Adacel Technologies: Opportunities Abound

Harley Grosser

Capital H Management

Adacel Technologies (ASX:ADA), the rapidly growing developer of Air Traffic Control simulation and Air Traffic Management systems, has been one of the largest holdings in the Capital H fund since May 2015. We were lucky enough to take advantage of the share price drop back down to $1.80 (with the partial sell-down from large holders) by picking up some more shares at those levels and have since offloaded some at $2.20+, believing that at those prices ADA is trading near fair value based on currently available information.

But we wanted to draw your attention to a few things that could result in significant earnings uplifts in the years ahead. One of the favourable factors to ADA is that we get some forward visibility on what revenue will look like through the FAA’s budget numbers. In this regard, we note with interest the FAA’s budget for the TSS and ATOP programs. Keep in mind the financial year for the US Federal Government is Oct 1 to Sep 30, so we are currently 3 months into FY16 for the purpose of this discussion.

Firstly, the TSS (Tower Simulator System) is delivered entirely by Adacel. The budget for capital spend for TSS (additional to multi-year support and maintenance which is the bulk of ADA’s revenue) in FY15 was US$4m, increasing to US$7m in FY16.

This increase is for the upgrade of TSS hardware for a total of 17 locations (there are currently 27 locations covering 135 tower facilities under the TSS program) so there is likely to be more upgrades to come. This does not include ongoing software upgrades that Adacel sell on a recurring, consistent basis that has been one of the primary drivers of the smoother revenue and earnings results over the last three years.

But more interestingly, and probably more under the radar of the market, is the potentially enormous budget increase for the upgrading of ATOP (Advanced Technologies and Oceanic Procedures). ATOP, which is responsible for managing all oceanic air traffic in the US, is delivered by Lockheed Martin and subcontracted to Adacel, with ADA providing 80% of the software and generating somewhere between US$8-$10m per year on a recurring basis for the company (contracted out to 2021, but we expect an extension when the time comes).

In FY15 the enacted budget for ATOP was US$3.5m. The request in FY16 jumps significantly to US$20m. That figure is currently expected to be US$19m in FY17 and US$27m in FY18. While it’s difficult to determine just what proportion of that would end up in Adacel’s hands the fact that 80% of the software is Adacel’s IP and that operating system improvements are a key purpose for the upgrade suggests that if it goes ahead the benefit to ADA’s top and bottom line (and our valuation) will be material.

Adacel continues to be well placed to benefit from the enormous investment in aviation infrastructure and the shortage of air traffic controllers globally. While the current share price suggests it is near fair value we note there are plenty of opportunities out there for Adacel to continue their impressive growth story.

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Founder of Capital H Management and Portfolio Manager of the Capital H Inception Fund. Previously worked for Pie Funds and Bligh Capital.

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