MIC: After a Long Run, Catalysts for More Upside

With the stock trading at $22.50 per share, up from $14 a year ago and a low of $1 in early 2009, it seems that the easy money has been made; however, there are a few catalysts that will likely drive the stock higher.

First, a bit of history.  Macquarie Infrastructure Company (NYSE: MIC) went public in late 2004 when there was strong appetite for infrastructure companies with high dividend yields.  The stock performed well through 2007 and increased from an IPO price in the mid-20s to a high of $44 per share.  The problems began in the financial crisis of 2008 as some of its operating businesses proved to be more cyclical than expected, especially the aviation services and airport parking segments, and the company was caught with too much debt at the holding company level as well as the subsidiary level.  Business was down, the dividend was cut and the stock slid to as low as $1 per share in early 2009.

Through the financial crisis, MIC made some strategic moves to improve its position.  It offloaded its underperforming and debt-laden Airport Parking subsidiary.  Although Atlantic Aviation (airport services) experienced weakness, MIC did not sell it, instead it renegotiated its lending agreements to provide room to pay down debt from free cash flow.  Furthermore, MIC eliminated its holding company level debt.

After reducing and then suspending its dividend in 2008, MIC announced that it would reinstate it after Q1 2011 with an initial quarterly dividend of $0.20 per share.  At $22.50 per share, this represents a 3.6% annual dividend yield.  However, there is room for the dividend to increase significantly.

I established a position in MIC over time, buying shares in October 2008 at $11.30, December 2008 at $3.52 and, finally, in August 2010 at $13.06.  Basically, I bought shares after the stock declined significantly, near the low and again on the rebound after it made progress on the operating and financial fronts.

BUSINESS OVERVIEW

MIC is a holding company in the infrastructure space with four distinct businesses.  The largest business, IMTT (MIC owns 50%) is currently in growth mode and performing very well.  The second largest business, Atlantic Aviation, has a high debt load, which it is reducing through free cash flow.  The other two businesses, District Energy and The Gas Company (Hawaii) are defensive businesses that have very little impact from the business cycle.

MIC's initial $0.20 quarterly dividend is being funded mainly by cash flow from District Energy and The Gas Company.  IMTT is generating enough cash flow to provide for a dividend; however, there is a conflict between MIC and the other shareholder about IMTT's dividend policy.  MIC wants IMTT to use some of the free cash flow to fund dividends, but the other shareholder is blocking this.  An arbitration process will settle this dispute.  However, at some point, IMTT will be begin to issue dividends to MIC, which MIC will dividend out to its shareholders.  Atlantic Aviation is currently not in a position to issue dividends because of its high debt load and prohibitive debt covenants.  But, Atlantic Aviation is generating free cash flow and reducing debt.

Already, MIC's management announced that it intends to increase its quarterly dividend to $0.375 per share.  At $22.50 per share, this represents a 6.7% dividend yield.

Before going into the valuation, the following is a brief overview of MIC's businesses.

IMTT
2010 Revenue: $557 million
2010 EBITDA: $237 million
2010 FCF: $147 million
Debt / 2010 EBITDA: 2.77x
Revenue growth: 61%
EBITDA margin: 43%
FCF margin: 26%
MIC's ownership: 50%

IMTT is MIC largest segment (though MIC owns 50% of IMTT). IMTT owns and operates bulk liquid storage terminals in the US and Canada. The company has 42 million barrels of storage capacity. It mainly stores refined petroleum, not crude. In addition, IMTT has an environmental services subsidiary, Oil Mop, which was very active in the Gulf of Mexico oil spill cleanup in 2010.

MIC's management projects $200 million of EBITDA for IMTT in 2011. Although this is down from 2010, 2010 EBITDA benefited from the increased activity of Oil Mop due to the Gulf of Mexico oil spill. Oil Mop generated gross profit of $69 million in 2010 and is projected to generate $5 million gross profit in 2011.  IMTT has a strong pipeline of growth projects which are expected to come online in the next couple of years.

Atlantic Aviation
2010 Revenue: $573 million
2010 EBITDA: $117 million
2010 FCF: $48 million
Debt / 2010 EBITDA: 6.88x
Revenue growth: 18%
EBITDA margin: 20%
FCF margin: 8%
MIC's ownership: 100%

Atlantic Aviation operates the largest network of fixed based operations (FBOs) in the US. FBOs serve private and corporate jets with terminal operations, refueling, de-icing, aircraft parking and hangarage.

Atalantic Aviation is highly levered; however, it is actively reducing its debt. In 2010, the company reduced its debt by $55 million and is continuing to delever in 2011. Before the financial crisis, Atlantic Aviation distributed dividends to MIC, which were passed on to MIC's shareholders. With 6.88x leverage, Atlantic Aviation cannot issue dividends under its credit agreements. However, Atlantic Aviation is using FCF to de-lever and expects to exit the dividend lockup in 4Q 2011.

The Gas Company
2010 Revenue: $85 million
2010 EBITDA: $44 million
2010 FCF: $25 million
Debt / 2010 EBITDA: 3.60x
Revenue growth: 8%
EBITDA margin: 52%
FCF margin: 30%
MIC ownership: 100%

The Gas Company (TGC) is a producer and distributor of synthetic natural gas (SNG) and a distributor of liquefied petroleum gas (LPG) on the six major islands of Hawaii. TGC owns and operates an SNG plant and more than 1,000 miles of pipeline serving over 35,000 utility customers (businesses and households). The business serves an additional 33,000 non-utility customers via on-site propane tanks or portable gas cylinders.

The Gas Company is a solid unit that generates $25 million per year in FCF, or $0.55 per MIC shares. The company has limited growth opportunities and downside risk.

District Energy

2010 Revenue: $57 million
2010 EBITDA: $23 million
2010 FCF: $15 million
Debt / 2010 EBITDA: 7.44x
Revenue growth: 17%
EBITDA margin: 40%
FCF margin: 26%
MIC ownership: 50.01%

The district energy business includes Thermal Chicago which operates the largest district cooling system in the United States. Thermal Chicago provides chilled water under long-term contracts to over 100 customers in Chicago, Illinois. The business also provides district heating and cooling to a hotel/casino complex and adjacent shopping mall in Las Vegas, Nevada.

Like the Gas Company, District Energy is solid unit with limited volatility. District Energy generates $15 million of annual FCF, half of which is attributable is attributable to MIC and translates into $0.16 per MIC shares.

VALUATION


Currently, MIC is trading at $22.50 per share.  My target price short term target price for MIC is $27, which represents a 20% increase.  Longer term, I believe that MIC will reach $37.50, which represents 67% upside.

MIC's accounting is complicated and its financial statements do not clearly reflect its actual performance.  Since MIC owns 50% of IMTT and 50.01% of District Energy, its financial statements make adjustments for the consolidation of these segments.

I use two valuation models for MIC.  Valuation A is a dividend yield analysis and Valuation B is a sum-of-the parts analysis.

Valuation A above looks at the dividend yield in various scenarios:

• Current - MIC has announced a $0.20 per share quarterly dividend ($0.80 annually).  At the current share price of $22.50, this implies a 3.6% dividend yield.  This dividend yield is below the yield of the comps (using mainly IMTT comps, since IMTT comprises the majority of MIC's value).  However, the yield is low because MIC has announced its intentions to increase the dividend to $0.375 per share quarterly ($1.50 annually) by the end of the year.  The $0.80 annual dividend is derived mainly from cash flow from the Gas Company and District Energy, since Atlantic Aviation is using cash flow to delever and IMTT's other shareholders are currently blocking dividend distributions.  Over time, MIC's dividend will increase with contributions from all four segments.
• Scenario I - As mentioned above, MIC intends to reach a $1.50 annual dividend rate by the end of this year.  Assuming a 6% dividend yield, in-line with IMTT's comps, then the implied share price is $25.00.  With the shares trading at $22.50, the market seems to be factoring in these developments.  
• Scenario II - Despite MIC's intention to raise the dividend to $1.50 per share in the short term, MIC is generating significantly more cash flow, which will provide for future dividend increases.  MIC's management has announced that it projects $3.00 per share of cash flow in 2011.  As mentioned above, some of this cash flow is trapped at the operating company level (Atlantic Aviation is using FCF to delever and IMTT's distributions are being worked out).  However, in 2012/2013, Atlantic Aviation should resume distributing cash to MIC and IMTT's shareholder issues should be resolved by then.  At that point, IMTT should have, at least, $3.00 per share of free cash at its disposal, before assuming growth.  Although it will probably not use all of its free cash for dividends, assuming a 6% yield on $3.00 per share of FCF implies a $50.00 share price.
• Scenario III - Although MIC's management is forecasting $3.00 per share of FCF in 2011, it is bringing forward certain CapEx projects that will reduce FCF to capture an accelerated depreciation tax benefit.  According to MIC's management, the accleration of CapEx in 2011 is going to reduce FCF by $0.25 per share.  Therefore, on a run-rate basis, MIC could generate $3.25 per share from its current operations.  Assuming a 6% dividend yield, as described above, implies a share price of $54.17.

Valuation B is a sum-of-the-parts analysis of MIC.  According to this valuation method, 79% of MIC's value is ascribed to IMTT and only 1% to Atlantic Aviation.  Over time, Atlantic Aviation's value should increase as it reduces debt and continues to benefit from cyclical trends.  Atlantic Aviation is a key driver of future growth, but is essentially treated as option value for this analysis.

• IMTT - The analysis assumes $200 million of 2011 EBITDA, which is lower than the $237 million of 2010 EBITDA because of the one-time benefits from the cleanup of the BP oil spill.  The analysis uses 2010 EBITDA for the other segments, but in IMTT's case, to be conservative, it uses 2011 EBITDA, which is expected to be lower.  A 13.0x TEV / EBITDA multiple is below the 14.3x multiple for the comps.
• Atlantic Aviation - The analysis is based on 2010 EBITDA of $117 million.  Management forcasts $120-$130 million of EBITDA for 2011, but the lower number is used to be conservative.  Furthermore, Atlantic Aviation is paying off debt, but the analysis uses the debt balance at December 31, 2010.  Atlantic Aviation's closest comp is trading at 8.3x TEV / EBITDA, but the analysis uses a 7x multiple for Atlantic Aviation.  There is upside in this analysis for future growth, reduced debt and a higher multiple.
• The Gas Company - Because of the limited growth opportunities of the business, the analysis is based on $44 million of 2010 EBITDA.  The 11.0x TEV / EBITDA multiple is a discount to the average multiple of the comps of 13.0x
• District Energy - Like the Gas Company, the 2010 figures are used with an 11x EBITDA multiple.
• MIC Holding Company - The holding company generated -$11.3 million of EBITDA in 2010, which is multiplied by a 10.5x EBITDA multiple (the average of the other segments).

The following is the comps analysis:

Based on the sum-of-the-parts analysis, the target share price is $27.06.  However, there is hidden value at this price because it assumes almost no value for Atlantic Aviation.  As Atlantic Aviation continues to reduce debt, its equity value will grow and will increasingly provide a positive impact on MIC.

In the short term, I believe that MIC will reach $27 per share, which is the value from the sum-of-the-parts analysis.  In the mid term, I expect MIC to reach $37.50 per share, which is the average of scenarios I & II in the dividend yield analysis: $2.25 per share dividend (133% FCF coverage with $3.00 FCF per share) and a 6% dividend yield.

CATALYSTS

There are a number of short term and long term catalysts for MIC.  The main drivers for the stock will come from IMTT and Atlantic Aviation:

IMTT

• Dividends - In the next year, MIC should resolve its disagreement with the other MITT shareholders, which could lead to increased dividends from IMTT.
• Growth - IMTT has $125 million of growth projects under way, which are expects to generate $21 million of EBITDA.  In addition, it has a pipeline for more projects.

Atlantic Aviation

• Deleveraging - Atlantic Aviation still has a high level of debt.  As it continues to pay down its debt, its equity value will increase.
• Dividends - Atlantic Aviation may resume distributions to MIC by the end of 2011 or 2012 based on the pace of its debt repayments.

RISKS

There are a number of key risks to the opportunity in MIC's shares:

• Economic risks - MIC is an infrastructure company and its performance is tied to the performance of the overall economy.  A recession could reduce the demand and price of oil, which will have an indirect impact on IMTT.  Furthermore, a downturn would have a more severe impact on Atlantic Aviation as private jet use decreases.  
• Leverage - MIC's operating businesses are all leverage and the debt of Atlantic Aviation is especially high.  
• Interest rates - Historically, MIC appealed to shareholders because of its dividend yield.  Should interest rates rise significantly, then other income generating securities may offer shareholders more attractive opportunities.

DISCLOSURE: I AM LONG MIC.