IB Net Payout Yields Model

Merger of Genesis Lease and AerCap

This expected merger was announced on Friday morning. Its expected to create the largest independent airplane lessor in the world with a market cap just over $1B. Its also expected to create a serious increases to the 2010 EPS estimates for Genesis Lease (GLS) shareholders per slide 9 of the merger presentation. The estimate goes from $0.77 to $1.75. That has to be the largest increase Stone Fox Capital has ever seen on a merger announcement. At the same time it also enhances the Leasing EPS for AerCap (AER) slightly. This is important because analysts and investors typically prefer a steady recurring revenue stream over the lumpy earnings that AER typically generates from airplane and engine sales. Adding in those earnings give the potential for an EPS total closer to $2 for 2010.

Whats amazing is that the stock for AER trades sub $9 at the close. This for a stock expected to earn $2 in 2009 and 2010. So why does the stock trade at a sub 5 PE? Its really difficult to answer that question. Most message boards like Yahoo Finance and others are devoid of any interest on the stock. The airplane leasing industry faced serious pressure in 2008 and early 2009 due to fears of customers (traditionally weak airlines) going bankrupt and thoughts that the lessors would break loan covenants and face issues with refinancing loans. The surprising fact has been the ability of airlines to almost instantly re-lease planes at rates similar in value to the bankrupt lease usually signed during the bull market and the fact that they had very few relative planes to re-lease in the first place.

The emerging market demand for leased planes has been resilient. That should be encouraging to any investor in this sector. It should help fuel the steady increase in share price in the sector as well.

So why does AER trade at such a low PE? Our main speculation is that the sector and more specifically AER is just unknown and understood. If anything, this buyout of GLS elevates the concept of this stock to the market. Once underfollowed, it should now garner a lot more attention from analysts and institutional investors. Investors that will increasing question why a company expected to have recurring earnings of $1.75 next year is trading at sub $9. For the most part stocks like AER and GLS have traded more like financial instruments then global growth concepts and maybe this will revert now. In a lot of cases banks and insurance companies have soared of late while those stocks still have uncertain balance sheets with massive amounts of toxic assets, AER doesn't face those same risks.

AER also has growth opportunities with 80+ most pre-leased planes already on order from Airbus. This should provide future growth to 2010 estimates as well. Not to mention that the combined scale of these two companies could provide additional opportunities for cherry picking some distressed plane sales.

And to all those investors that think GLS shareholders got the raw end of the deal since it's book value is substantially higher then the initial offer price.

John McMahon, Chairman & CEO of Genesis added, "Genesis' board and management are committed to enhancing shareholder value. This transaction, through the solid profitability and strong cash flows of Genesis, combined with AerCap's scale and order book, which is nearly all placed, provides our shareholders with a significant and immediate premium to recent stock trading levels and positions them to participate in enhanced earnings and business growth in the future."

It's very clear after doing some low level analysis that not only is AER trading at least 50% below value of a more normal 10x eps or $18. It's also clear that GLS shareholders got one heck of a deal in the process. One share of AER is clearly worth a lot more then 1 share of GLS.

Not long after putting this together I see that the Wall Street Journal has come out with an article about the merger and the potential for the sector heating up. This is the exact type of news that I expect to get AER closer to a resonable valuation. It'll just take a few fund managers reading this article to realize the value in this stock and sector.


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