Clarus, Orion and Westwind on Discovery Air tuckunder acquisition

Here is a medley of last week’s research reports on Discovery Air (DA.A:TSX):

From Clarus Securities research:

1. Discovery Air to Acquire DMS for $10 million

Yesterday, Discovery Air announced that it has signed a letter of intent to acquire Discovery Mining Services Ltd. (“DMS”) for $10 million in cash and stock. We understand there to be no previous relation between the two companies. Expected to close in Nov-07, the Company will issue DMS $5 million in DA.A shares and pay $5 million cash ($3 million from working capital with the remainder from a note payable). We believe the Company paid ~5.0x trailing EBITDA which is at the lower-end of previous acquisitions made by the Company.

2. Enhances Exposure to Long Term Resource Projects

Based in Yellowknife, NWT, DMS provides end-to-end remote mining camp services including cargo transport, logistics and general exploration and drilling camp services across the Western Canadian resource basin.

3. Better Positioned to Meet DMS Needs

DMS is an existing customer of Air Tindi and Great Slave Helicopter. We therefore believe that Discovery should benefit from this transaction by having a better sense of matching aircraft with DMS’ business requirements.

4. Valuation

In terms of valuation, we look at comparable remote camp and catering services company, Horizon North Logistics Inc. (HNL-TSX, NR) which is currently trading at ~11.9x EV/EBITDA on FY07E consensus and ~7.4x FY08E. Given this valuation, we believe that Discovery paid an appropriate multiple for DMS.

5. Adjusting Estimates

We are neutral on this acquisition and believe it will add ~$6.0 million in revenue and ~$1.9 million in EBITDA to our respective FY09E and FY10E estimates. Our FD EPS forecasts are unchanged at $0.16 in FY09E and $0.21 in FY10E.

Conclusion and Recommendation

We continue to believe that Discovery’s market-leading position in Canada’s North will result in continued pricing power, organic and external volume growth and ultimately higher margins going forward. The Company’s exposure to the northern Canadian resource industry as well as other niche aviation and related markets (flight combat training, fire suppression and logistics) should result in strong revenue, EBITDA and EPS growth over the investment horizon. We maintain our BUY recommendation and target price of $2.30 per share.

From Orion Securities:

What Happened?

• Discovery Air plans to add to its dominant position in Arctic-based mining services. The company entered into a letter of intent to acquire Discovery Mining Services Ltd. (DMS), a camp rental, logistics and expediting company based out of Yellowknife, NWT. The purchase price is set at roughly $10 million ($5 million in cash and $5 million in DA.A shares).

• Completion is subject to due diligence, regulatory approvals and the finalization of a definitive
purchase and sale agreement. Closing is expected sometime in November.

What Does it Mean?

• DMS would be a natural fit with Discovery’s existing northern operations… One of the most compelling aspects of Discovery’s business is the formidable market share it has built in Nunavut and the Northwest Territories in helicopter (Great Slave Helicopters) and fixed wing
(Air Tindi) transportation services. These two subsidiaries control roughly 75% and 40% of their respective markets. With this type of infrastructure in place, we believe it makes sense for the company to tack on complementary businesses, especially in its core mining/exploration niche. DMS certainly fits that bill. In fact, DMS routinely uses Discovery’s fleet for scheduled and expedited equipment transportation and deliveries.

• …and would build on Discovery’s strong community presence. DMS also owns a 49% interest in Nunavut Expediting Services, a federally incorporated joint venture with 51% Inuit ownership. As we have highlighted in the past, maintaining solid relationships with local
Aboriginal communities is a key aspect of doing business in the North.

• Plenty of room to expand. While there is obviously some overlap, we expect Discovery to quickly find ways to market DMS’ services to its large and growing customer base. DMS’ business is not particularly capital intensive and it generates margins in line with Discovery’s overall business. This bodes well from a return-on-capital perspective.

What Is it Worth?

• Nice tuck-in but unlikely to move the needle much; DCF-based $2.60 target intact. DMS is expected to generate roughly $6 million in revenue and $2 million in EBITDA on an annual basis. As such, and while we like the move strategically, it is not overly material within the context of Discovery’s current business. We will review our forecast upon closing.

What to Do

• Business development kicking into high gear – potential yet to be recognized in the share price. Tuesday’s announcement is the latest in a series of initiatives that should add significantly to Discovery’s growth for the next several years. As these initiatives begin to hit
the bottom line, we expect to see DA.A shares re-valued by the market.

From Westwind Partners:

Discovery Air Inc. (DA.A-T: $1.50)
Rating: BUY Target: $2.25

Mkt. Cap: $196 MM ‘09 EV/EBITDA: 5.9x Total Annual Ret.: 50%

Company Announces Acquisition Of Discovery Mining Services

Insight or Development:

Discovery Air (DA) has entered into a letter of intent to acquire Discovery Mining Services (DMS), a leading provider of camp management, expediting, logistics and environmental cleanup services to mining companies operating in Northern Canada.
Despite being a relatively small acquisition, we believe that DMS could provide a number of strategic benefits to DA going forward.

Analysis:

DMS is expected to be acquired for $5 MM in cash and $5 MM in common shares of DA, with the cash amount to be financed partly from working capital ($3 MM) and the rest by debt ($2 MM). This pegs the purchase price at $10 MM and implies a relatively inexpensive 4.9x EV/EBITDA multiple (DA trades at approximately 5.9x EV/2009 EBITDA). The acquisition is expected to close in November 2007, subject to due diligence and regulatory approval. On an annual basis, DMS is expected to contribute approximately $6 MM in revenue and $2 MM in incremental EBITDA.

As a result of the acquisition, we have increased our revenue and EBITDA estimates for FY2009 to $174 MM and $55 MM, respectively (from $168 MM and $53 MM, respectively). Our 2009 EPS estimate remains unchanged at $0.17, partly due to the dilutive impact of the additional 3.3 MM shares issued. With the acquisition scheduled to close in Q4/08, we expect no material contribution this year and our FY2008 estimates remain unchanged.

As mentioned earlier, DMS provides various support services to some of the largest gold, base metal, uranium and diamond exploration companies operating in Northern Canada. Most of these activities require air transportation services, which DMS currently subcontracts to aviation service providers operating in the region (including DA’s subsidiaries Great Slave Helicopters and Air Tindi). As a result, there could be a number of synergies and strategic benefits to DA going forward:

The acquisition should help increase utilization of DA’s existing fixed and rotary wing aircraft.
DA should benefit from DMS’ experience and knowledge of the mining industry, and will likely be able to leverage DMS’ existing industry relationships to create additional business opportunities.
Following the acquisition, DA will be able to expand the range of services provided to existing customers.

DA has been exploring the possibility of acquiring heavy-lift aircraft in the future. The DMS acquisition should also help lock-in some demand for a potential expansion into the higher margin heavy-lift aviation service offerings.

Overall, we believe that this acquisition, though small, is a sensible addition to DA’s portfolio.

Conclusion:

We continue to like Discovery Air’s growth profile and its leverage to the booming resource industry in Northern Canada. Recent acquisitions such as Top Aces and DMS could provide for additional growth opportunities. With a 50% total return potential to our $2.25 target, we reiterate our BUY rating.

(All figures in C$, unless otherwise noted.)
John Grandy, (416) 815-3067 jgrandy@westwindpartners.ca ; Rahul Paul, (416) 815-3128 rpaul@westwindpartners.ca

MRM
(disclosure – Wellington Financial Fund II and certain managers/LPs own shares in DA.A as a result of the acquisition of portfolio co. Top Aces. I also own some DA.DB convertible debentures.)