Private investors, answerable to neither shareholder nor public pressure, have begun transforming world aviation and are pouring money into airlines

Private equity is just that: small groups of wealthy individuals who take stakes in companies in return for a payback over a timeframe as long as five or seven years. This longer horizon, freed from the demands of shareholders that profits and stock prices constantly rise and that a company's innards be exposed every 90 days, is a central feature of private equity.

Texas Pacific aviation investments

Continental Airlines cashed out

America West Airlines* cashed out


Gate Gourmet
(airline catering)

Spicejet (India)

The Sabre Group

NOTE: *later US Airways

SOURCE: TPG, SEC filings 

In this, they are different from other forms of investments such as hedge funds. Also drawn from the pockets of a few wealthy individuals, these funds look for short-term and usually spectacular profits based on technical trades such as currency-exchange deals, credit swaps or interest-rate changes. In these hedge-fund deals, a minute change in a decimal point from one second to the next can drive vast profits or dramatic losses, while private equity looks for such fundamentals as steady cashflow and hard-to-replace assets like aircraft, technological processes or a very strong brand name.

Private equity firms such as Blackstone Group, Kohlberg, Kravis, Roberts & Co, Texas Pacific Group, or Toronto-based Onex and other buy-out firms accounted for a stunning 26% of the $1.4 trillion in US merger deals last year, a doubling in the value of private equity deals of 2005. Onex bought two major US aerospace concerns last year, the former Boeing manufacturing centre in Wichita, Kansas, now dubbed Spirit Aerospace, and Raytheon's business jet unit.

Private equity brokered the stunning buy-out of the largest global distribution (GDS) system last year. Texas Pacific Group joined with technology specialist Silver Lake Partners to snap up the Sabre Group in a $5 billion buy-out that put Sabre's reservations and booking service, Travelocity website and airline consulting unit in private hands and away from the shareholder pressure that had pushed it down throughout the year.

Distribution players go private

In going private, Sabre joined its most significant domestic competitor, Galileo, which had gone private along with its parent, the former Cendant distribution units, in a $4.3 billion takeover earlier in 2006. The Cendant units, now dubbed Travelport, also consumed Worldspan, another other major GDS, in December. Private equity giant Blackstone financed the Travelport deals. Technology, with its lure of large future payoffs on a limited up-front investment, has always attracted private equity.

Groups such as Texas Pacific have until now been major players in such US sectors as hi-tech and consumer products. They have played roles in airline reorganisations but have until recently largely confined themselves to "special situations" such as rescuing troubled carriers and backing restructuring or taking a piece of an airline that the investors know personally. For instance, Texas Pacific became involved in airlines in large part because its co-founder, Texan oil-money man David Bonderman (pictured), knew Continental Airlines and invested in it in the 1990s. Similarly, he also knew the situation at America West Airlines. Both then were troubled companies, and Bonderman did well as he cashed out his stakes in both firms. His $66 million stake in Continental was eventually worth about $700 million.

But now as the airline industry is poised to enter a new period of prosperity in the USA and the number of private investors has increased globally, Texas Pacific and other funds are playing an increasingly important role in the airline industry. The impetus is a rational one: private equity likes businesses that have strong brand names and it likes businesses in which cashflow is strong and constant even when profitability is not, says CreditSights analyst Roger King.

Cashflow is king

Those "cashflow characteristics" made the GDSs attractive, according to Merrill Lynch analyst Justin Post. These same criteria make airlines a natural draw, King says. "There's something compelling about airlines to investors, but private equity really makes sense when they're trying to build something and not just respond to shareholders every three months."

Another attraction to these groups of investors is the relatively tight supply of new aircraft, says King. Signing up for a new aircraft from Airbus or Boeing does not mean immediate or even near-term delivery but a place in a long waiting list. And that scarcity value lifts the value of the aircraft.


Source: Airline Business