Doric Nimrod Air One – DNA:LN

Remember OTCAdventures? I’m still here, just very busy with Alluvial Fund, LP and all the fun of a young family. I found an intriguing investment idea, but be warned: I don’t know how to buy this. Futhermore, I cannot provide any advice on the tax implications of owning this investment or related securities. But here it is: Doric Nimrod Air One. “DNA One” is a Guernsey-domiciled closed-end fund that trades on the London Stock Exchange.

This fancifully-named fund could hardly be simpler. It was formed in 2010 for one purpose:  to acquire a single aircraft, lease the aircraft to an airline for an extended period of time, then to sell the aircraft at the conclusion of the lease and liquidate. Payments received over the course of the lease would be used to amortize acquisition-related debt and to pay an investors a steady quarterly distribution. DNA One acquired an Airbus A380-681.

The A-380 is the world’s largest passenger aircraft, able to handle extremely long flights. Over 200 of these aircraft have been produced and delivered, with many more in production. The UAE’s “Emirates” is the largest operator of these aircraft, with over 100 in its fleet. True to form, DNA One leased its A380 to Emirates for a period of 12 years.

The original debt associated with the purchase of the A380 was $122 million. In the seven years since the acquisition, DNA One has reduced the balance of that debt to $43 million. Meanwhile, the fund has paid a quarterly distribution to investors of 2.25 pence. The lease with Emirates is scheduled to terminate in December 2022, after which DNA One will sell its aircraft. Emirates has the right to purchase the aircraft at fair market value. If Emirates declines to purchase the aircraft, the fund will put the A380 up for sale in the general market. The global market for modern wide-body passenger aircraft is liquid, so I don’t anticipate any issues in achieving a quick sale.

So the question becomes “How much can investors expect to receive as a liquidating payment?” Fortunately, the fund helps us out with that. The fund orders an annual appraisal of its aircraft from multiple appraisers and provides this information to investors. As of March 31, the average estimated value of the A380 at lease expiration was $101 million.

Using the $101 million figure and June 30 exchange rates, the fund projects a capital return of 178 pence per share when the aircraft is sold at the end of its lease. Between now and then, investors will continue to receive 2.25 pence each quarter. Shares of DNA One recently closed at 100.50 pence, indicating potentially excellent return potential. If the quarterly income and capital return estimates hold true, investors purchasing shares today stand to earn an IRR of a little more than 21% between now and the end of 2022. The fund spells things out in its quarterly report.

Now for a look at what could go wrong. The biggest risk Doric Nimrod Air One faces is the possibility that its aircraft could actually be worth substantially less in 2022. Aircraft values are affected by supply and demand, which in turn is driven by the activity of airlines and the pace of production and technological advances by aircraft producers. A look at the trend in recent appraisals does show a downward trend. In 2017, appraisers valued the A380 at $104 million. In 2016 the figure was $107 million. A 10% decline in aircraft value from the current $101 million estimate wold reduce liquidation value for shareholders by 18 pence. Still, it would require a very large decline in the value of DNA One’s A380 to create a truly adverse scenario for investors. By my calculations, the value of the aircraft at lease expiration would have to plunge 40% to $60 million for investors’ IRR to fall to 10%.

Then there is counter-party risk. Let’s not forget that DNA One has only a single asset, and a single lessee. If Emirates encountered financial difficulty, the stream of lease payments could be interrupted and suddenly DNA One would find itself with no revenue and bills to pay. However, Emirates has long enjoyed strong profitability and the firm support of the UAE’s ruling family, so I consider the airline a high quality counter-party. There is also the fact an early lease termination could even be a good thing for DNA One’s shareholders. Even after paying off the remaining acquisition debt, the fund’s net asset value would be substantially in excess of its trading price and shareholders could receive a large payment several years earlier than planned.

So why does DNA One appear so cheap? My guess is the usual suspects: size and illiquidity. The fund’s market capitalization is only £42.7 million and less than £20,000 worth of shares change hands daily. I also suspect that only a small sub-set of investors is willing or able to invest in a Guernsey-domiciled closed-end fund.

Could be an opportunity.

I should also note there are two other related funds: Doric Nimrod Air Two and Doric Nimrod Air Three. Each is substantially larger than DNA One, more diversified, and has a longer time remaining in its aircraft leases. DNA Two appears to offer an IRR of 16% at current exchange rates and appraisals, while DNA Three offers 14%. Each fund owns the same type of aircraft and leases mainly to Emirates, so the huge divergence in prospective returns is a little strange to me even with Doric Nimrod Air One’s tiny size and asset base.

I would really like to hear your thoughts!

Note: I have already received some good comments highlighting the difficulty that the A380 may face down the line given its limited acceptance from major carriers. Residual value is a more serious concern than I had indicated in this blog post. That’s what’s fun about investing: the learning.

Alluvial Capital Management, LLC does not hold shares of Doric Nimrod Air One, Two, or Three. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

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19 Responses to Doric Nimrod Air One – DNA:LN

  1. james egan says:

    incredible find

    • james egan says:

      How did you even come across this?!

      • otcadventures says:

        I turn over a lot rocks. One day I started going through all the London-listed closed-end funds and it didn’t take long to find DNA.

        • Timothy Webb says:

          I am a UK based investor and have had a lot of success in closed-end funds but I have no clue where I can find a complete list of them. Where did you look?

  2. Kirk says:

    Take this with a grain of salt because I spent 5 minutes on this, but in the prospectus it states this: “THIS SECURITY MAY NOT BE OFFERED, SOLD, RESOLD,
    TRANSFERRED, DELIVERED OR DISTRIBUTED, DIRECTLY OR
    INDIRECTLY, INTO OR WITHIN THE UNITED STATES OR TO, OR FOR THE
    ACCOUNT OR BENEFIT OF, US PERSONS (AS DEFINED IN REGULATION S
    UNDER THE US SECURITIES ACT)”. It goes into more detail on page 86 too.

    • otcadventures says:

      Yes, that’s very common with securities offered outside the US. Nobody wants to deal with the Hassle of complying with US securities offerings laws.

      • PS says:

        Might be a stupid question, but does that mean US investors cannot own this stock? Or do you simply need to be a Qualified Purchaser (as defined in the Investment Company Act) just like funds/companies in the US that do not want to register their securities? From the limitations described on page for Qualified Holders, it sounds like Qualified Purchasers are fine but curious if anyone knows for sure. Thanks

  3. Z says:

    Why can’t you buy it?

  4. Abel Gizaw says:

    Great find as usual. However, I am very skeptical about the appraisal value. The A380 is a dying fleet. Here are some points that make the A380 less favorable:

    – Super heavy aircraft with four engines
    – Overflight and landing permits for the are high
    – Not every airport can accommodate its size
    – High operating cost – maintenance and fuel cost are high for the A380
    – Long range travel is falling out of favor. Its size & fuel usage makes it less attractive for short/medium range flights

    Airbus almost canceled this project from start. Emirates’ last minute order at the Dubai airshow saved this program. The fact that Emirates is leasing it from these guys says something. Airbus’ A350 is supposed to be the answer to the above-listed problems.

    I remember Quatas CEO saying somthing like “If we were to fly two 787s, the per-seat cost would be less than the A380.”

    Overall, the A380 is a dying fleet in my opinion. The A380 can be useful at congested airports, etc… so, not a completely dying fleet. But the point is that it’s hard to see demand for it in 2022.

    While I was excited about the idea, based on the appraisal value math; I find it hard to believe that they will find a buyer in 2022. Very hard to justify all the cost.

    Great find nonetheless. Thank you for sharing.

    • B says:

      I agree with Abel’s comments. There isn’t a liquid market for second hand A380s and the entire program is contingent on what Emirates.

      A380s are being retired now due to economic challenges and not airframe fatigue and a 50/50 bet that the fund can’t sell the jet at the end of the lease seems like fair pricing to me.

      • Alex U. says:

        Abel,

        Thanks for the insights on this fleet’s issues. I agree that there is risk in the post-lease disposition of the plane.

        Not knowing too much about the airplane re-sale market, I was wondering what made you think the appraisers have not taken the above concerns into account. Since the issues noted appear to be well-known in the industry, it would be reasonable to assume that the appraisers took the detrimental impact of some/all of these issues into account in the valuation of the plane.

  5. Maarten says:

    Thanks for sharing this idea. Seems very interesting at first sight.

    You can buy shares via degiro.nl, although they are not the ideal broker. Experienced some issues with liquidation payments from a small company that traded on the LSE (AIM market).

    • Alex U says:

      Great find! Agree with the estimated IRR~21%.

      One item to note, at the bottom of the June report, it is noted that “German asset manager Dr Peters Group announced plans to part out two of its four Airbus A380s, while continuing to lease the engines to Rolls Royce. Dr Peters Group anticipate that during the two year process the funds will generate proceeds of around USD 80m per aircraft.”

      With a little bit of reverse engineering (178 pence expected based on current appraisal of $101 million and total outstanding shares of 42.45 million,) I estimate proceeds at the end of the lease may be close to 129 pence. This results in a respectable IRR of 13%, even when the planes are ‘parted-out.’

      Do you have any thoughts on the marketability of the planes for parts at 2022?

  6. Alex U says:

    Great find! Agree with the estimated IRR~21%.

    One item to note, at the bottom of the June report, it is noted that “German asset manager Dr Peters Group announced plans to part out two of its four Airbus A380s, while continuing to lease the engines to Rolls Royce. Dr Peters Group anticipate that during the two year process the funds will generate proceeds of around USD 80m per aircraft.”

    With a little bit of reverse engineering (178 pence expected based on current appraisal of $101 million and total outstanding shares of 42.45 million,) I estimate proceeds at the end of the lease may be close to 129 pence. This results in a respectable IRR of 13%, even when the planes are ‘parted-out.’

    Do you have any thoughts on the marketability of the planes for parts at 2022?

  7. Ben says:

    Probably the main risk is the value of the Airplane – https://www.youtube.com/watch?v=Q2vFMGw4q1w

  8. NT says:

    I am a uk investor and know this stock well. I agree it has compelling returns but I also agree (sadly) that the resale value is a bigger issue than your blog post first recognized. The Dr Peters planes that are being sold for scrap (expected $80m) were some of the first off the production line, which I am told are the least desirable of any fleet as teething problems were smoothed out in the early production days. In addition those planes were in a German vehicle that still had debt at the end of the lease, therefore the banks called the shots and likely forced the fire sale.

    having said this I don’t think $80m is a realistic expectation for scrap value beyond a certain point. a sizeable portion of these would be the engines, resold to existing carriers and were the global fleet to decline so to would the engine value (c.$6m each I was told by Doric).

    The bull case is Emirates purchasing the plane (or releasing and the vehicle offloads to another holder). Emirates are playing games with words here and have said they won’t operate planes older than 12 years on some occasions. More recently they have backtracked from this though.

    the base case is probably a sale but hopefully to a new or existing carrier rather than scrap. c $80m feels reasonable for base case (15% IRR).

    Bear case is somewhere between breakeven and 6-7% IRR I think. not a bad risk reward.

  9. Stefan says:

    Thank you for such a simple and interesting idea. Reminds me of Buffett’s ideas even before the partnership days.

    Does anyone have a view on how inflation changes the residual values?
    The company has stopped giving its estimate of residual value including inflation and started giving one without inflation. GBP 63.1m reported in the report is a bit lower than $101m used in the fact sheet.
    Not necessarily a deal breaker in terms of IRR, but worth thinking about in terms of direction of the values.

    From the Annual Report:

    “After consulting with the auditor and the Company’s Advisors, the Directors have concluded that an
    uninflated value for the Aircraft at the end of its useful life best represents residual value as required
    by a strict interpretation of relevant accounting standards. In estimating residual value for the
    2017/18 year, the Directors have made reference to uninflated values for the Aircraft obtained from
    three independent expert aircraft valuers and determined that the residual value (using uninflated
    values as the basis) of the Asset was £63.1 million at the year end (2017: £80.4 million, including
    inflation and taking into account the associated costs of disposal). The residual value has been
    changed to reflect the most recent average appraised value of the aircraft, excluding the effect of
    inflation.

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