Stranger Things Have Happened

I thought Air Canada’s IPO would be a hard sell, particularly considering that, as a company, it has very little to offer to investors. Raising red flags are also analysts, who call its IPO price an “accounting invention.” Now, for the most part, I get why Bay Street likes it. Canada’s investment landscape is relatively barren, apart from energy and financial stocks, and grey suits got a little bored. But, why ordinary investors would like it, is beyond me.

I travel a lot overseas, always making sure I never use Air Canada. First of all, Air Canada packs the economy class so tightly that I would either have to sit with my knees glued to my chin or let a stranger in the seat in front of me sleep in my lap. Second, I would also have to pay an arm and a leg for this “privilege,” while the food, for which the airline came up with some ridiculous overhead, is not really food at all! No, it’s KLM or British Airways for me, thank you very much. For the record, I’m not interested in Lufthansa affiliations either.

Aside from this traveler’s saga, let’s return again to why analysts are calling Air Canada’s IPO price an accounting invention. If I understand what financial press is saying, if and when this IPO goes through, Air Canada would have a market cap of C$2.2 billion. The million dollar question, or I should say the 2.2 billion dollar question, is if Air Canada at that price is undervalued. To answer that question, we need to decipher what the company’s revenues are. And, this is where things get a little complicated.

Air Canada does not want you to look at the very bottom line. Instead, the company wants you to stop looking a few lines earlier, where the figure of C$958.0 million appears under the heading “adjusted EBITDAR.” In plain English, this is how much the company earned for the past twelve months (ended June 30, 2006) before interest, taxes, depreciation, amortization and costs of owning and renting airplanes.

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But, once all that is put back into the equation, you end up with an operating income of only C$169 million! Plus, once bondholders collect their interest payments, investors are left with, well, nothing! (Actually, less than nothing, we would enter negative earnings territory.) Sure, there is foreign exchange profit and perhaps the elusive category of “non-operating” income. But, pairing together a market cap of C$2.2 billion to no real profit, well, no wonder Air Canada wants you to look at EBITDAR figure only. Almost a billion dollars in revenues sounds so much better, doesn’t it?

So, OK, ordinary investors have been known to do silly things just because someone told them so. But, why would anyone on Bay Street even want to come close to Air Canada deal? The way I see it, grey suits are bored again. Mergers and acquisitions are selling Canadian companies one by one, while underwriters haven’t seen anything interesting in years.

As bored as they are, in the case of Air Canada, they came up with a bet that fuel costs will drop more dramatically then ticket prices. Granted, in the past few months, that has been the case, which would allow Air Canada to push its head just above water and for real this time.

However, the problem with this bet is what grey suits at Air Canada have to do to justify their fat pay checks–and that is not merely keeping their heads above water. No, the Street and investors want them to swim ashore every time, and bearing gifts at that. And the way things look right now, the only way the management can do that is to base their performance on EBITDAR numbers, which is why I would think long and hard before investing in anything Air Canada, either plane tickets or IPO shares. Though, stranger things have happened…