs ATSG vs AMZN vs market

Source: Yahoo Finance

It is banking on air freight demand while exploiting very favourable trends, as the four charts below show.

 

Atlas Air

Source: AAWW

Source: AAWW

Of course, Atlas is investing in its expanding fleet, buoyed by Amazon’s demand, while cementing its leading position as one of the main freighter lessors in the world.

Source: AAWW

If its 2017 numbers looked pretty good, the 2018 outlook is even better.

Atlas Air

Source: AAWW

This is really the best time for Atlas to share its resounding success with employees, also considering surging cash flows. And the company agrees, on paper.

In late June, it told investors it aimed to be the most trusted partner for its customers, and to achieve this goal it would “seek to attract talented individuals and to develop them to fullest potential”, while it had developed “affirmative action plans to ensure qualified applicants and employees receive an equal opportunity for recruitment, selection, advancement”.

In what it defines as an era of significant business growth and development, it expects “sharply higher adjusted net earnings in 2018”, given its focus on “express, e-commerce and fast-growing markets”.

Caveats?

It is obvious who is paying the price for its growth and rocketing adjusted earnings, which are expected to rise more than 30% this year.

Atlas Air doubles ATSG in terms of sales, with its top line reaching $2.15bn in 2017.

It is basic maths. Based on our calculations for salaries, wages and benefits (SW&B), if we applied ATSG’s SW&B/revenues ratio to Atlas Air, the latter would have incurred additional combined costs of $241.7m for 2017 and 2016, against $265m of net income during the period, which it achieved thanks to a large tax boost ($81m) in 2018.

ATSG vs AAWW

Source: Hedging Beta

In those two years, it was in the black, mainly because it managed to keep down SW&B expenses, while fuel costs as well as maintenance, materials and repairs expenses greatly outpaced revenue growth.

Source: AAWW

So, it would have booked only about $23m of net income, had its staff costs been as high as ATSG’s. Even assuming the same number of shares outstanding, the ebit/share gap between the two lessors would be meaningful at a time when Atlas Air’s heavy investment is at record highs and its growth comprehensively supported by debt funding.

ATSG vs AAWW

Source: Hedging Beta

 

Operating/investing cash flows

Source: AAWW

Financing cash flows

Source: AAWW

With 2,870 employees – 1,749 of whom are pilots – Atlas Air is very similar in size to ATSG, which has about 3,000 employees, but Atlas Air’s revenue/employee is about $750,000 versus ATSG’s $350,000.

Atlas is now leasing and operating 15 767-300Fs for Amazon and expects “to have 20 in service by the end of 2018”, while ATSG turns over 44% from Amazon.

There are caveats to a buyout, of course, but if Amazon’s revenues for Atlas become heavier than currently (perhaps at around $250m), such an end game would likely have only one loser.

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