IBA and Kim & Chang Aviation Seminar Seoul, Korea Wednesday 22nd March, 2017 Jonathan McDonald, ISTAT Certified Aviation Appraiser IBA - UK
The market is still hot but returns are trickier to realise Maturity many more players Competition LRFs declining Getting In Getting In Asset selection and valuation Asset purchase Financing arranged Credits assessed Over-Supply - narrow bodies just keep on coming Volatility outlook less uncertain >10%+ ROI Getting Out Redelivery management Transition options: sell, part out, extend Remarketing Getting out Staying in Staying In Risk mitigation Getting paid Utilisation and maintenance
IBA facilitates decision making Full service Intelligence, Asset management, Advisory Only consultancy that appraises, manages and sells the metal Independent No vested interest in a deal progressing No conflict in treatment of assets under management or for sale Diversified talent pool Imaginative solution finding from a breadth of backgrounds Global Supporting opportunities and challenges in developing markets Exit IPO readiness DD on prospective buyer Sell side advisory Aircraft disposal Addressing Issues Portfolio monitoring & analysis Early warning of concerns Litigation & dispute support Repossession 4 Exit Running the Asset Technical support and advisory Regulation Redelivery planning Maintenance reserves and DOC analysis Regular report around fleets and values 1 Identification 3 Building Value 2 Acquisition Selection Target intelligence Market entry Competitive intelligence The deal Negotiation Critical factors Risk assessment Opportunity Competitor analysis Key stakeholder DD Asset DD & values Benchmarking
Informing growth and corporate activity IBA has become synonymous with delivering insight to support critical growth decisions, be that acquisitive or organic. We deliver advice and opinion across the range of transactions and capital markets : Expansion of fleets, destinations, lessees or customers Acquisition, IPO or financing Our unique mix of market expertise, technical understanding and access to data provides the most informed support on aviation-specific elements of transactions. Relevant experience Mergers & acquisitions, joint ventures Private equity investments Debt and equity offerings Due diligence Market intelligence Competitive intelligence Market entry Resources 30+ years of industry data ISTAT appraisers and senior appraisers Market intelligence analysts Industry and sector specialists Distinct teams across twin aisle, single aisle, regional, corporate, engines and helicopters Financial analysts Market Analysis & Trend Monitoring Transaction support Market Analysis Due diligence Competitive Intelligence
Maximising operational efficiency IBA delivers cost savings, improves efficiency and reduces exposure to regulatory risk. Whether as an outsourced resource, or as additional expertise around a key event, we provide: Outsourced management of fleets Technical support and advisory Regulatory compliance Redelivery planning Maintenance reserves and DOC analysis Regular reports around fleets & values Relevant experience Technical management Lease negotiation Costs benchmarking Fleet optimisation Transition management Delivery and Redelivery Remarketing Resources Asset management for lessors and lessees 400+ years of collective technical expertise Engineering & maintenance Aircraft finance and consulting Airline operations & fleet planning Aircraft marketing & sales Transaction advisory Fleet selection Fleet management Lease negation
The aviation growth story Air travel still doubling every 15 years IATA still bullish Developing market growth Doubling of commercial fleet over 20 years. 40,000 aircraft delivered between 2016 and 2035 five a day Capital markets supporting financing demands Why lease: Latest tech Fuel efficiency Lower capex Flexibility Access the backlog Avoid residual risk
Why invest Lots of reasons Demand increasing Stable cash flow Regulation minimises corner-cutting Capetown Mobile and liquid (see opposite) assets Predictable returns But be careful with Credit risk: security, reserves, lease rate The spec of your assets Records Maintenance Operations External influences
Asset Selection What is your business model Get this Defined Are you thinking short or long term New Aircraft Mid Life Aircraft Used Aircraft End of Life Aircraft
Asset Selection Cont d Having established these parameters what are you into Narrow-bodies Wide Bodies Regionals & Turboprops Pax / Freighter or both
Asset Selection Narrow-bodies - A320 / 737-800 Safer Investment Narrow-bodies tend to be the most attractive investments as they are far lower risk Most popular models are the Airbus A320-200 and Boeing 737-800 A320 and 737-800 historically have shown relatively stable value and lease rate performance even during downturn periods post 9/11, SARS, GFC etc Relatively easy to transition / cost of reconfiguration is not excessive Wide operating bases Active / healthy end of life solutions and P2F options emerging for both. Good OEM support
Asset Selection Narrow-bodies Avoid MD-90-30 / 737-500 Some narrow bodies need to be treated with caution Boeing / McDonnell Douglas MD-90 and Boeing 737-500 Historically have shown volatile lease rate and value performance especially during downturn periods post 9/11, SARS, GFC etc Relatively easy to transition / cost of reconfiguration is not excessive however there are limited placement opportunities No P2F options. Good OEM support but high proliferation of spare parts limited demand means low asset values.
Asset Selection Wide-bodies Wide bodies do bring high rental incomes per month which is obviously an attraction We regularly see new Boeing 777-300ER bring in monthly rentals of US$ 1,400,000 per month!!! However there are the pitfalls. Reconfiguration cost is very high US$ 15,000,0000 US$ 20,000,000 is normal P2F options are available for aircraft like A330-200 / 300s, but the downtime is high (several months minimum) meaning lost revenue Disconnect between Market Value and Lease Rates e.g. New Boeing 787-9 CMV = US$ 137,000,000. In theory lease rate should be US$ 1,200,000 or 0.87% LRF Reality is that some leases are being signed at US$ 960,000 or a mere 0.7% LRF
Asset Selection Regionals & Turboprops Smaller aircraft are attractive during downturns and high fuel price environments Despite this, we have seen softening of rentals on ATR 72-600s which in turn has softened rentals on ATR 72-500s Lower reconfiguration penalty as most Turboprops & Regionals are delivered in single class configurations Larger variants seem to be performing better than smaller derivatives, mainly due to superior seat mile costs. E.g. Vast majority of ATR orders are for the ATR72-600 and not the ATR42-600. Turboprops have long useful lives e.g. most 30 year old Dash 8-100s still flying; residuals on Dash 8-100 strong have remained circa US$ 3.8 million for past 5 years
Asset Selection Freighters Larger Freighters have proven very volatile to market downturns. Pre 2008 McDonnell Douglas MD-11F and Boeing 747-400F/ERF/SF/BDSF/BCF Demand was very strong but now high numbers in storage / on PBH agreements / Part Out Little sign of recovery Medium size freighters showing recovery and strength ie Boeing 767-300F FDX orders as well as strong Amazon demand Narrow body freighters Strong performance from Boeing 737-400F. Good Feedstock + Freight Conversion + Maintenance + Down time + On site reps / legal costs etc can result in a 20 year old converted Boeing 737-400F being worth US$ 9,000,000 with a monthly lease rate of US$ 150,000 or LRF of 1.7%!! Turboprop Freighter Values quite stable e.g. 1992 ATR 72-202F has been worth US$ 3.5 million for several years now and unlikely to change
Market Value (US$ Million) Valuation Market Value Performance A320 vs 737-800 $50.00 $45.00 $40.00 A320-200 vs 737-800 $35.00 $30.00 $25.00 $20.00 $15.00 $10.00 $5.00 $- 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2006 Build Airbus A320-200 2006 Build Boeing 737-800 Source: IBA Values Book
Market Value (US$ Million) Valuation Market Value Performance A340-300 vs 777-200ER $140.00 A340-300 vs 777-200ER $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $- 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2006 Build Airbus A340-300 2006 Build Boeing 777-200ER Source: IBA Values Book
Market Value (US$ Million) Valuation Market Value Performance A340-600 vs 777-300ER $160.00 A340-600 vs 777-300ER $140.00 $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $- 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2006 Build Airbus A340-600 2006 Build Boeing 777-300ER Source: IBA Values Book
Financing Structures Source: Boeing
Financing Structures Cont d Source: Boeing
Analysing Credits Asset Model Country Risk Operator Credit Record Lease Return History Lessor Relationships Maintenance Record Currency Risk Operating Cost Management Operation Type Customer Product appeal
Shifting sands. The lessor market The top tier Listed Buying direct from OEMs Need to trade regularly Broad mix of operators and aircraft types Mr 10% 10-20 aircraft Mid-life narrowbodies Chasing returns, not scale The mid market Consolidate or IPO Can be broad or niche Evolution A look at the ownership buyers or sellers? The new entrant Insurance, Pension, SWF or PE Asian focus last few years Disruptive in terms of margin, experience and ambition
Where to go and not to go The good, the bad the ugly jurisdictions, regions and countries how to monitor risk The mix of risk and reward Tier 1, Tier 2 and Tier 3 airlines Qualitative analysis Quantitative analysis FAA/EASA Banned lists Changing circumstances e.g. Brazil (GOL) Turkey (THY) Use of registers Cape Town Treaty
The aircraft operating lease sector The Growth of the Sector. Why airlines like leases flexibility Why investors like leases typical returns The changing face of the top 50 lessors The new money The variations in leasing entities from the mega lessors who order speculatively, the mid-band and the new entrants The downside what can go wrong? How to mitigate risk
DD and risk: Filling in the gaps Whether analysing a target, preparing for sale or placing an asset with a new operator, it is essential to identify and qualify the associated risk. Lease Credit Asset Technical Jurisdiction Transition Our approach to better understanding and managing risk blends an unmatched understanding of the aviation-specific elements in play with expert information gathering, a formidable network and unique access to values and maintenance data. Reserves vs compensation Ambiguity IBA Score Track record Values Residuals Maintenance costs Utilisation PESTEL analysis Capetown Scheduled v unscheduled Reconfig costs We analyse risk across the following six areas, both pre transaction and on a monitoring basis for challenging jurisdictions and credits. AD cost share Deferrals & route changes End of life options Technical Due Diligence Courts Reserves or cash Return conditions Management team Market shift Asset Inspections Arrests Liquidity of asset
Security The asset, other income e.g. maintenance reserves v LC v compensation at lease end Security deposits. Rentals. Supplemental Rent/Maintenance Reserves/Letters of Credit. End of Lease Compensation. Redelivery Conditions.
Which of the four represents your fleet? New lease options Pre return Process Redelivery & Remarketing On-going Asset Mgmt Identify Opportunity Due Diligence Lease Negotiation 1. Lessor getting paid and the aircraft being looked after: clearly the ideal state and one that requires the least monitoring though one should remain alert for danger signs between regular inspection visits, such as falling utilisation, removal of serviceable engines, or shifting operator circumstances. 2. Lessor getting paid but aircraft maintenance ignored or grounded: When this is happening, send a team to monitor the fleet and records and consider putting an ongoing presence on the ground to monitor any attempt to create a Christmas Tree. 3. Lessor not getting paid but aircraft looked after: This happens when an operator has enough cash to fly and generate revenue, but is not paying you. Get on top of the issue; are there reserves? Might some short term arrangement on deferrals stabilise the situation? Keep a close eye on maintenance status as position may change rapidly. 4. Lessor not getting paid and aircraft at technical risk: Red alerts all round. Implement some of the options above and also begin to explore the logistics of repossession. In an ideal world, push for a voluntary repossession.
Pre Purchase Selecting the correct operator, platform or aircraft is clearly a critical and integral step in the processing of investing in aircraft Uniquely at IBA, we combine appraisal expertise, with aviation management experience and technical advisory skills in order to provide expert opinion on issues such as: the risk profile of the prospective fleet, and objective insight into the operators, your cashflow implications, maintenance events and a commercial review of leases for technical language and terms that might negatively impact the all-important residual values or transactional efficiencies Our ability to offer combined appraisal and technical team expertise enables us to deliver ISTAT-certified valuations and independent inspections in order to assess the true condition of the aircraft and provide negotiation leverage or alternatives if the aircraft are sub-standard We also advise on how the aircraft will be managed by the airline for example whether it outsources MRO or performs maintenance in-house and what are the value and remarketing implications of that decision are likely to be Equipped with this information, the acquirer has a clearer view of the value and of the potential of the investment. In a little more detail IBA typically: Assesses the current and future market value of acquisitions and provide guidance on lease rate trends Conducts maintenance cash flow analysis, or Fly-Forward to provide a snapshot of the critical maintenance events in the asset s life Monitoring Transition Running Reviews leasing documents to highlight areas of leverage, negotiation, concern, or exposure. Engine Performance Restoration and PMA parts/der repairs, for example, are two areas of frequent debate Audits the maintenance and operations of selected lessors to asses their ability to meet obligations Audits aircraft and records for evidence all is up-to-date; and Pre- Purchase Sources, negotiates where applicable, and oversees delivery of new aircraft
Running While aviation operating leases continue to provide impressive returns compared to other asset classes, few other assets are as complex or critical to maintain as aircraft and their engines. Inadequate or inefficient maintenance not only has serious implications for safety but will also impact residual values and increase risk of delay around future transitions. Running an aircraft fleet requires two distinct skillsets: 1. Oversight and execution of the many processes and events required. For instance we would gather and analyse utilisation reports, manage operator modification requests and manage certificate and insurance renewals. We would also conduct aircraft/records inspections at appropriate frequencies or as a result of any damage. Additionally, our exhaustive dataset allows lessors to forecast the likely and timings of items of expenditure, across key components. Such details provide complete transparency around events enabling lessor to have visibility of potential upcoming maintenance events. Monitoring Transition Running Pre- Purchase 2. A proactive effort to optimise costs. IBA s 25+ years of data provide unmatched benchmarks and datapoints in relation to the timing and cost of maintenance events. Through analysis of data we can deliver tangible savings. In one recent review of Maintenance Reserve Claims, for example, we reduced the quantum from 1.8m to 200k by demonstrating that the work performed was not to a sufficient level to drawdown all of the accrued reserves. Where beneficial, we also produce rolling Fly Forward reports on maintenance reserves, allowing them near real-time visibility of reserves vs maintenance events. Lessees often underestimate the costs of the redelivery and incorrectly assume accrued reserves can be used in total as part of the process. Making sure the lessee fully understands the process and costs can often lead to a useful lease extension rather than redelivery.
Monitoring When monitoring aircraft and engines at IBA we talk of building a moving picture. We combine the technical and regulatory aspects of lease management with the commercial and externally-focused analysis to provide a comprehensive overview of how the aircraft is being utilised and if the risk of grounding or default is increasing or decreasing. Slowing traffic, declining geopolitical stability and rising concerns over defaults and bankruptcies are three contributors to the increased need for monitoring services. Early warning of airlines facing challenges can be the difference between removing aircraft quickly and efficiently, or facing a default and or a repossession and, in our experience, the former is always preferable. At IBA we have conduct risk monitoring in order help lessors keep better track of operators they feel are at risk. On a timescale agreed with the client, IBA will provide a summary of key news around highlighted operators or geographies which would typically include: Information we hear on the airline through our broad network of MROs, financiers, advisers, planespotters and other aviation insiders and specialists. Along utilisation rates, which are the key aspect to monitor in terms of red-flags, other examples might include: Key staff changes, Route changes and cancellations Monitoring Records & maintenance systems issues Transition Running Pre- Purchase A comprehensive trawl of English language media and industry sites including: aviation industry sites, business news sites, regulatory filings, aviation blogs and forums, agreed social media feeds and employee-platforms such as glassdoor. Economic & regulatory changes, Order deferrals, and Rumours of payment difficulties
Warning Signs Late Payment of rentals or reserves Financial reporting, business plans Press articles/peer networks, other lessors/financiers concerns Key staff changes, route cancellations Supplier payment issues Economic/regulatory changes Order deferrals SO...WATCH FOR THE SIGNS INTEGRATE THE COMMERCIAL AND TECHNICAL ASPECTS BUILD THAT MOVING PICTURE
Bad Case Study Aviacsa Mexico B737 Classics financed by a US Bank. Airline went into liquidation. Capetown not ratified Aircraft protected by unions Rampant corruption Main lesson learnt the importance of complete records Outcome 18 month process for recovery and sale.
Risk monitoring, easy in hindsight Look at operator and macro environment as well as the asset itself. Financial reporting, business plans Route changes and cancellations Records & maintenance issues Political, economic & regulatory changes Key staff changes Order deferrals Staff and suppliers not getting paid Desktop: Trade, Business, Stats like these to my right Peer networks Data: Fleet, Utilisation, Routes and Usage Spotters Fleet Info
Transition management An established expert in transition management, IBA has extensive experience of redeliveries from both the lessor s and lessee s viewpoint, allowing a unique insight into the dynamics at play. As the aircraft leasing market begins to shows signs of a softening, IBA is able to assist with key questions, such as: Extend, part out, convert or sell? We analyse demand and rates to provide more transparency around the decision to extend or return. On behalf of, or in conjunction with IBA, we can review the operator s plans and properly assess the extension term to align with the maintenance cycle and the levels of reserves & compensation due at the new expiry date. Redelivery planning. Is the lessee focused and engaged? Neither side of the transaction benefits from a poor redelivery, especially when the lessor has a lessee lined up. IBA often works lessee-side for the lessor in order to maximise the chances of a smooth process. What to do if the aircraft is returning? IBA manages matters such as return planning meetings and discussions around issues such as: meet return conditions, or utilise the reserves. We oversee any modifications or reconfiguration necessary for the next lessee and we supervise final inspections, the return and the new delivery. If the aircraft has no future lessee, 12 months out we will commence remarketing efforts as part of IBA s integrated suite. Additionally, redelivery disputes are on the Monitoring Transition Running Pre- Purchase increase, and IBA has comprehensive experience expert witness and other support to legal teams. Is my lessee about to default? If monitoring suggests a lessee is struggling, IBA has been involved in dozens of repossessions. While we would always advise repossession as a last report, we are able to provide a wealth of technical and strategic support in relation to issues such as re-registering the aircraft, what condition is the aircraft likely to be in, how robust is the local legal system and where are you flying the aircraft to.
Aircraft Operating leasing. The Transition Management Minefield Top 10 contributors to transition challenges Poor contract drafting around redelivery conditions. Lesser inspection rights and disputes processes Lack of lessee planning and early engagement with lessor Inadequate focus on assets during operations Lessee operational demands consuming redelivery resource Decentralised, missing or incorrectly completed records Underestimation of the total workload Discovery of additional work required during maintenance input Lack of lessor appetite for returning aircraft Engines failing borescopes carry out precautionary borescope much earlier Underestimating lead times and lessor expectations.
Getting the job done. First mover advantage When a repo is the best solution, there s a lot to think about. 1. Aircraft tracking and physical state where and when to arrest 2. Titled engines - are they on? If not where are they? 3. Capetown, legalities and liens, robustness of legal system 4. Records and Manuals withheld, ransomed or damaged. This point should never be the first time you ve scanned them 5. Insurance and Ferry 6. Parking and Storage 7. Deregistration/registration issues 8. Corruption - getting the job done but not at any cost 9. Remarketing
These are rarely the cleanest of processes No two are alike. It s not every day that you find yourself: Negotiating with Unions ransoming records Jumping over fences to avoid access issues (not advisable if the gate guards have AK-47s) Finding planes being moved from hangar to hangar to avoid service of papers Arguing with crew refusing to get off the aircraft Having the technical team being refused access to records as these are kept airside and they don t have necessary permits Arriving at an open empty aircraft at LHR with court order, to receive call from lawyers to say that faxed notice of termination not served as all lessee fax lines down Finding the aircraft has been hijacked just before a planned repossession was to be carried out Sitting next to aircraft in an SAS APC at a UK airport and hearing a bomb threat alert on radio quick exit! Having another lessor come after their landing gear on the aircraft you just repossessed, because their aircraft was sitting on bricks
Summary and Questions 1. Implement an appropriate asset management programme. 2. Base the level of oversight on the specific transaction and the risk/reward profile, BUT continuously reassess and stay pro-active and flexible. 3. Obtain all the data you can, analyse it and ask the lessee questions about it. Always be looking over the horizon. 4. Always have a contingency and remarketing plan in place, but understand the costs involved with transition and remember that a repossession will not always give the best outcome 5. Be proactive...if a potential problem arises the best place to be is on the ground with the lessee. 6. Be prepared to play the long game, and sometimes to think and act creatively to get to where you need to be. 7. Relationships you build in country and with the lessee s key personnel will pay off. Get the best advice in country. 8. Consider what legal steps you want to take post repossession to claim for damages or unpaid rent.