ANALYSIS: View from the City

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View from the City: Mine is Bigger than Yours

Article contributed by Bert van Leeuwen, managing director, aviation research DVB Bank

With the depreciation debate in full swing and well established as a topic for most aviation finance events, it is now time to take a pause and deal with a slightly more "lightweight" issue.

For most of us, manufacturer briefings are regular items on our agendas, and although we all complain in advance about the expected brain-washing, we all generally enjoy attending them.

I am talking about those "annual events" that the major manufacturers organise to update the financial community about the latest product developments, their view on the finance situation, and most of all, to convince everybody that their product is superior to that of the competition.

Of course, separate events are run for the people that matter most, the airlines and operating lessors, because they are potentially in a position to actually order the products.

However, those manufacturers that understand what is going on in the business do not ignore the guys and girls with the money, nor their advisors, the appraisers, the lawyers and the insurers . Even some airline representatives can be spotted occasionally at the manufacturers' financiers briefings, but usually in the centre of a gaggle of bankers.

Airbus and Boeing seem to be the most active and have a of tradition of how and where they run their events.

The smaller airframers have a mixed policy. After a well know representative from the leasing community joined Embraer, it seems they have become more active, as demonstrated by the excellent pre-ISTAT event in Rome. Bombardier generally runs smaller events, usually aimed at specific focus groups. Mitsubishi Aircraft Corporation is an ambitious newcomer to the scene with investor and financier events in Dublin and Tokyo and other locations. The Chinese and Russian manufacturers do not seem to bother too much because either their products are not yet ready to be presented, or they do not care, as the funding will come from the government anyhow.

What most of the manufacturer events have in common is the "mine's bigger than yours" element. As a rule, their own products, being the aircraft or the engine, are presented in a way that clearly demonstrates their goods are far superior to anything the competition has to offer, or will be able to offer, in the foreseeable future. With the recent Airbus and Boeing presentations during the Hong Kong conference back-to-back, this resulted in a situation where, in the morning, it was proven, beyond any doubt, that the Boeing 747-8I is far superior to the Airbus A380, in terms of passenger comfort, as well as trip and seat-mile costs. During the afternoon - predictably - the situation was the reverse; the A380 would crush the opposition in whatever way possible. Clearly this makes for a good show with a huge entertainment value. Less experienced bankers, however, are left clueless. How can both be right and who is lying? Well obviously, nobody is lyingc, but the trick generally is in the assumptions built into the comparison.

As a simple and honest banker - I would not even dare to list all the little tricks that the manufacturers have up their sleeves to dazzle us, but one of the more common ways to show superiority is by boosting the seat-count of their product while understating their adversary's product. Adding 10 or 50 seats can be a very effective way of lowering the operational cost per seat-mile. The added condition of "equal passenger comfort" is also a nice one, as there are many ways to measure this, so a Piper Cub and an Antonov 124 could both end up as winners.

Maybe ISTAT appraisers should determine a set of rules for seat-count, comfort and other measures? A set of standardised assumptions, similar to the European New Car Assessment Programme in the automotive industry, would be convenient.

On second thought, why even bother? Financiers, appraisers and lessors do not operate aircraft, and to put it bluntly, who cares whether the fuselage width at shoulder level differs by one inch compared with the competition? Clearly, the more comfortable and fuel-efficient aircraft should be more popular in the market, but the qualities that really matter to financiers, investors and lessors are asset liquidity and asset value.

Residual values are the "biggest" elephant in the room. While these conferences are run for financiers and investors, purchase price data, lease rates and residual values are clearly still taboo subjects.

Interestingly enough, there are many factors that can influence residual values that are not determined by the manufacturers. Fleet demographics, such as extremely high lessor fleet-shares, are beyond the manufacturer's control as many aircraft end up at lessors through sale and leaseback transactions.

One can argue that rapid product improvements launched by the manufacturers to give the airlines a better product actually hurts the residual values of the predeceeding generation. Engine manufacturers generally are more motivated to limit obsoleting the old product and keep them flying, because the huge initial discounts on engine purchases have to be compensated by the profit margin on after-market support, parts sales and, in particular, full service programmes, such as Total Care.

But back to those product briefing events, here is a suggestion: Shift the focus to residual values and liquidity issues and go easy on the the generic product information slides.

For new aircraft types, detailed product information is understandable, but for well-known types, which most investors or financiers already have on their books, it seems there is hardly a need for such discussions. The same goes for cabin cross sections, demonstrating that product "X" offers better comfort at ear-level, while product "Y" claims superiority at knee-level. Sure, but how does this affect my loan to value in 2021?

Actually, - to be honest - at recent conferences, we have seen a few occasions where the depreciation debate was mentioned. Obviously, this is a discussion that is keeping many of us in the industry busy and that could have far-reaching consequences if we come to the conclusion that the "25 years to 15%" rule does not make sense any longer.

May we suggest that it would be useful if the manufacturers, with their vast industry data, share their findings about value curves and other pertinent information with us?

So, please, dear manufacturers continue the tradition of financiers, investors and appraisers briefings. These have become essential and enjoyable parts of the general industry interaction. We all love them, and look forward to attending these events, if anything (as one of Boeing's electronic surveys revealed) for the scale models raffle! Guilty.

But with now well over one-third of the global commercial jet fleet controlled by financial investors, it may be time to reconsider the message for this group. The focus should be around issues that are directly relevant to liquidity and values and much less around pure operational matters. Despite all the manufacturers' claims, when the residual value elephant in the room wakes up, it will be clear to everybody, who in the end really did have "the biggest".