Sold IAG

Sold IAG.  Because:

• I'm not sure it can survive without a capital injection.  I think it can last 5 to 10 months (Jun to Nov), but the virus may have effects that go on for longer.   Even after the lockdowns are slowly loosened, and even if there is no second wave, it will be a long time before people are allowed to travel.
• I think the current market rally is a bear market rally.  Use the opportunity to sell.

Loss is around SGD 25K.  This was a hard decision:

• Can it survive without a capital injection?  Maybe.  Or maybe not.
• Would I buy it now?  No, because of the above.  I would not catch it as a falling knife.

Longer term, I would like to buy it again.  It may be at a higher price later.  Or it may be at a lower price after they raise capital.  I prefer to sell now and buy it with a clear head later when the risk/reward is better.

IAG: Can they survive?

Rough guess to see how long International Airlines Group can survive without raising capital.

Their balance sheet on Dec 2019:

• Current liabilities are 6.7bn.  Ignore deferred revenue as advanced ticket sales are refunded with credit and  no one cares about customer loyalty points when there are no flights.
• They have 2.2bn receivables.  Not sure how much they can collect.
• They said in March they have 9.3bn cash and undrawn credit.

Their biggest expense is employee costs.  I think it can be cut from 4.9bn to 2.6bn:

• Flights are reduced by 90%
• Under the UK Job Retention Scheme (JRS), furloughed employees' are granted 80% of their salary up to 2,500 pounds per month.  Spain's ERTE scheme pays 70% of the salary - the remainder is social security which may be delayed.
• IAG is paying 80% of their cabin and ground crews' pay through JRS (so IAG will have to pay anything above 2500 the pounds limit). And pilots agreed to take one month unpaid leave in April/May.  I think if it is still bad after this, the pilots need to continue on half pay, or else be let go.

So I estimate total operating costs at 5.9bn:

• 2bn for IT/property (no change)
• 2.4bn for staff
• 0.6 interest payments
• Operating lease 0.9bn (from 2018 - in 2019 it is lumped under D&A for IFRS16, but this is a cash cost that will still be there).

So I guess they can last 5 months (end June) to 10 months (end Nov), depending on how much of their receivables they can collect.

Natural Gas

Harris Kupperman's natural gas trade looks interesting.  WTI going negative sends a clear signal that oil is not profitable, therefore shale oil shut ins should decrease the supply of natural gas.

What are the chances of it happening?

Around 30m Bcf/day of natural gas production is associated with oil (p19), out of 92 Bcf/day total.  So around 1/3rd of it is associated.

For demand, the EIA predicts a drop in demand due to covid-90, due to less commercial usage (especially restaurants), less industrial and exports.  Slightly offset by an increase in home demand.

There are many moving parts to the thesis.  What are the risks?

1. Shale oil producers may not begin to cut back until next year, due to hedging.
2. Even if the supply of natural gas drops, demand may drop further.
3. Trump may put tariffs on imported oil, or simply force the Saudis from targeting US shale production.  There are good reasons why the US needs its own oil industry.

How would I play it?

Initially I wanted to follow the textbook and but the lowest cost producers.  Cabot, here.  But there are too many things about this industry that I can't understand.  I do not understand industry decline curves, or how much companies have to reinvest to maintain reserves.   Nor well level data.  Or takeaway capacity from the different producing regions.  This industry is difficult to understand, and full of liars.

Better to spread my bets and just trade the FCG ETF.  That removes company specific issues, though it concentrates on the Marcellus.  Most of the companies there are generating cashflows from operations, though many are loss making - but they look like they won't go to zero.  I do not know enough to cherry pick companies or create my own ETF.

This is far from a certain thing, so if I took the trade, I would trade around the position to manage risk.  Take my signals from the market and play a rising natural gas price as it happens.  Don't throw all my bets down on the table and say 'this is definitely going to happen'.

I do not know if or when I'll make this trade.

AENA SME

Spanish Airport owner/operator.  Interesting because they have (had) high operating margins, and are trading at 13X trailing (peak) earnings.  But I won't buy yet because too many uncertainties.

Air travel is not allowed in Spain now, except for "reasons that cannot be postponed".  Airports are considered essential services, and must still be run, but many are partially closed.  How long can AENA survive without revenue?

Survival

Balance sheet first.  At end 2019:

1. Current liabilities are 842m, excluding debt.  Current assets (inventories, cash and receivables are 750m).  Thats almost a 100m shortfall, even assuming they can get all their 500m receivables paid.  There is a real risk of airlines going bust.
2. Ignore long-term debt, at 5.6bn.  Forget this now, worry about 2020 first.  Debt includes lease liabilities (under IFRS 16).
3. Short-term debt is 1.2bn.  But, 640m of this is from a joint loan with ENAIRE (Spanish Government).  AENA may not have to pay it immediately.  Both ENAIRE and AENA are "mutually obligated to each other before the bank" to pay off the loan.   If AENA does not meet its obligations, ENAIRE will pay off the loan first, then charge 3% plus penalty interest to AENA (bottom p98).  Even if they can defer this, it still leaves 560m to pay this year.
4. (1st April) AENA has taken 1bn loans that mature in 1-4 years.
5. (26th Mar) AENA has the ability to issue another 550m of Euro Commercial Paper.  Ignore this now.
6. Loan covenants (p96) specifies that net debt can be up to 7X EBIDTA and 3X financial expenses.  Measured half yearly.  EBITDA was around 2.8bn in 2019, debt is now around 7.8bn.  So EBIDTA cannot drop below 1.1bn.  Difficult if the lockdown continues.

So, assuming they can delay the 640m short term debt in 3. and assuming they can collect all receivables in 1., they have 580m cash.

What are their cash operating costs?

• Other operating expenses of 1bn.

          Remove the 158m taxes.  They said they can cut monthly operating expenses by 43m, so remove another 516.  So 400m. 

• Staff costs: 456m.  ERTE will pay up to 70% of a worker's salary (excluding social security, which is 30%, which the employer can now delay), but AENA has not said they have taken advantage of this program.
• Interest: 124m.  With the new 1bn loan, let's make it 135m.
• Thats it: so annual operating costs drop to 1bn.

So, if they can delay the 640m short-term debt, they can last 7 months (end July).  If they can use ERTE for half their employees, then we reach almost 9 months (end Sep).

The key is really point 3 above: can AENA delay paying the 640m joint loan?  Normally I would say yes, but the Spanish government can't print its own money. They are trying to sell AENA in the first place to fill their budget deficit!

Business

96% of their 2019 EBIDTA was from Spain (p56).  I think they own their Spainsh airports (not operating under a concession), but I could not find it in any official document.  Slide 65 talks about a 40 year development plan.

They manage nearly 50 airports in Spain.  A few of them are very busy, like Madrid or Barcelona, but there is a long tail of underused airports.  "One estimate has it that all but eight of AENA’s airports are regularly unprofitable. And some of the more remote ones do not even see daily flights."  So they are running these as a public service.

A large proportion of their passengers are domestic or from the EU (slide 52), so they are not big spenders.

Operating margins were 44% in 2018 and 2019.  Pretty high.

Competitors

Spain has a good high-speed rail network as an alternative to domestic flights.

Conclusion

AENA can probably survive, the issues are:

1. Can they delay their 640m short term debt?
2. Collecting 500m receivables (from airlines?)
3. Can they reduce staff costs by using ERTE?
4. Assume banks wont enforce the debt/EBIDTA covenant.

I'm guessing they have an 80% chance of surviving without issuing new equity.

This company is more risky than Grupo Aeroportuario Centro Norte as they have less cash, but has higher upside because they own their airports.  My gut feeling for this one is to wait for their 2Q results for more clarity.

Really hard to know what to do for this one.  I want to buy highly profitable airports (that are owned, not leased).  But 4 points above need to be cleared up.  But when things are 100% clear, the stock price will have recovered.

Misc

Company news updates are here (they call it "Inside Information").

Disney Part 3: The rest of the company, and valuation

The rest of Disney is well known: movies, theme parks and toys.

Disney sells stories that children love.  They take the money, risk and time to craft stories and characters that touch young audiences.  This is a bit of an art - throwing more money into a movie does not make it better.  This makes children to spend money on Disney's other products: merchandise and theme parks- the flywheel effect - buying one service from the company leads you to buying more.  From Walter Disney himself:

Disney recently bought Twenty First Century Fox (TFCF), increasing their debt to 48bn.  Probably for content to put on Hulu and Disney+.

Disney+'s Profitability

Disney+ launched in October and wildly exceeded expectations.  Its going to become an increasingly important part of their business.  How profitable is it, and is it going to burn cash like Netflix?

Disney capitalises film and television production costs, and amortises them over time:

"Film and television production, participation and residual costs are expensed over the applicable product life cycle based upon the ratio of the current period’s revenues to estimated remaining total revenues (Ultimate Revenues) for each production....For television series, Ultimate Revenues include revenues that will be earned within ten years from delivery of the first episode, or if still in production, five years from delivery of the most recent episode, if later."

Not sure of this applies to their Direct-to-consumer segment - could not find it in the 1Q results,  though they amortise TFCF and Hulu content (Search for "intangible assets").  In that quarter, CFO dropped 0.5bn to 1.6bn (top p8), due to "higher film and television production spending".  That may be it.

So Disney+ Direct-to-consumer operating profits do not necessarily translate to CFO.

Since I can't get anything from Disney's results, lets estimate in other ways:

• If season 1 of "The Mandalorian" cost $120m to make, making 30 series a year comes up to, lets say, 3bn (not all shows will be that expensive).  With their current subscriber base of 28.6bn (revenues of 1.8bn/year), thats a cash outflow of 1.2bn. 
• In 2019, Netflix had 20bn revenues but still burned 2.9b CFO.  Rough guess, they burn around 18bn/year on production and acquisition of titles.  If Disney+ follows this, they will expand production as they grow bigger, but less than Netflix, since they are fundamentally different.  Netflix's business is to get you watching as long as possible ("We're competing with sleep").  They try to be everything to everyone.  Disney's more focused business is to get children to love their characters and spend money on them. Also, Disney already has a large catalog of movies, plus TFCF.

I expect Disney+'s subscribers and costs to grow, similar to Netflix's past trajectory, but on a smaller scale.  How do you value something like that?

Baby Yoda costs 5m

Threats

Disney has no video game IP (eg: pokemon, minecraft).  Its a glaring hole in their entertainment business.  They are great at films/movies, but that does not translate into video games.  This essentially means you are ignoring half the population.

2019 was the peak of the movie cycle.  Expect a decrease in movie revenues over the next few years:

• The top grossing movie of all time, Avengers Endgame, completes a 22 movie arc.  Two main characters are dead.  This year has movies with minor characters, and they will take a few years to "build up" the characters/universe again.   Don't expect another big hit from the Marvel universe for a while.
• After initial excitement, Star Wars revenue has declined for each of their main movies, culminating in a loss for the 2018's "Han Solo" movie.  They fucked it up by producing bad movies too quickly, and need to slow down.

Disney has been through long bad periods before.  The 60s to the end of the 80's was considered Disney's "dark age", when they did not know what types of movies they were producing.  The company nearly went bankrupt.

The Black Cauldron (1985)

There was a second smaller "Dark Age" from 2000 to 2009.  Movie making is a hit-and-miss business.  Despite all the "magic" of Disney's brand and characters, its easy for them to lose sight of what they're doing and get a string of misses.

Valuation

Lets make a conservative long-term scenario for Disney (while forgetting about the coronavirus).

Assume long term profits in Movie Studio and Parks get back to 2019 levels.  ESPN moves entirely to ESPN+, losing all affiliate fees, but advertising is unaffected.  ESPN+'s price rises to $10/month.  ESPN's sports rights costs do not increase.  Disney's OTT competes with Netflix: they are both different services, so many will subscribe to both.  The key question is, can OTT make up for ESPN's decline?

Basic stats:

• 128m households in the US.  45m of them have children, 30m of them have both parents with the children.
• Netflix has around 60m US subscribers and over 100m international subscribers
• Hulu currently has 28m subscribers
• 115 million NFL fans in the US.

Lets take:

• 30 million US households using the Disney+, Hulu & ESPN+ bundle for $17/month (currently $13/month, but expect ESPN+'s price to rise as it replaces ESPN).  So 6.1bn streaming revenue.
• Another 20m other households are sports fans and subscribe to ESPN+ @ $10/month.  2.4bn revenue.
• 50m international subscribers to Disney+ only @ $7/month (assume the increase the price a bit).  NFL/baseball are purely American sports, so forget about ESPN.  Gives another 4.2bn revenue.

So 12.7bn revenue.  Minus 5bn annual cash production costs for Disney+.  Gives 7.7bn, to offset against the current ESPN affiliate fees of 9bn.  So thats a 1.3bn  drop in operating profit, or a 12% drop.  This is purely guesswork, but they are reasonable numbers so its the best we can do.  At 15X earnings, you would pay $82 per share.

Disney Part 2: ESPN

Continuing with Disney, their largest segment is actually ESPN, which is in long term decline.

At Sep 2019, the largest contributor to Disneys' earnings is Media Networks (44% of profit):

Media Networks is domestic, mostly cable TV, with a little free-to-air broadcast.  It excludes OTT (Hulu, ESPN+, and Disney+).  Most of it is from ESPN, with a little from other channels such as Nat Geo and Sesame Street:

What is ESPN?  It is the dominant live sports channel, playing 24/7 sports rubbish.  Their main sports providers are NFL, NBA and MLB.  Their business model has been to aggregate all sports under one channel.  "When you think of sports, you should think of ESPN".

This business model has high fixed costs:

• They bid for long-term rights to exclusively air sports.  For example, they paid 15.2 billion to air Monday night US football for 8 years until the end of 2021.  So the "Operating Expenses" above are mostly fixed.
• ESPN is sold to consumers as part of a cable bundle, so people buy it whether they need it or not.  Carriers pay an average of $9/month to ESPN for every subscriber.  (Thats the 9bn in pink above.)  They also get some advertising revenue.
• ESPN+ is an OTT version of ESPN.  It is an addition to ESPN, not a replacement - you still need an ESPN subscription to watch the main sports.  ESPN+ is still losing money.

ESPN's domestic subscriber numbers have been in long term decline:

Source: Disney Annual Reports

A lot has been written about ESPN being squeezed.  The cost of rights is expected to increase, while subscriber numbers are dropping.  Viewership may also be dropping: sports results can be obtained online now, and people have more to do than watch TV (Fortnite, twitch, Youtube, Netflix, Periscope).  This hurts their advertising.  ESPN is a distributor in a world where distribution is becoming cheap.  Or free.

They have been managing the decline by raising prices slowly.  The average subscriber fee has risen from $7 in 2016 to $9 today.  I think they are slowly trying to segregate the market into those watch sports and those who don't.  And see how much those who watch it will pay.  They will switch ESPN to OTT sometime, but they don't know when ("There will be a time...when the pay TV numbers are low enough, and all you have are sports fans that are in that bundle...does it make sense at that point, rather than wholesaling a sports fan bundle, to be a retailer...I'm not sure where the precise crossover point would be").

The 3 big risks are:

• Will the remaining sports fans be willing to pay enough to make it worthwhile?  Its been estimated ESPN would have to charge $30 a subscriber to maintain profitability.  And ESPN may pay more when the rights are renewed in 2021/2022.
• How and when do they switch?  If they gradually switch the popular sports to ESPN+, this makes ESPN less valuable, reducing the money they can pay for rights.  If they don't switch, ESPN slowly becomes irrelevant to everyone.  Sports providers deal with ESPN now because they (still) have the largest broadcast exposure, and the most cash. They can't switch it fast, and you can't switch it slowly.
• Other players (Google, Amazon, Apple, FB) may bid for the rights.  Or the providers go OTT themselves.

Valuation of ESPN

How do you value a business that is in decline and will undergo disruption?  Hopefully self-inflicted disruption.  Even the executives say they "don't know" when they will go OTT.  So we can't value it.  You can come up with many scenarios (N subscribers paying $X per month) - I'll do this later.  But no one really knows.

ESPN is the riskiest part of Disney's empire.  Theres a chance it will be unrecognisable in 5 years time.

Disney Part 1: Survival

Disney is a great company I'd love to buy, but let's see if they can survive first.    They have been hit hard by the coronavirus, shutting down theme parks, hotels, movie studios, and sports.  The company has high fixed costs.  How long can they last without a capital injection?

Balance Sheet

At Dec 2019 (p13), they have:

• 8bn cash, 18bn current receivables and 20bn current payables.  So net 6bn, assuming they can collect all their receivables.
• 10bn in current borrowings.
• 5bn in deferred revenue and other current liabilities.

So we are at -9bn.

They have 12.8bn in unused commercial paper (p103, plus this, and subtracting 1.2bn on p14).
Since December, they have issued another 7bn new notes (1) (2).
So they have 10-11bn headroom.  Again, assuming they collect all their receivables.

Cash Burn

I try to estimate their cash burn during the coronavirus period from their segment operations (pp37-44).  For most numbers below, I am using the full year (ending Sep 2019) results:

• Media networks.  This is mostly cable (which is mostly ESPN), and some broadcast free-to-air (like ABC's Sesame Street).  Assume Broadcast revenue remains.  But Cable revenue gets halved (ESPN has no live sports - assume half the subscribers up for renewal cut subscription).  Get a cash burn of 0.5bn per year.
• Parks, Experiences and Products (merchandise).  Assume merchandise revenue is cut from 4,5bn to 1bn (eg: Spider Man toys and Frozen crap).  Everything else for parks & resorts is zero.  On the cost side: Reduce operating expenses from 14bn to 6bn (staff reduced from 6.2bn to 4bn), and SG&A from 3 to 1bn.  Ignore D&A as non-cash.  So they burn 6bn cash a year.
• Studio Entertainment.  This is movies in theatres, plus distribution for home entertainment (DVDs, pay-per-view and licensing for cable/free-to-air, excludes OTT).  Assume no Theatre distribution revenue, but unchanged revenue from Home Entertainment and TV/SVOD.  On the cost side, ignore 3.7bn of the operating expenses which is amortisation, and reduce SG&A to 2.5bn.  Gives a profit of 2.5bn.
• Direct-to-Consumer.  These are streaming subscription services: ESPN+, Hulu and Disney+.  I'll use the Dec 2019 results for this, because of Disney+'s rollout.  They have a 700m loss per quarter, annualise it to 2bn a year.   (The actual cash burn may be higher, due to their film amortisation, but there is no segmented cashflow.  Thats a problem for another day.  Just use -2bn for now.)

So we get a cash burn of 6bn a year.

Conclusion

With luck, they can last 12 to 18 months.  The main thing is the 18bn current receivables.

I guess if they run out of money they can always print some.