Stockwatch: This big spender is half-price

Has BBA sold off justifiably, or emotively? The chart for this mid-cap aviation/aftermarket services stock saw a rise from 150p in 2012, into a 220-260p range for about 18 months. It then failed to sustain this, de-rating from a high of 360p at the beginning of 2015 to about 170p where it is currently finding support. It rather follows general trends in cyclical stocks, but the drop in BBA is more marked.

In particular, it follows last September's $2,065 million (£1,362 million) acquisition of Landmark Aviation which is expected to complete in the New Year.

This was a big stretch involving a £748 million, deeply discounted 6 for 5 rights issue at 133p and £670 million of new debt. The group's size is being doubled to consolidate leadership in global airport services, especially in the US. Equity finance will also aid expansion of BBA's existing Signature network of "fixed base operations" towards the hoped-for synergies with Landmark. If the US economy evolves well enough, this is all a timely and logical move, although the rights issue pricing hinted at risks and is, I believe, partly responsible for BBA's de-rating.

Current pricing offers value if merger works

The current 175p/share area makes BBA interesting for investors willing to risk whether air travel will pick up in the medium term, and if this ambitious merger can avert the debacles of other such "transformational" deals - e.g. Lloyds/HSBC, AOL/Time Warner. Also, the balance sheet is stretched even after the rights issue: net debt is expected to be 3.5 times operating profit this year-end, which the board looks to reduce towards the top end of its target range by end-2017.

With the interest rate cycle turning up (if gradually) it all helps explain recent selling. However, if 3 December independent forecasts by N+1 Singer are credible (see table) then key numbers are moving in the right direction; also, the Landmark deal is expected to be earnings-enhancing from 2017 and genuinely create value from 2018. This is BBA's essential, higher risk/reward profile, and also why the stock is prone to sell off in jittery markets yet also find buyers.

Chairman buys heavily

Management insists timing and pricing are right; that despite Landmark's size they know the business very well, i.e. this mitigates risk. The boardroom view likely explains chairman Sir Nigel Rudd buying 73,500 shares, his wife 70,200 shares, and a related investment company 55,700 shares, all at 192.1p on 13 October.

The timing of that £383,000 purchase may look a bit odd around a big share issue at 133p. However, Sir Nigel only held 4,000 shares on which to gain rights, and would have been restricted to buy in advance of the deal being announced. So these trades are a significant marker for belief in value and the merger working out.

In the opposite corner, two asset managers are short: on 22 October Cigogne Management increased its short position by 0.07% to 0.83% of BBA's issued share capital, while JP Morgan Asset Management declared a 0.57% short position on 25 November.

Further to the risks I outline, bears may latch onto Landmark being ex- the Carlyle private equity group, figuring that private equity ownership has mixed implications for corporate health. But contrary arguments and short-sellers characterise contrarian stocks, and such traders have to buy back at some point.

Latest trading update: resilient, but mixed

A 9 December update cites revenue for flight support (about two-thirds of group revenue/profit) slipping 3% due to contract losses e.g. at John F Kennedy airport and Singapore Changi airport, and weakness in business/general aviation in Europe. More positively, the Signature flight support business achieved "another strong performance with organic revenue up 3% and good drop-through to operating profit".

The aftermarket services side (about a third of revenue/profit, servicing engines) saw a 3% revenue decline, but there is a strong pipeline of licence opportunities. The update concludes adorningly, citing "strong momentum into 2016 driven by flight support" and the merger with Landmark offering "very significant customer and stakeholder benefits".

A sceptical interpretation is BBA needing a major deal like this to inject interest, otherwise the stock de-rates into income territory, priced for a useful yield. Now in a 4.5% to 5% area, that has happened anyway.

Balance sheet emphasises earnings/yield valuation

Besides the risky extent of debt - just over $1.8 billion following the latest increase, versus $131.4 million cash at end-June - the balance sheet has nearly $1.2 billion goodwill/intangibles, accounting for the weak trend of negative net tangible assets per share. This typifies major acquirers, although BBA promises to cut debt with disposals; a factor to watch given it affects the risk profile. Value still depends heavily on the Landmark deal working out successfully and aircraft services proving resilient, in support of the earnings/yield profile.

So the chairman and the short sellers underline how BBA can potentially reward both sides of trading. The de-rating makes the stock attractive if management integrates Landmark like they say they can; also, a bias to the US economy will benefit sterling-based investors if the US remains robust, likewise the dollar as interest rates creep up. But if a deflationary scenario takes hold and/or expectations for the merger aren't met, BBA is potentially struggling under high debt.

At some point this stock will still turn up decisively, as BBA is industry leader; and operational proof of the merger would spur both more coverage and upgrades, 250p+ being easily achievable.

This will only become clear in hindsight, however, hence the reason to consider the current support level of 170p as a prompt to average in - keeping aware of the risks. If you are a deflationary doomster, battening down for a cynic's life in a barrel, consider the short side.

For more information see the company's website.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.