Why Sky Harbour's CEO Isn't Worried About Valuation or Competition (SKYH Interview)

Good to see you, Brad. Appreciate your analysis lately.

The short answer is yes, Brad. One of the things that's kind of becoming increasingly clear to us ourselves, and we get this from our resident surveys that we do twice a year, is people do appreciate the physical infrastructure that we're putting down, that facility, but what they overwhelmingly note is the service offering, which is increasingly differentiated. There's no service offering like it. I'm not saying it's better or worse than others. It's distinct. It's very different. Now, people who I think study us closely understand that those two go hand in hand. Like, you do need a very specific physical infrastructure in order to deliver that service offering. But we think it's distinct. And it manifests itself in areas that we think are increasingly important. One is time to wheels up. People who fly these expensive aircraft typically value their time a lot, and not having any kind of delays or congestion on the ramp or anything like that is a very big deal for them. All the way to things like security. The fact that we can offer really kind of airtight in-hangar parking, in-hangar boarding, in-hangar deplaning, and we can also work to kind of customize a service to accommodate the specific needs of a given security team, for example. These are all kind of these nuanced features, which again sound like perhaps they're a little simple to deliver. They're not. So, yes, I think increasingly people will look at us as much more than a real estate developer.

I think when we see it from the inside, the path is a lot clearer. For obvious reasons, we don't really share our airport pipeline. That's very proprietary information. So, that's I think been a frustration that the market's had is that we're not really able to sketch out in detail what that road map looks like. What I can say is empirically, first of all, we're halfway there already in terms of number of airports, and I think we've gotten there a little bit faster than the market perhaps expected a few years ago. I'll also say maybe because this is a long-form discussion, which I appreciate, it might be worth just getting into a little nuance. We used to use, and you'll see this in our quarterly earnings calls going forward, we used to use that metric of number of airports, but fundamentally that misses the point. I think we used that because it was a simple, very digestible metric to use. A much more worthy metric would be the square footage of revenue-producing hangar that we're going to be able to put down. If we translate that from 50 airports, you figure 10 million square feet of hangar with attendant support space around the hangar, but figure 10 million square feet. And if you want to get even closer to the reality, what we're really going after is NOI. So, as you can imagine, a square foot of hangar in the New York area is worth a lot more to us than a square foot of hangar in pretty much any other location. Very few locations in the country would match that, for example. So, increasingly I think you're going to see us getting more nuanced as people just become more comfortable with the metrics that we're putting down and showing how we're actually targeting NOI specifically. And again, that can manifest in the number of square feet, of course, but it also manifests in the specific square feet that we're targeting.

Yeah, great question. Look, here's the evolution briefly. We started with a pretty arbitrary targeting criteria for airports. Really kind of took the path of least resistance. Maybe the one rule that we had is let's stay away from the New York area, Southern California, Northern California, because we know those markets are the best in the country, and we know we're going to make mistakes at the beginning and let's make mistakes in places where the stakes are a little bit lower. And that ended up being, I think, a wise decision, because we made mistakes. You're familiar with them. Some of them, pretty expensive mistakes, in the early days. Now that we're in a place where we feel like we have a pretty tight grasp of the variables that make this business a success, we are targeting the top markets in the country. We would not have dared in those early days, for example, go after an airport like Dallas International Airport. And I'm glad we didn't because I think we probably would have messed that up in a way that might have been unsalvageable. And here we are now developing at Dallas International Airport. That's been great.

That evolved into what we called a SHARE analysis, S-H-A-R-E, which stands for Sky Harbor Equivalent Rent. Because we want to take occupancy risk in this business because your pricing leverage is so much better when you have a standing product. We don't build the suit for anybody. We needed some way of de-risking our decisions. How do we know that we're going to be able to fill up hangars at Miami Opa-locka Airport at the rates that we're looking for or better? And that SHARE methodology is really kind of an intel effort where we go out and find how much people are paying in that market and specifically in that airport. We also use the surrounding airports because that's relevant as well. How much are they paying in hangar rent? Sorry, when I say they, I'm referring to base tenants versus transient traffic. How much are base tenants paying in hangar rent? And how much are they paying in fuel margin? There are a couple smaller variables that go into it, but we could stick to those two as the main drivers of SHARE. That is from our perspective the available revenue capture at that specific airport. That's what people are paying today to base at an FBO. And our assumption is if you're willing to pay that in kind of the hotel where you're contending with a lot of transient traffic as well, you should be willing to pay at least that if you're in a private hangar setting. And so that methodology served us well while we were using it. And I think you've seen it, our actual rents are exceeding our underwritten rents. So great, we were happy with that methodology.

What we've been able to refine, and this is the tool that you saw, because again, by the way, I think about 18 months ago, more or less, we had a town hall meeting. We do that once a month, and people can send in questions in advance. So from across our network, I speak to everybody. Somebody asked a question about AI. And I said at that town hall meeting that I really don't see any use for AI in this particular company. We're an airport infrastructure company. So, I was probably more wrong about that than almost anything. So, we've integrated AI across almost everything that we do in the company. So, the example that you saw was exactly that, is that we've mapped out all of the business jets in the United States, all the business jets that are based in the United States, using all sorts of sources, and derived, and some of it through inference, a lot of data on the ownership, the usage pattern of those jets, which has allowed us to get much more specific in our targeting. So, when we show up in a new geography, we already know who our top 50, who our top 100, who our top 200 potential residents are going to be, and we're going to approach them pretty much in that order. They don't know it yet, and we're going to build it first, but that's been the methodology.

So, to kind of give you an example of how that comes in, you could ask a query. Let's say you're doing leasing at Camarillo, which if you remember, that's the one airport that we actually bought, we didn't build Camarillo. And we needed to get up to speed. It was about, I think, about 40% leased when we bought it. We needed to get up to speed on that market pretty quickly, and we already had a more primitive version of the tool I just described at the time. And if you look at Camarillo's location in Ventura County, it's sort of in between the town of Calabasas and let's say Santa Barbara on the west side of that. So, we started looking at different resident profiles for whom we would be a really good fit. And one of the queries that we were able to put in is if you live in Calabasas and you keep an aircraft at Van Nuys, as most aircraft owners who live in Calabasas do. By the way, I think mostly because they did live in Beverly Hills or somewhere a little bit further east. They kind of got it in their minds that Van Nuys is the place to keep a plane, kind of like Teterboro is for New York. Again, if there's not a specific reason to challenge that assumption, people don't challenge it. If you live in Calabasas, have an airplane at Van Nuys, you tend to depart and you tend to depart in the mornings and arrive in the evenings, which is a pretty typical profile for a business jet user. You should be attracted to Camarillo because your drive time to Van Nuys is 60 minutes, and if there's heavy traffic, it could be 90 minutes, whereas your drive time to Camarillo is 28 minutes. And we can provide you a much less congested airport experience. So, your time to wheels up from arrival at the airport will also be shorter. That's a very, very strong value proposition for these guys. Again, time is probably the most valuable resource that we cater to in business aviation. So, that tool allows us to do that sort of analysis and mapping, and today a lot more granular, a lot more refined in the questions. But even spitting out output that we didn't expect. There's all sorts of kind of really interesting insights that can be gained from the tool. I mean, at some point I think it's going to replace us all, but that's a longer conversation.

Yeah, but first I think it's an appropriate concern, right? And the bottleneck in this business, like in any business, is going to shift. And when you kind of open up one bottleneck, another one's going to form elsewhere in the value chain. That's fine. That's how it should work. And I think in the early years, site acquisition was the bottleneck, should have been people's primary concern. Can these guys actually go out and secure land at airports? Once that was demonstrated, the bottleneck shifted to construction, as you're saying, and that's absolutely right. Construction on an airport, I say, is one of the areas that I was probably overly dismissive of at the beginning, as you know, these are simple metal boxes. How complicated could it be to put these up on airports? Turns out it's not a straight line. Again, we're not building Manhattan skyscrapers. We get that, but there are some very specific snags. I don't think we are the biggest hangar developer in the country, I'm guessing probably in the world. So, we've kind of learned in many cases the hard way how to get around those snags. And now our construction is moving faster, cheaper, and I think we're widely recognized as the best hangar in business aviation. So, that bottleneck has also shifted, and I think leasing is a good place to put it. By the way, it will shift from leasing to operations as well. But I think the things to look at is, watch how our strategy has evolved on the leasing side and judge if it's working or not. So, we started out with don't really start leasing until you actually have a certificate of occupancy and a standing facility, fully staffed, ready to operate. Because, frankly, I don't think we had the credibility to start leasing before that. If you remember, this is not an FBO where you're doing a month-to-month lease. We're asking people to sign up for five years, eight years, ten years. I get it, and they're looking saying, I don't want to be paying fifty, sixty, eighty thousand dollars a month only to discover a few months in that the service is not what I expected, and now I'm kind of stuck without a real contractual out. I want to see that the facility works. I want to see your HVAC, your electricity, your hangar doors, all the things that could go wrong are actually working correctly before I make a commitment. So, that was totally appropriate when we got it, and that led to those very, very long, twelve, fourteen, fifteen-month lease-up times on our first campuses, Miami, Nashville. Nashville, I think, took even longer. We have evolved to a pre-leasing strategy. Where we're saying we like to target being call it half to two-thirds leased before we even open our doors.

And I think what's allowed us to get to that place is the fact that it's a prototype hangar and it's the same experience at every airport, the same hangar at every airport, allows people to come in and kick the tires somewhere else, right? So, you might be looking at, for example, right now, Bradley, Connecticut. If you're going to be visiting Denver, Colorado, we could offer you to fly into Sky Harbor and just see what it's like and spend as much time without the company management, actually be there with the field crew in Denver and do all your due diligence, and sometimes that's pilots, sometimes that's mechanics, sometimes it's principals doing that. And certainly if you could do it in more than one location, you can develop some confidence that what's going to go up at Bradley is exactly what you're expecting. So, we trialed that. The first airport where we tried that was Opa-locka phase two, which we opened, I think, Francisco, correct me, 67% leased. To be clear, we don't want to go to 100 or 120, which I think we can get to there, because I think we're leaving a lot of money on the table in the pre-leasing. You've got more leverage at the end. It's like anything, it's supply and demand at the end of the day when you only have a few slots left and there's a couple dozen potential takers, you can drive better rents. So, we don't want to go to 100%. But that half to two-thirds, we think kind of makes sense. The next one that we'll see, and I think we'll give investors a chance to judge, will be Bradley, Connecticut, which will be opening in Q4 this year. We also have a significant pre-leasing effort going on there and people will be able to judge what it looks like when the doors open. Are we indeed one half to two-thirds leased and are we getting the lease rates that we underwrote for that airport? I will say, for the skeptics out there, who I appreciate, I'm often one of them. We did have a big advantage in Miami phase two. We had some tailwind there in that we had a fully leased phase one with a long waiting list and we're very well known in Miami. I think we're maybe just getting to a point where Sky Harbor is a well-recognized national brand where we get credit in Bradley, Connecticut for things that we've done in Houston or Dallas or in Miami. But there's nothing like having that standing in the local market where, despite the premium that you pay, Sky Harbor is definitely the home base of choice for the top end of business aviation in Miami. So, that was tailwind that we had in phase two in Miami that we might not have in future campuses, but we'll just leave it for investors to observe as we open up those campuses.