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Aviation History
1957
1957 - 1889.PDF
27 December 1957 977 Who Pays for the Civil Jets? Equipment Finance: The Airlines'1 Dilemma IN the spring of 1955 an order for 20 de Havilland Comet 4swas placed by B.O.A.C. That summer Boeing and Douglasannounced their intention of marketing turbojet airliners, but it was not until late in the autumn that the first aircraft wereordered. With the exception of Pan American, all the first pur- chasers were U.S. domestic airlines. But in November, Douglasannounced the sale of eight DC-8s to K.L.M. By the year-end Air France, S.A.S., Sabena and Japan Airlines had followed suit.The race was now on. Orders flowed in steadily throughout 1956, and at this stagea controversy developed as to whether the appearance of these aircraft in 1959 and 1960 would result in excess capacity. During1957 the flow of orders slowed down to a trickle. Many prospec- tive customers were having second thoughts, not only on thedangers of creating over-capacity, but also on the fundamental economics of turbojet operation. (It is significant that 1957 sawa swing of procurement in favour of turboprop aircraft.) As delivery dates—and payment dates—draw nearer, those airlineswho had already ordered rurbojets have begun to ask themselves an uncomfortable question—"Where will the money come from?"The amounts involved are considerable. Douglas and Boeing have each sold almost 150 turbojets. Additional sales are 48CV-880s, 25 Comet 4s, 18 Caravelles and 35 VC-lOs. The total value of these orders is about £750 million. To obtain such a vastamount of money in time to honour existing obligations is a problem which has yet to be solved. The ploughed-back earnings of the U.S. carriers as a whole arequite inadequate to meet such a demand. A high proportion of the non-U.S. carriers are still requiring subsidy to cover theircosts, let alone to build up reserves. It is possible to remedy this shortage of undistributed profit by increasing fares. But thiscourse can be self-defeating if higher fares lead to a slowing down in traffic growth. Even if fares could be put at the limit set by thisfactor, it would still be necessary to look outside for other sources of finance. Shy Shareholders Those airlines which are public companies can appeal to theirshareholders. But airline shares are not popular with private investors. Past dividend rates have been too low. Shareholdershave also been scared by the controversy over the economics of turbojets. Airlines have placed so much emphasis on their poorfinancial condition—in their attempts to obtain approval for fare increases—that there is little possibility of raising sufficient capitalfrom this source. Airlines have been more successful in approaching financialinstitutions. American carriers have been able to draw upon the resources of their national banks and insurance companies. Otherairlines have frequently made use of the facilities offered by the Export-Import Bank. But again, this method has severe limita-tions. Interest payments could be crippling (American Airlines has arranged a loan of $135 million to cover the purchase of 30Boeing 707s. Annual interest on this sum will exceed $6 million— more than the cost of one 707.) The institutions themselves appre-ciate this problem and are reluctant to see too high a proportion of their clients' funds being in the form of loan capital. Still hungry for money, the airlines have one other possiblesource to tap—their national governments. There are three ways in which money can be taken from the pocket of the taxpayer anddeposited in the tills of the airlines. The most obyiqus form is direct subsidy. An impression of the wide extent of airiine subsidycan be obtained from I.C.A.O.'s recently published digest, Financial Data 1955. The following figures show subsidies foronly a few of the many subsidized carrieis in that year—Air France, $9.7m; AeroUneas Argentinas, $8m; Panair do Brasil,$4.6m; Aerovias Brasil, $1.2m; Pan American, $1.0m. Alternatively, the airlines might benefit from indirect subsidysuch as uneconomic landing fees or high mail rates. Here the outlook is less bright. Many airport authorities are digging theirheels in. Swissair is having difficulty in persuading the appropriate local bodies of the need to extend runways to allow turbojetoperation. United Kingdom airport charges have recently been increased. As regards mail rates, the general trend is downward.At a conference held in Ottawa last autumn the airlines pressed for higher mail rates. Although the resolutions of this conferencehave not yet been published it is probable that the postal authori- ties have had their way, and have managed to reduce the mailrates paid to airlines. An even less direct form of government assistance is taxationrelief. This does not usually take the form of a concession in normal tax rates, but is achieved by applying a less stringentdefinition of taxable expenditure. The principal item of expendi- ture involved is depreciation.Permission to allocate higher depreciation charges has the imme- diate effect of reducing taxation payment and of increasing profitby a like amount. In theory, the reduction in taxation paid in earlier years when depreciation rates are very high is balanced bythe extra taxation paid in later years when high profits are being earned on fully-depreciated aircraft. But in practice the aircraftin question is normally transferred to another owner before the second stage takes effect. As the aircraft has been written downin the first stage to a value well below its probable selling price it is likely that high depreciation rates will mean substantialcapital gains. High depreciation rates are seen to allow both increased net profit and higher capital gains. Accelerated Depreciation Although American carriers have not enjoyed the lavish sub-sidies so frequently available to airlines abroad, this disadvantage has been largely offset by permission to depreciate their aircraft ata faster rate. Under the mobilization policy introduced early in the Korean war, U.S. airlines were frequently allowed to depre-ciate over very short periods in an attempt to facilitate purchase of strategically superior aircraft. The impetus behind this concessioncame from the defence authorities. In recent years this impetus has waned. But the practice which it engendered—the ability topurchase the latest aircraft without needing to depend on assist- ance from outside investors—has continued. Unfortunately, thejets appeared just about the time that defence needs were relaxed and tax concessions accordingly reduced. The Civil AeronauticsBoard were pressed to approve higher depreciation charges. But after almost two years' deliberation they have just announced thatfrom next January aircraft must be depreciated evenly over a minimum of seven years down to a minimum residual value of15 per cent. Although these rates appear low to American airlines, to most other carriers they are comparatively generous. B.O.A.C.and B.E.A. have until this year been depreciating over a period of ten years, and only recently have stepped their rates up so as todepreciate their aircraft to a residual value of 25 per cent in seven years.Regardless of which course each airline follows in its search for capital, the outcome will depend on one factor: whether thegovernment concerned approves its purchase of jet aircraft. Where governments are anxious to see their national carriersoperating the latest equipment, then ways and means will be found to arrange the necessary finance. (The Indian Government,for instance, has guaranteed the principal and interest on loans amounting to $ 16.8m negotiated by Air-India International withthe International Bank and five American commercial banks.) For this reason it is unlikely that the fare increases proposed byI.A.T.A. will be opposed by governments other than that of the United States. A Changed Attitude? In strong contrast, the C.A.B. have resolutely refused to allowfareincreases either on domestic routes or on foreign routes to and from the U.S. Their attitude is based on sound economic reason-ing : if the characteristics of these new aircraft were as attractive as was claimed by manufacturers and customers, then sufficientcapital for their purchase should be forthcoming on the prospects of operating these aircraft profitably; if this is not the case, thenthe aircraft should not have been bought; if airlines have already chosen to swim out of their depth, there is no reason why today'sair travellers should come to their rescue. It is likely that the C.A.B.'s present policy will be modified.A situation could develop where U.S. airlines, having originally precipitated the jet procurement programme, are forced to canceltheir orders while state-aided airlines abroad continue to order even more jet aircraft. It is the consequences of such a situation,rather than the arguments—and threats—of the air transport and manufacturing industries, that is likely to cause the C.A.B. an"agonizing re-appraisal." Another factor recently brought to the fore is the quickening pace of aeronautical development in theU.S.S.R. The imminent possibility of Russia becoming an ex- porter of airliners such as the Tu-114, and an operator of highlycompetitive international air services, is now putting an increas- ingly greater premium on considerations of prestige and strategy. It seems that if the public are to have jet airliners tomorrowthey must pay more today—whether they like it or not. J.C.S,
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