Over recent decades, the commercial aircraft business has developed from a global market where aircraft manufacturers and airlines were the main players, to a much more complex place.
Both airlines and manufacturers were very much focused on the metal, the hardware used as production tools by the airlines. But as carriers increasingly require external sources of funding to buy these tools, the role of the money-men has become more prominent. The bilateral manufacturer-airline relationship has changed to a triangular relationship between the manufacturer, the airline and the financier/investor/lessor.
With over a third of the commercial jet fleet controlled by the money-men - rising to over half for the more popular types - some interesting potential conflicts of interest between the metal and the money can be observed. While airlines want the most advanced equipment, featuring low fuel burn, passenger appeal and huge range, the money-men are more interested in technological stability, long life, low depreciation and ease of remarketing. While an airline's ideal is probably something like the USS Enterprise, the money-men prefer the black Model T Ford.
To look at the list of in-development aircraft - Bombardier's CSeries, the Mitsubishi Regional Jet, Comac C919, Irkut MS-21, Sukhoi Superjet, Airbus A320neo, Boeing 737 Max, A350, 787, 777X - and you could be forgiven for thinking the metal has won out.
The conflict between metal and money can also be observed at other places. Before the A320neo was launched, virtually all the big leasing company chiefs were very explicit in their rejection of the idea of re-engining. With the current A320 the mainstay of most leasing fleets, any development that could jeopardise the economic life and value of these aircraft was seen as a threat. A leasing company doesn't benefit from lower fuel burn or superior passenger comfort, so why fix what isn't broken? But, despite protests from the financial types, the Neo was launched. With its hand forced, Boeing had to follow suit with its 737 Max. Ironically lessors are queuing up to place orders for both.
The current topic on the agenda of all self-respecting commercial aviation conferences is the issue of overbuilding of commercial jets. Money-men generally are of the opinion that there are already too many aircraft leaving the factories in Seattle, Toulouse, Hamburg and Tianjin with a detrimental effect on their used equipment values. The aircraft manufacturers however maintain that the world needs more aircraft and have announced production rate ramp-ups, maybe even reaching 50 per month for the most popular single-aisle models.
Any moderation is not so much caused by the risk of the European financial crisis affecting economic growth in the rest of the world - and consequently air traffic growth - but rather by supply chain concerns. Obviously, the manufacturers argue that market growth will absorb all these new aircraft and that there is still a backlog of thousands of A320s and 737s from generally credible and financially strong customers. This is correct, and it cannot be denied that many airlines and lessors have committed to huge orders for the current generation aircraft before they even realised there would be something like a Neo or a Max.
However, it seems any investor with a significant orderbook for the A320 or 737 must be getting worried. If we were talking about the technology sector, the concerns would be obvious. If you were a retailer with an order for a few thousand Apple iPad 1s at full price scheduled for delivery only weeks before the release of the iPad 3, what would be the consequences for your store? You could probably only move those iPad 1's at a significant discount with a predictable consequence for your bottom line. So, while production may need to rise to satisfy the need for aircraft as production tools, but for an investor, the expected return on investment on these 2012-15 built aircraft may not be fantastic - to put it mildly.
There are other situations where metal and money may conflict. Over the past few weeks we attended a number of market and product presentations organised by various engine manufacturers. A significant part of all the presentations was dedicated to future product developments. Clearly manufacturers are competing against each other with ever more sophisticated technologies. Here the interests of airframers and engine manufacturers seem to diverge. For the aircraft - or rather airframe manufacturers - there must be a clear benefit in a relatively rapid succession of technologies. As long as airlines buy the new product in large quantities, the airframers can look forward to healthy sales figures and profitability. For the engine manufacturers, the situation is different. While a major part in the improvement of aircraft performance is the result of better engines - the A320neo being the perfect illustration - engine manufacturers still seem to play second fiddle. This has resulted in a situation where in many cases engine manufacturers are forced to spend billions on development of new engines with no guarantee it will be selected by an airframer. This situation is compounded by the expectation that they must contribute financially to the development of the airframe/engine combination and by being forced to sell new engines at heavily discounted prices to the airline and lessor customers.
For the engine manufacturers this means they have to look for other sources of income and profitability. For this reason we have seen a strong development of the integrated maintenance services offered by the engine manufacturers. TotalCare, OnPoint, PureSolutions and their ilk are now well known terms to anybody that has been close to an engine manufacturer's marketing team. Generally the trick is to sign up airlines to these support programmes and by doing so control their engine maintenance and overhaul dollars, often to the benefit of both parties. For an investor or financier that is relying on the value of the asset, this becomes an issue in those situations where they compete with the service-provider for the same dollar. Here both the manufacturer/service provider as well as the lessor/financier claim that it's their money. In the meantime a sort of solution has been found for the problem of the maintenance reserves. The other issue that is not as widely discussed is the problem of the residual value of an ageing aircraft. As aircraft get older, most of the value is in the engine and by the end, all value is in the engines. Now what happens if the traditional way of unlocking this value is cut-off? What if all the TotalCare, OnPoint and PureSolution programmes have created a closed market where it is unclear if and how engines or engine parts can be sold to any independent third parties?
Fortunately this scenario is not yet a reality today for the majority of engine types, but what's the guarantee for an investor that there will be an open and free aftermarket for the engine parts 10 years from now? Finance and investment decisions should be based on residual value projections taking into account the realiseable part-out value of the aircraft, including its engines. If there is no clear aftermarket, one can hope and pray or take the prudent route and take a minimal residual value into account.
While money talks, it's not yet the loudest voice in the commercial jet market and that's probably a good thing. While money-men have been around in the market for decades, many representatives from the metal side still have to learn about the sensitivities of what are perceived as the new kids on the block. As the current financial crisis has shown, the money can disappear quickly if the right returns are not there. While airlines and manufacturers have huge investments in fixed assets and a production organisation, financiers and investors are generally much more diversified and can move much quicker. With a little bit of consideration for the other players, our industry's three-way relationship will bring a lot of joy to all involved.
Article contributed by Bert van Leeuwen, managing director, aviation research DVB Bank SE
Source: Commercial Aviation Online