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This is written with serious investors in mind, though sometimes they're just drafts in progress. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

Sunday, May 1, 2016

Kicking around a new idea: $PSSR Inexpensive and Independent Airspace Technology Company

Summary bullet points:

  • $PSSR is a micro-cap with long operating history in aerospace technology and improving balance sheet.
  • Book of business is growing with recurring revenue subscriptions and the tailwind of long term industry trends.
  • Trading at inexpensive 5x EBITDA despite visibility into continued revenue growth.

In a recent article in the WSJ about a successful test using blockchains (ie bitcoin technology) to record transactions in the credit default swap market, I read the following quote ...

"Some may be reluctant to make changes that threaten their own market share or introduce new complexity to current systems that have been tested and refined over the years."

... and it struck me as something that could have been written about any industry, at any point in time in history.

This post is about technological change in the aerospace industry, NextGEN, and a tiny company called PASSUR Aerospace (PSSR) that until 15 years ago had a niche in "old technology" but is evolving with the "new technology" and could have an opportunity - given its established space in the industry, its slate of solutions that support NextGEN and recent hires - to grow revenues, maintain margins and thereby expand ROE and ROA back towards double digits.

The "old technology" is locating airplanes on a map, once essential, soon to be ubiquitous. The "new technology" is helping their customers - airlines, airports and ATC's - analyze, understand and make sense of enormous amounts of information to make better, faster and more efficient decisions around airspace and airport operations; scheduling, on the ground asset management, and routing.

Many larger companies are focused on using algorithms to provide better information for these customers. PSSR says its competitive advantage is +20 years of data analysis tracking its own and other information for more accurate predictive software.

I see another advantage as the stickiness of real estate in the enterprise, in the airport and ATC - the company has been there for more than 30 years - combined with finding solutions for airline customers that actually improves efficiency (a member of the board Kurt Ekert says he was formerly a sr employee at Continental Airlines when he found the company as a customer and fell in love with the product).

If ...the industry continues to modernize and evolve, if ... the product continues to improve and if ... the company continues to focus on meeting needs of existing customers, the stock could be attractive - revenues have grown recently and deferred revenues (a measure of subscriptions) imply continued growth - while the current valuation of of 5x trailing EBITDA seems to discount much in the way of a positive outcome.

I don't make price targets or predictions but I can imagine a future where continued and consistent steady growth and cash flow justify a higher valuation off of a larger pool of profit, while the balance sheet continues to delever, implying the potential perhaps for material growth to shareholders. Or not?  I am still trying to learn more; continued study and patience will be key.

PASSUR was founded in 1967 and has been publicly traded for more than three decades.

For most of this time, it operated under the awful / awesome name “Megadata” until 2008, when it changed its name eponymously to the pronunciation of the acronym of its heritage product, “Passive Secondary Surveillance Radar”.

Underlying PSSR – the acronym – are fixed radar sites – currently 185 in all - the largest passive commercial radar network in the world - at or near airports mostly in the US but also in Europe and Asia - that provide faster and more accurate position updates to airline operations control and ATC's. (These are the spinning radars that are used as establishing shots in movies, typically followed by skidding wheels on the runway).

The company once sold the machines, then sold the information from the machines as a subscription service. This fixed asset - and the service from it - gave PASSUR its name in the industry for solving the problem of locating an airplane and putting it on a map. As an example of this legacy, after the 1996 crash of TWA Flight 800, its radar network helped establish the precise location of the airplane at the moment it exploded and also the locations of other airplanes in the vicinity that might have witnessed it.

For several decades that legacy business was niche, yet essential and unique in busy airspaces. But new technology - notably ADS-B - is disrupting that position. By 2020 all airplanes flying in US airspace are required to have ADS-B - whether or not this actually happens is unknown - but it would make passive secondary surveillance radar a redundancy.

However PSSR is evolving ... and this brings us to NextGEN 

If you read the newspapers you've heard of NextGEN, perhaps as a bloated and expensive, FAA program; a failure; a plodding success; an over-promised and under-delivered program to - depending on your viewpoint - upgrade airspace technology to improve efficiency and safety in US airspace; or to simply force all the air traffic controllers out of work.

But NextGEN's over riding ambition is to modernize the US aviation system "... to improve the operational performance of the national airspace system."

Because of the collaborative nature of the US airspace, the benefits of any modernization at one airport or in one airplane isn't effective unless surrounding regional airports and airplanes using those airports also upgrade.

In the simplest least complicated explanation of NextGen, it is an effort by the FAA to "quarterback" the collaboration required between the primary agents in the industry ...

Airlines (ie operators)
Air Traffic Control Towers

... in order to modernize the US airspace.

The whole plan unfolds in a tough politicized environment where there is reluctance to change "... or introduce new complexity to current systems that have been tested and refined over the years" as per the introductory quote.

Big contracts. Government agencies. Modernization. It's all very complicated, long term and likely to benefit the large industry players, right?

The RTCA (Radio Technical Commission for Aeronautics) is an industry advisory committee used by the FAA as a "Public-Private Partnership venue for developing consensus among diverse, competing interests on critical aviation modernization issues in an increasingly global enterprise."

And here - among many places - is where PASSUR plays a part; despite their small size they are trusted, independent and known in the industry, so they have a seat at the table helping to develop, implement and track NextGEN priorities as well as participate in opportunities to improve operating efficiencies in the industry.

Furthermore, their "last generation" technology isn't so last generation; they continue to roll out new SSR systems at airports, as backups and redundancies.

And finally, they have been generating meaningful - and it seems recurring - revenue growth helping airlines and airports use the enormous quantities of data available to airlines from a variety of sources to solve one of three general problems that occur primarily when weather disrupts flights ...

Better ETA’s and ETD’s to airlines improve on time performance and better prepare for arrivals and departures.

Better on-the-ground airport information (ie “surface management”) to improve – among other things - turnaround times and on-ground performance.

Better air-traffic management to safely accommodate increased overall capacity in the airspace and airports.

... in predictable environments these things on their own are not terribly complex but throw in diversions associated (most frequently) with poor weather and non-linear problems around availability of runways, gates, crew time, surface equipment, etc. begin to escalate.

This is where PSSR's service / solution / revenue generation comes in. The company integrates its own sources (PSSR) with other available data sources (ADS-B, ASDE-X, Mode S, En Route Radar, Airline OOOI data, ACARS, fleet databases, etc) as a data feed to flight and airspace information, then runs the data through its own algorithms and uses it to provide better analysis for predictions and performance, which ultimately supports better decision making by its customers.

It sells services and software systems via subscriptions that provide more efficiency in various aspects of the airline industry. Large material customers include $LUV and $JBLU in their most congested regions that experience weather.

I hate to rely on cliches and jargon but this where I'll throw out the term "big data" with a link to an HBR article about how PSSR - and Sears Holding (lol) - are using "big data" to improve operations. (take it FWIW, I felt I had to reference the article).

A key question here when we reflect on the world of big data is why aren't other people doing it, why is PSSR still independent, why aren't revenues higher, etc? 

On the face of it, having better resources to solve these problems sounds like a “no-brainer”. However, based on our research and our understanding of the industry, there are headwinds to customer adoption of both solutions.

On ETA / ETD, it’s not generally seen as a complicated problem where the benefits of shrinking the ETA / ATA gap is seen as critical. When a plane leaves late it can fly faster, weather remains an acceptable excuse for delays and with the exception of the most congested airports, “good enough is good enough”.

On on-ground performance and turnaround times, the biggest factor is planing and deplaning customers. A subscription service that improves on ground performance without improving that process does not appear to be a problem customers feel need solving

And finally, reference the quote at the beginning of this post. A source I spoke with at a competing company who said the PANYNJ, which manages some of the busiest airspace in the world, is a huge obstacle to investment in new technology for reasons as simple as "turf battles".

In light of these obstacles, the answer to selling a customer a solution to a problem they don’t feel they have and in a crowded and competitive field is to increase and improve selling and marketing function. PSSR is doing this, it appears with early initial success albeit with some degradation of margins (EBITDA margins now 28% down from the mid- 30% range; we'll get to this in a minute).

But the investment thesis that underlies the opportunity for material long term gains is that there will be an evolution in how these problems are viewed by the customers.

We have seen examples in other markets and industries where marginal improvements were deemed unimportant and unnecessary until eventually they became essential and ubiquitous.

That is the path to a maximal and exciting return. For the patient investor, if that evolution occurs and customers are willing to pay, there could be material gains. In the meantime, you're getting some solid "blocking and tackling" at a low multiple.

We see a company growing revenues and backlog, this as a decent cash flow generating growing business trading for a low multiple at today’s prices.

Revenue and Subscription (aka backlog) Growth
The evidence demonstrates that since losing contracts in 2012/2013, quarterly revenues have been growing through 1Q16 (quarter ending 1/31/16) with pronounced sequential and y/y over growth over the last four quarters. The company indicated the "lost contract" was not a recurring revenue "core" program but a one-off for DHS.

This chart tells the current growth story (revenues) as well as the future growth through two balance sheet items that capture the equivalent of “backlog” (ie subscriptions); they are deferred revenue netted against accounts receivables. Higher levels of subscriptions should lead to continued higher levels of revenues over the next 12-months leading to potential growth acceleration.

Balance Sheet Improvement 
When we think about a business and its all-in consistency, we look for companies with good balance sheet management as reflected in growth in shareholder equity. Here the improvement since 2012 has been slow and steady . The bulk of improvement prior to that came via a partial recapitalization / debt to equity conversion in 2012. The company’s primary shareholder GS Beckwith Gilbert owns 4M shares (53%) and is also the note holder on the $3.5M in outstanding debt.

High EBITDA Margins, but Investments in SG&A a Headwind
Until recently, EBITDA has largely kept pace with the growth in revenues. However, new hires in the last 12 months have absorbed a greater share of expenses.

The new hires that impact SG&A include back office talent as well as customer facing talent:

David Brukman, CTO.
David Henderson, CFO
Leo Prusak. Former FAA Deputy Director to head airport operations
Bob Junge, formerly head of JFK airport operations, to sell airport solutions
Howie King, formerly of competitor Saab Sensis, to be a director in business development

Other evangelists for the product include …

Jim Barry, CEO
Tom White, head of product
Chris Maccarone, airline performance

The impact of these new hires might be evident in future revenue growth but it is certainly evident in current SG&A which at 1Q16 had increased 38% to $1.6M; it is as high as its ever been and is now up to 48% of revenues, up from the 38% average in the prior five years.

The question of course is, can the revenues scale these new hires? The evidence from recent revenue and subscription growth is that it is on the way.

Current competitors that sell “data driven” solutions tied to weather diversions, on ground performance and operations systems management include SAAB Sensis, Navtech (an airspace technology company recently acquired by Airbus) and IBM / weather channel, but none are as narrow and focused as PSSR.

The risk associated with competition should include the question: "When does google get into this space"? In some respects, though the degrees of complexity are different, the evolution of NextGen is not materially different from the evolution towards self driving cars. Many of us already use devices for routing, ETA management, etc when driving. I would argue its easier to penetrate the automobile since there's no "gatekeeper" (or union) advocating obstacles to automated driving the way there is keeping it out of the ATC or cockpit.

To this aspect, I see the company's legacy through the lens of that initial quote as a benefit. The company's real estate in the cockpit, ATC, and operating control room has value; the company is trusted and present. Best of all, they have been evolving slowly and successfully in the right direction.

As I've dug into this industry, I've been surprised with how "old fashioned" it is. On the front end, the customer interface seems to have leapt forward with ticket ordering and boarding pass apps and the evidence shows that overall safety has improved as well.

However, on the back end, based on what I've learned, many companies continue to operate inefficiently - and more critically - airports, municipal authorities and ATC's are as well. As someone told me recently, "the air traffic control system in this country is so antiquated, it would scare the shit out of you if you knew about it."

Because airlines, airports and ATC's are all partners in the industry ecosystem, the full benefits of an improvement by one agent - an airline say - in on time arrival might not result in faster turnarounds if the airport or ATC doesn't improve efficiency and a gate isn't available. Again, this is the reason for NextGEN.

It makes for an interesting investment quandry, because the situation can go on indefinitely. Ultimately however, my investment thesis is driven by the view that while improvements in efficiency can be overlooked and ignored eventually they became essential and ubiquitous. And in the meantime, you're getting a company that has a long history of quality management,

There are obvious risks with investing in general, nano-cap specifically and in particular companies - like this one - with ownership concentrated in the hands of one person.

Beckwith Gilbert owns ~53% of the equity of the company (4.1M shares) plus the $3.5M note paying 6% interest. He is by many accounts committed to the success of the company and was willing to stand by when it had financial difficulties but it is unclear he is committed to returning shareholder value and that's made me cautious on this position in my portfolio.

Two issues specifically give me pause:

1. His compensation. Mr Gilbert is paid  $300k / year for his role as the Chairman, which is as much as the CEO, Jim Barry, who does most of the heavy lifting. I have no view on what Mr Gilbert does to earn his compensation but it is in addition to the interest he receives on his $3.5M in debt to the company. Viewing that $300k comp as a form of interest expense on the debt, the implied rate on the debt is closer to 16%, which is well in excess of junk yields.

At face value, perhaps it should be viewed as an indication of the speculativeness of the investment with as high a degree of risk as a junk bond.

2. A comment to me about his goals for the company. I recently attended the shareholder meeting and followed up with questions after digesting what I'd learned. A final question of mine, which I like to know from all executives of all my investments, is what are the goals for company, or in short: "why"? Why be in business? Why do this? Often its just lip service but sometimes there's a commitment to customers, to employees, to shareholders, etc.

In this case, when asked why they're still independent (given that some have rolled up and been acquired) his answer was along the lines of "b/c it's more fun to be independent and take on the big boys."

And when I asked about the long term goals for the company, where they expected to be, etc. there was no comment beyond "having fun".

I don't think that's untrue - there is something refreshing about that - but what does it mean for shareholders and maybe even about the employees who don't have the same financial independence as he has.

I think its much more fun to have winning investments. 

ADS-B. Automatic Dependent Surveillance - Broadcast

ASDE-X. Airport Surface Detection Equipment, Model X

ERAM. En Route Automation Modernization.

TAMR. Terminal Automation Modernization and Replacement. "The TAMR program is upgrading air traffic control systems at terminal radar approach control (TRACON) facilities across the national air space (NAS) with the Standard Terminal Automation Replacement System (STARS) platform."

TRACON. Terminal Radar Approach Control

STARS. Standard Terminal Automation Replacement System

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