Description

Corporación America (CAAP) has been written up nicely a couple times before but it is worth a revisit as there are few areas in the market today more out of favor than Argentina combined with travel.

CAAP is >80% owned by the Eurnekian family in Argentina. The company operates airport concessions in Argentina, Armenia, Brazil, Ecuador, Italy, and Uruguay. Each concession agreement is different and spending time understanding each one is likely the greatest point of differentiation to understanding the company well (and in particular to realizing that COVID losses will be compensated and that nearly all the debt is non-recourse to the parent company). CAAP cannot compete with the cost of capital of the big airport operators, but it is an excellent operator with a strong track record (more below) and appears to be quite undervalued relative to its future cash flows.

Argentina is CAAP’s most material concession. It is a single-till concession which means that both aeronautical (airline/passenger) revenues and non-aeronautical (retail) revenues are considered in combination against the cost base. Aeronautical revenues are charged to each departing passenger as well as to airlines for landing and parking. Single-till regulation differs from dual-till regulation where the regulator assesses each source of revenues separately against the costs in each. The Argentina concession covers 37 airports, lasts until 2038, and is guaranteed a real, unlevered 16.45% IRR on CAAP’s investment by ORSNA (the regulator). In 2019, Argentina earned $270m EBITDA but was under-earning the promised return. This can happen in any one year or several years, but the 16.45% return must be achieved by the end of the concession. In the case the company under-earns (which clearly also happened in 2020 and continues through 2021), the regulator can agree to one of three mechanisms: 1) extend the concession life, 2) increase passenger fees, or 3) reduce required capex or annual canon payments (concession fees). Reducing required capex is not an optimal solution because passenger growth over time requires increasing capital spending. And a reduction in travel often means a reduction in variable concession fees anyway. Increasing passenger departure fees can weaken an airport’s competitiveness to other airports in the region. Therefore, an extension of the concession life is often the best solution. And this is precisely what we have seen in Argentina this year when the government extended CAAP’s concession 10 years from 2028 until 2038 (increasing the likelihood that the under-earning prior to COVID and during COVID will be compensated over time).

The second most valuable concession is Armenia, which is also single-till. The concession lasts until 2032 but is indefinitely renewable for subsequent 5-year periods. In 2019, the concession earned more than $50m EBITDA despite under-earning according to the 20% USD IRR guaranteed by the government (which sounds very generous but keep in mind it was contracted in 2002 – only a handful of years after the war with Azerbaijan and only a dozen or so years as a post-Soviet country, etc.). The value of the concession obviously differs whether the concession ends in 2032 or continues indefinitely, but a conservative DCF (using a 2032 end date) would easily suggest a discounted value of ~$300m.

Italy is a dual-till concession where CAAP operates the Pisa and Florence airports. The aeronautical revenues all go into a RAB (regulated asset base) and receive a regulated return, similar to many public utilities. This subsidiary (Toscana Aeroporti) is publicly-listed, 47% owned by CAAP (via its 75% shareholding of the entity that owns 62% of it), and has an EV of $420m and a market cap of nearly $300m. The merger (and success) of Pisa and Florence airports under one operating entity was one sign of CAAP’s visionary abilities. In 2019, Italy earned $38m EBITDA but this figure will only grow as low-cost carrier traffic for tourism to Pisa and Florence continues to increase and the regulated asset base increases via expansion. The market value is likely undervalued given the growth and duration of the concession.

In 2019, Uruguay generated around $56m of EBITDA. The concession lasts until 2033 and based on a simple DCF easily has an EV in excess of $300m. Uruguay is a good concession but it lacks the guaranteed returns of the previous concessions. Therefore, a drop in passenger levels goes straight to the bottom line.

Ecuador is a small concession with annual EBITDA of $25m and an 8-year remaining life.

CAAP also has concessions in Brazil for Brasilia and Natal airports, both of which have been unsuccessful. In the case of Brasilia, CAAP bid for the concession just before Brazil entered its horrible recession in 2015. It is still working on improving profitability there but for simplicity I give it 0 value. Meanwhile, the company has given up on Natal and is giving the asset back to the regulator for re-auctioning (for which it will be compensated around $80m). CAAP also has a concession for two airports in Ecuador.

Adding it all up, the sum of the parts EV excluding Argentina appears to be around $1bn. Today, CAAP has a market cap of $900m and EV of approximately 1.7-1.8bn (~800-900m of proportionate net debt).

So, what is Argentina worth? CAAP has a model of the future cash flows of the Argentina concession on its website. The figures are in Argentine pesos (ARS) based on the USD/ARS rate in 2019, which ended at 60 (the rate today is 100 and the black-market rate is even higher). But since the concession’s earnings are guaranteed a real return, inflation-induced currency depreciation does not negatively impact the company (and in the short-term actually inflates margins as international/regional passenger fees are in USD while costs are in pesos). The undiscounted sum of these cash flows is approximately $11bn but obviously we care about the discounted value of these cash flows. The concession has already been written into law through 2038, is guaranteed a real return, and the counterparties are the airlines/passengers that fly through CAAP’s airports.

If we wish to discount the cash flows, an Argentinian peso-denominated government bond discount rate doesn’t seem right (something crazy like 50%, value of concession is $700m - which means we are roughly paying fair value for the 1.7bn EV today). Nor does it seem right to use a Warren Buffett standard 6% 10-year USD discount rate in Argentina (i.e., he argues that a higher discount rate won’t save you if your cash flows are not certain; 6% - value of concession is >$6bn). The answer is likely somewhere in the middle. If we assume these $11bn in undiscounted cash flows over the next 17 years are worth something like $2.5-3bn discounted (implying a discount rate of 15-20%), CAAP’s 81% share would be $2-2.4bn. Adding the other $1bn EV gives $3-3.4bn EV. Subtract .8-.9bn net debt and we have $2.1-2.6bn equity value – a 2.5-3x from today's 900m equity value. If the company manages to win new concessions and create value, perhaps there could be additional upside. Another way to look at it: if the correct valuation ex-Argentina is $1bn, that leaves $700-800m of value ascribed to Argentina – equivalent to under 3 years of normalized Argentina FCF compared to a 17-year concession.

The risks here are plenty. Travel has been slow to recover in Latin America (but it will, and most of the company's earnings are guaranteed irrespective of passenger levels) and the subsidiaries have upcoming debt payments (worst case scenario is a particular subsidiary goes to 0 and the holding company is fine, but it seems unlikely). Argentina has a troubled economy, turbulent politics, and lots of corruption. In any business reliant on government tenders, it is wise to be careful with position sizing.

Catalyst

Recovery of air travel

Recovery of Argentina economy (though earnings are guaranteed and not really dependent on it) and reduction of Argentina risk premium