ANALYSIS: Has the bubble burst for China's business aviation sector?

Bull market peaks are often punctuated by landmark transactions. The 2014 Asian Business Aviation Conference & Exhibition (ABACE) saw one such deal, with Minsheng Financial Leasing’s jaw-dropping order for 60 Gulfstream private jets, one of the largest orders in the storied manufacturer's history. Bombardier also identified the lessor as the buyer in a late-2013 deal for 10 Challenger 350s.

The buzz at the show, held on an apron adjacent to Shanghai’s Hongqiao airport, was palpable. Well-heeled visitors browsed through the cream of the world’s business aircraft, enjoying jet makers’ hospitality in well-appointed chalets. Still, the overcast conditions shrouded the event, foreshadowing a year in which China’s hitherto unstoppable private jet bull market started to run out of steam.

Not to say industry executives have become bears about Asia’s biggest market for private jets. Every aircraft manufacturer Flightglobal has spoken to expresses long-term confidence about the market and the real need for business jets as Chinese companies grow at home and expand internationally. Still, they say the market is increasingly characterised by longer decision times, a tougher tax environment, and a glut in the large-cabin arena. Some market observers express concerns about the heavy involvement of Chinese financial firms in the business.

Roger Sperry, the regional senior vice-president, international sales at Gulfstream, has been doing business in China since 1996. He notes that the market has cooled in the past three to four years. “There has been a decline, but it is still a good market,” he says.

Sperry believes the market will remain dominated by large-cabin jets, but that there will be increasing interest in midsize types such as the G280, which can carry 10 passengers up to 3,600nm (6,670km), making routes such as Beijing-Singapore possible.

“Smaller companies are also likely to start looking at jets, but they will go mid-sized as they can’t afford a G450 and higher,” he adds. Furthermore, some customers are starting to use private jets to ferry around not just the chairman, but middle to senior-level executives. This shows that Chinese firms are recognising that private aircraft are, indeed, business tools, rather than a status symbol for the boss.

The overcast conditions in Shanghai for ABACE 2014 were perhaps apt for what was to follow

At Gulfstream’s rival, Dassault Falcon, China general manager Jean Michel Jacob also notes a distinct cooling in the market, but he too remains optimistic.

“The market has slowed down, yes,” says Jacob. “It might be a temporary slowdown as we need to face some political issues over which we have no control, and we have to face the fact that people have bought many business jets over the last 10 years, and now they have to digest that. China still needs business jets for the development of the economy. In the long run, we have to remain positive and optimistic. We will still invest in making our brand known.”

Embraer has also noticed a distinct tightening, with deliveries and new orders declining in 2014. Apart from China’s slowing economy, the Brazilian jet maker sees other constraints, such as parking spaces, a lack of pilots, and fast-growing commercial airlines that compete for scant airport and airspace resources.

It, too, notices a maturing trend, and believes that midsize jets, such as its Legacy 500 offering, will see growing interest in the country.

“Chinese customers have been more focused on the large-cabin aircraft, but in the past 12 months, purchases have tended to be more mature and focused on real usage instead of just huge cabins and long range,” says an Embraer spokeswoman.

Asian Sky Group, a Hong Kong-based consulting firm, used last year’s ABACE to launch a report about the greater China business jet fleet in 2013. It plans to use ABACE to launch a revised version for 2014. In 2013, it put the number of business jets operating in Greater China – Mainland China, Hong Kong, Taiwan, and Macau – at 371 aircraft.

The two most popular models in the region are the Gulfstream G550 and G450, representing 30% of Greater China’s total fleet. Another trend Asian Sky observed was an increased willingness on the part of Chinese buyers to acquire used aircraft. In 2013, 47% of the aircraft delivered into the China market were pre-owned, with the remaining 53% being new aircraft.

Asian Sky’s general manager, Jeffrey Lowe, corroborates the view that the market is slowing. He contends that more private jets actually left China in 2014 than entered the market. He cites three key reasons for the slowdown. The first is a tougher tax environment that makes it harder for jet owners to avoid duties and value-added tax, which can come to about 23-24% of an aircraft’s value or lease rate.

In years past, a favourite tactic was to set up an offshore structure to own a private jet, which was then leased to the user at an extremely low rate. Chinese officials, previously oblivious to the actual costs involved in jet ownership and usage, have become more sophisticated. They now possess a better sense of lease rates as defined by the aircraft’s overall value, and are willing to take jet owners and operators to task.

“Some Chinese owners facing a higher tax burden are changing the country of registration of their aircraft and then basing them offshore,” says Lowe. “This will cause some additional hurdles that owners will have to jump over when operating the aircraft back in China (as they are no longer domestically registered), but a good management company can help facilitate this.”

The other two factors Lowe points to for a slowing market are a general austerity campaign – a major element of which is the rooting out of corruption – and slower economic growth. Some high fliers simply cannot afford a private jet anymore.

Another area of concern, according to several people involved in China’s private jet market, is the prevalence of leasing firms. Flightglobal’s Ascend Fleets database shows that Minsheng manages 84 in-service private jets, most of which are leased out to local private jet operators, many of which are units of Chinese airlines. Other prominent financial firms with aircraft leasing arms engaged in the private jet business are the Industrial and Commercial Bank of China (ICBC), Bank of Communications, and the Agricultural Bank of China.

“In China we have a very specific situation where financial institutions buy aircraft and then sell or lease them to other people,” says one industry executive. “They thought they would control the market, but I’m not sure it’s a total success. The model is based on the assumption that the original equipment manufacturers will give away their marketing, and that the OEMs will offer them big discounts, essentially financing the aircraft until they are leased. This business model might succeed, but it might not.”

The executive says a key element of the model is predicated on the leasing firms’ belief that they have sufficient market connections to move aircraft.

“Imagine an OEM sells 10 or 20 aircraft to one of those banks, but then they decide not to take title?” he asks. “It’s always a risky business. You think you have a nice orderbook, but it’s very fragile, in fact.”

Asian Sky’s Lowe expects that the current economic environment will make it a hard slog for financial firms to move private jets, especially in light of the massive influx in jets during the past few years.

“This has led to an oversupply of new-build aircraft available in the Chinese market, which could also lead to a conflict with the OEMs, as they are both pursuing the same market,” he says. “It is firmly a buyer’s market in China these days, as there are a large number of aircraft on the orderbooks chasing a small market of buyers.”

Ascend shows firm orders for 48 aircraft for business usage in China, most of which are due for the delivery in 2015. These include eight Bombardier Global Express 6000s and 18 Challengers, eight Embaer ERJ-135s and two E-190s. Of the 48 orders, 17 are going to Minsheng, and five each to ICBC, CDB Leasing, and CIB Leasing.

Gulfstream’s 60-aircraft deal with Minsheng is not included among these 48 orders, however, because it has not disclosed details of the deal, such as the number of firm orders, number of options, and delivery timeframes. A Gulfstream spokesman says the deal is on track and that the first jet will be delivered, as planned, in 2015.

This year’s ABACE promises to be another major private jet event, with all the key manufacturers bringing their best aircraft to the show. Even though few industry observers expect big, landmark orders, they all remain optimistic about China’s long-term prospects. Every market goes through the odd trough, before eventually rising to new highs.

Source: Flight International