The 737 MAX – Taking Flight a PRODUCT ASSESSMENT

The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Steve Mason August, 2017 Steve Mason Senior Vice President, Strategy, Avolon

Steve has over 17 years’ aviation industry experience, working with operating lessors and manufacturers in a variety of roles. Steve joined Avolon in April 2017, and is based in New York. His responsibilities include asset and portfolio strategy, market analysis, aircraft valuations, thought leadership initiatives, setting portfolio risk management criteria and determining capital allocation targets.

Prior to Avolon, Steve was a Director and Head of Asset Strategy for CIT Group’s aircraft leasing business. Steve joined CIT in 2012 and led the team which was responsible for aircraft values, aircraft economics, aircraft performance and strategy, along with investment analysis for aircraft procurement. Previously Steve worked with Rolls-Royce and International Aero Engines in a variety of disciplines. Steve has a Bachelor of Engineering in Aeronautical Engineering from the University of Limerick in Ireland.

Acknowledgement: The author would like to acknowledge James Morrison, Avolon's AVP of Aircraft Evaluation, for his insights and analysis. The author would also like to acknowledge FlightGlobal Ascend whose online databases are the source of all fleet and airline schedule data used in the analysis (as of June 28th 2017), unless otherwise noted.

Disclaimer This document and any other materials contained in or accompanying this document (collectively, the “Materials”) are provided for general information purposes only. The Materials are provided without any guarantee, condition, representation or warranty (express or implied) as to their adequacy, correctness or completeness. Any opinions, estimates, commentary or conclusions contained in the Materials represent the judgement of Avolon as at the date of the Materials and are subject to change without notice. The Materials are not intended to amount to advice on which any reliance should be placed and Avolon disclaims all liability and responsibility arising from any reliance placed on the Materials. The 737 MAX – Taking Flight 1 A PRODUCT ASSESSMENT

Contents

The 737 Max – Taking Flight 2 Executive Summary 3 Key Findings 4 The Evolution of the 737 MAX 5 The 737 MAX Market and Competition 12 Risks and Mitigants 17 The 737 MAX Investor Proposition 20 Conclusions 22

Appendix A Aircraft Cash Operating Cost 23 Appendix B Airlines without MAX Commitments that have previously ordered 737NGs 24 2 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

The 737 MAX – Taking Flight

Boeing unveiled the 737 MAX in August 2011 in response to Airbus’ A320neo. The new family of MAX 7, MAX 8 and MAX 9 was designed to deliver maximum efficiency, reliability and comfort and leverages the strength of the existing 737NG with new technology CFM International LEAP-1B engines. The family has taken over 4,500 orders and commitments, of which the majority are for the 737 MAX 8 model. The MAX 7 and MAX 9 models have not shared the MAX 8’s success, which has led to several tactical product line changes to re-position the new family, most recently introducing the MAX 10, which fills a crucial gap in the family and could be a game-changer.

Boeing unveiled the 737 Max in August 2011

The 737 Max family has >4,500 orders The 737 MAX – Taking Flight 3 A PRODUCT ASSESSMENT

Executive Summary

This paper presents Avolon’s assessment of the Investors will be predominantly focused on the MAX 737 MAX family and analyses the impact of the 8, which remains the heart of the market. With the evolving changes to the family’s composition on the launch of the MAX 10, Boeing has the means to narrowbody market. The key issues being debated correct much of its market share imbalance with by the industry are addressed: how will the MAX Airbus. With some limitations, the MAX 10 has the 10 improve the marketability of the MAX Family? potential to replicate the MAX 8’s market strength, Will it be a capable competitor for the A321neo? resulting in two strong family members. Although Has the airline industry’s capacity up-gauging trend later to market than the A321neo, the MAX 10 is diluted the MAX 7’s market and will recent changes a better competitor than the MAX 9, will protect to its design improve its prospects for investors and Boeing from customer defections and addresses the airlines? Is the MAX 9 now a marginalized product growth needs of existing 737 operators. The MAX 9 and will more customers migrate to the newly is now wedged between other family members and launched MAX 10? With only three customers, what has an uncertain future due to its marginalized role in is the outlook for the MAX 200? Will the LEAP the family. The MAX 200, a sub-variant of the MAX 8, engine, the chief source of efficiency, deliver on its has not proven to be the game-changer that Boeing promises? expected and has gained very little traction with its target low cost and ULCC market. The MAX 7 has At a broader level, the paper analyses the strategic become a niche product for performance and range moves that led to the launch of the MAX family and driven by a shift away from smaller variants of the how Boeing responded to the strategic dilemma narrowbody market, but if innovatively priced could presented by Airbus. If Boeing had launched today’s do better than its current performance suggests. fully formed 737 MAX family in 2011 would their new-technology narrowbody market share split be closer to parity with Airbus? Why did Boeing launch the 737 MAX program without sufficient attention to the strengths of the A321neo? Why has Boeing’s MAX strategy been more reactive compared to other programs? How has Airbus benefited from Boeing’s iterative MAX family design? 4 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Key Findings

Boeing’s MAX product strategy A well understood, cost efficient decisions have been reactive, and timely reconfiguration package resulting in lower market share and to convert the MAX 200 aircraft a plethora of variants which do not to the MAX 8 model is required to all reflect actual market demand. increase investor appetite for the type in the event that sales pick up.

The rush to get the 737 MAX to market caused Boeing to neglect The MAX 7 is a niche product when Airbus' key strength, the A321. performance and range is required. The market shift away from smaller MAX 7 variants has been driven by several The recent launch of the MAX factors, including unit price and the 10 has strengthened the MAX focus of the LCCs on larger models. A change in pricing strategy could MAX 10 family and has already doubled Boeing’s market share in the stimulate further demand. large narrowbody segment. The aircraft is right-sized and will be a capable seat-cost machine The value proposition of the MAX 9 for operators looking to grow has been severely impacted by the beyond the 737-800 and MAX launch of the MAX 10. It is unclear 8. Although the A321neo will MAX 9 what role remains for the aircraft remain the seat cost leader in high but it is expected to have a very density configurations, theMAX limited future. 10 is a much improved competitor compared to the MAX 9. CFM will deliver on its fuel burn commitment for the Leap engine, The MAX 8 remains the heart of however it will be challenged the MAX family and a key target to meet the cost performance for investors. The aircraft has of its predecessor, the CFM56. MAX 8 maintained its Cash Operating It is imperative that CFM puts Cost (COC) advantage over the commercial measures in place to A320neo, albeit only by a small allow the benefit of maintenance margin. agreements to survive multiple operators and owners. The 737 MAX – Taking Flight 5 A PRODUCT ASSESSMENT

The Evolution of the 737 MAX

The first MAX aircraft was delivered in May 2017, almost exactly 50 years after the first flight of the 737. The original 737-100 series model, with 85 seats in a 2-class configuration, was quickly followed by the -200, which went on to sell more than 1,100 units to well over 100 airlines.

In 1981, the successor to the -200 was announced, a Consequently, in 1993, Boeing launched the 737 NG stretched and re-engined aircraft that encompassed family, which evolved to broadly match the A320 a range of aerodynamic, structural and cabin family product range across four size segments. The features developed for the 757 and 767. The baseline design focus for the 737 NG was higher structural 737-300 was offered alongside a stretched -400 and efficiency, greater range and performance, better a -500 shrink and this 737 Classic family sold almost fuel efficiency, lower maintenance cost and higher 2,000 aircraft to airlines and lessors, with the -300 reliability and passenger comfort. Boeing’s centerline variant accounting for over 50% at the then market aircraft, the -800, was significantly upgraded in sweet-spot of ~150 seats. terms of capacity, range and performance relative to the -400 and became a capable competitor to In 1984, Airbus entered the single aisle market with the A320, which was slightly smaller. Boeing has the launch of the A320, which began service in 1988, continued to develop the NG family with the addition as depicted below in Exhibit 1. Within five years, of blended winglets, engine upgrades, aerodynamic despite Airbus’ new entrant status, it had achieved improvements, the Boeing Sky Interior along with significant competitive success against a 737 family several navigation and avionics improvements. that did not match its capabilities.

Exhibit 1: Airbus A320 Family and Boeing 737 Family Entry into Service Dates

737-600/700/800

A320 A319 737-900 737-200 737-400 737-100 737-300 A321 A318 737-900ER

1960 1970 1980 1990 2000 2010 6 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Whilst demand for the smallest gauge family members never took off, Boeing and Airbus achieved broad sales share parity overall and in two of the three remaining size segments over the period from the launch of the NG to the announcement of the NEO. However, at the largest end of the range, Boeing’s initial offering, the -900, failed to deliver on customers’ requirements. This forced a re-design and launch of the -900ER relatively late in the day, leaving Boeing with less than 30% of this market segment (Exhibit 2), as even the redefined variant fell short of the payload/range capabilities of the A321 and never appealed to the wider 737 operator base.

Exhibit 2: Airbus A320ceo Family and Boeing 737 NG Family Order Book Market Share Firm orders from the launch of the 737NGTaking Flight: An assessment of the Boeing 737 MAX to the launch of the A320neo

Total Units

Exhibit 2: Airbus A320ceo Family and Boeing 737 NG Family Order Book Market Share Firm orders from the launch of the 737NG to the launch of the A320neo

Whilst each manufacturer had contemplated a new clean sheet design to replace their existing aircraft programs, until 2010, neither Boeing nor Airbus saw an opportunity or risk significant enough to justify launching either a derivative or an all new program. However, in December 2010, Airbus launched the A320neo, which promised to deliver 15% better fuel burn with two new engine options - the Pratt and Whitney (P&W), Geared Turbofan and the CFM LEAP-1A.

Airbus’s decision to launch a re-engined A320 family (comprising of three aircraft, without the slow-selling A318), was enabled by the availability of a new geared turbofan engine developed by P&W, who were extremely motivated to re-enter the single aisle market and had been selling the merits of the engine very aggressively to Airbus. With little in the way of other engineering modifications required to the airframe, this would be a relatively low-cost family upgrade and Airbus also concluded that Boeing’s strategic options in response would be constrained by several factors, including the configuration and design of the 737 itself and Boeing’s engineering and financial resources, both then under pressure as a result of the 787 program problems. Airbus believed that a “simple” re-engining of the A320ceo would present Boeing with an extremely challenging technical and commercial dilemma. In addition, a number of new competitors were beginning to challenge the mid-market single aisle space, including Bombardier with their new CSeries, also P&W GTF-powered, and Airbus saw the NEO as a way to limit the traction of these new programs at an early stage.

In February of 2011 Boeing’s CEO, Jim McNerney, told analysts "We're going to do a new airplane" stating that they were not yet done evaluating the situation but that their current bias was to move to an all new aircraft at the end of the decade. By July of that year sentiment had swung, American Airlines placed the largest order in aviation history and Boeing had partly lost a key customer. American’s order for 460 narrowbody aircraft included 130 A320neo Family aircraft and 100 of Boeing’s “expected new evolution of the 737 NG”. Airbus had forced Boeing to re-engine their 737 NG family to prevent American’s complete defection. On the 30th August, one month after American’s order, Boeing officially launched the 737 MAX program. A new clean-sheet design aircraft from Boeing would have left too much time between the entry-into-service of the A320neo and Boeing's new offering, severely impacting their market share. If launched in 2012, a new program may not have entered into service until the end of the decade, leaving at least four years since the entry-into-

The 737 MAX – Taking Flight 7 A PRODUCT ASSESSMENT

Whilst each manufacturer had contemplated a new American’s order for 460 narrowbody aircraft clean sheet design to replace their existing aircraft included 130 A320neo Family aircraft and 100 of programs, until 2010, neither Boeing nor Airbus saw Boeing’s “expected new evolution of the 737 NG”. an opportunity or risk significant enough to justify Airbus had forced Boeing to re-engine their 737 NG launching either a derivative or an all new program. family to prevent American’s complete defection. On However, in December 2010, Airbus launched the the 30th August 2011, one month after American’s A320neo, which promised to deliver 15% better order, Boeing officially launched the 737 MAX fuel burn with two new engine options – the Pratt program. and Whitney (P&W) Geared Turbofan and the CFM LEAP-1A. A new clean-sheet design aircraft from Boeing would have left too much time between the entry- Airbus’s decision to launch a re-engined A320 family into-service of the A320neo and Boeing's new (comprising of three aircraft, without the slow-selling offering, severely impacting their market share. If A318), was enabled by the availability of a new launched in 2012, a new program may not have geared turbofan engine developed by P&W, who entered into service until the end of the decade, were extremely motivated to re-enter the single aisle leaving at least four years since the entry-into- market and had been selling the merits of the engine service of the A320neo. More concerning to Boeing very aggressively to Airbus. With little in the way was their ability to match the A320neo production of other engineering modifications required to the rate with an all-new program. Boeing would have airframe, this would be a relatively low-cost family to achieve rates in excess of 50 aircraft per month upgrade and Airbus also concluded that Boeing’s from a standstill position, a major challenge with strategic options in response would be constrained significant risks. by several factors, including the configuration and design of the 737 itself and Boeing’s engineering and The "do nothing" alternative was not an option. financial resources, both under pressure as a result Bombardier, COMAC, Irkut and Embraer had all of the 787 program problems. A “simple” re-engining launched new programs competing on top of, or of the A320ceo would therefore present Boeing with encroaching on the lower end of the 737 NG Family. an extremely challenging technical and commercial Boeing had to act to protect their market position dilemma. In addition, a number of new competitors from these new entrants and Airbus. were beginning to challenge the mid-market single aisle space, including Bombardier with their new CSeries, also P&W GTF-powered, and Airbus saw the NEO as a way to limit the traction of these new programs at an early stage. In February of 2011 Boeing’s CEO, Jim McNerney, Airbus’s“” decision to launch told analysts "We're going to do a new airplane" stating that they were not yet done evaluating the a re-engined A320 family situation but that their current bias was to move to (comprising of three aircraft, an all new aircraft at the end of the decade. By July without the slow-selling A318), of that year sentiment had swung, American Airlines placed the largest order in aviation history and was enabled by the availability Boeing had partly lost a key customer. of a new geared turbofan engine developed by P&W, who were extremely motivated to re-enter the single aisle market and had been selling the merits of the engine very aggressively to Airbus. 8 The 737 MAX – Taking Flight Taking Flight: An assessment of the Boeing 737 MAXA PRODUCT ASSESSMENT service of the A320neo. More concerning to Boeing was their ability to match the A320neo production rate with an all-new program. Boeing would have to achieve rates in excess of 50 aircraft per month from a standstill position, a major challenge with significant risks.

The "do nothing" alternative was not an option. Bombardier, COMAC, Irkut, Embraer had all launched new Since engine efficiency and aircraft operating costs were key to countering Airbus’ A320neo, the challenge programs competing on top of or Boeing faced was to squeezeencroaching on the lower end of the additional performance out of the existing737 NG platform. Family Throughout. Boeing had to act to protect the their market positiondevelopment stage,from these new entrants and Airbus the design underwent multiple changes:. the engine diameter grew from 66 inches to 69.4 inches, a nose gear door bubble introduced to accommodate the modified gear was eliminated, the tail cone was re-shaped and advanced technology winglets were added. Boeing’s iterative design was an Since engine efficiency and aircraft operating costs were keyattempt to catch up with Airbus but this reactive approach, to countering Airbus’ A320neo, t illustrated below in Exhibit 3, ultimatelyhe challenge Boeing cost faced wasthem to squeeze additional performance out of the existing platform. market share, a situation they remain determined to remedy. Throughout the development stage the design underwent multiple changes: the engine diameter grew from 66 inches to 69.4 inches, a nose gear door bubble introduced to accommodate the modified gear was eliminated, the tail cone was re-shaped and advanced Exhibit 3: 737 MAX and A320neo Program Timeline technology winglets were added. Boeing’s Boeing hasiterative design was an attempt to catch up with Airbus struggled to match Airbus product strategy but this reactive approach, illustrated below in Exhibit 3with, ultimately their approachcost them market share, a situation they remain determined to to MAX family development remedy.

Exhibit 3: 737 MAX and A320neo Program Timeline Boeing has struggled to match Airbus product strategy with their approach to MAX family development

The 737 MAX Family was originally launched with three members: the MAX 7, MAX 8 and MAX 9, each variant the same size as its NG predecessor. The main changes when comparing the 737 NG to the 737 MAX are shown below in Exhibit 4, the most significant being the new LEAP-1B engine, advanced technology winglets and aft body aerodynamic improvements. Since its original introduction, the MAX family has expanded: a higher capacity version of the MAX 8, the MAX 200 was launched in 2014; a stretched MAX 7 was announced in 2016, and a brand new model, the 737 MAX 10, was launched at the 2017 Paris Air Show.

The 737 MAX – Taking Flight 9 Taking Flight: An assessment of the Boeing 737 MAX A PRODUCT ASSESSMENT service of the A320neo. More concerning to Boeing was their ability to match the A320neo production rate with an all-new program. Boeing would have to achieve rates in excess of 50 aircraft per month from a standstill position, a major challenge with significant risks.

The "do nothing" alternative was not an option. Bombardier, COMAC, Irkut, Embraer had all launched new The 737 MAX Family was originally launched with programs competing on top of or encroaching on the lower end of the 737 NG Family. Boeing had to act to protect three members: the MAX 7, MAX 8 and MAX 9, each variant the same size as its NG predecessor. The “”Since its original introduction, their market position from these new entrants and Airbus. main changes when comparing the 737 NG to the the MAX family has expanded: 737 MAX are shown below in Exhibit 4, the most Since engine efficiency and aircraft operating costs were key to countering Airbus’ A320neo, the challenge Boeing significant being the new LEAP-1B engine, advanced a higher capacity version of technology winglets and aft body aerodynamic the MAX 8, the MAX 200 was faced was to squeeze additional performance out of the existing platform. Throughout the development stage the improvements. Since its original introduction, the design underwent multiple changes: the engine diameter grew from 66 inches to 69.4 inches, a nose gear door MAX family has expanded: a higher capacity version launched in 2014; a stretched of the MAX 8, the MAX 200 was launched in 2014; MAX 7 was announced in 2016, bubble introduced to accommodate the modified gear was eliminated, the tail cone was re-shaped and advanced a stretched MAX 7 was announced in 2016, and a and a brand new model, the 737 technology winglets were added. Boeing’s iterative design was an attempt to catch up with Airbus but this reactive brand new model, the 737 MAX 10, was launched at the 2017 Paris Air Show. MAX 10, was launched at the approach, illustrated below in Exhibit 3, ultimately cost them market share, a situation they remain determined to 2017 Paris Air Show. remedy.

Exhibit 4: The 737 MAX Key Design Change Source: Boeing Taking Flight: An assessment of the Boeing 737 MAX

Exhibit 3: 737 MAX and A320neo Program Timeline Exhibit 4: The 737 MAX Key Design Change Boeing has struggled to match Airbus product strategy with their approach to MAX family development Source: Boeing

The 737 MAX Family was originally launched with three members: the MAX 7, MAX 8 and MAX 9, each variant the The 737 MAX 7 same size as its NG predecessor. The main changes when comparing the 737 NG to the 737 MAX are shown below The original MAX 7 had 400nm more range than its NG predecessor, allowing operators to serve new city pairs and in Exhibit 4, the most significant being the new LEAP-1B engine, advanced technology winglets and aft body to continue to use the aircraft’s performance to add hot and high airport capability. By July 2016, approximately aerodynamic improvements. Since its original introduction, the MAX family has expanded: a higher capacity 1,200 737-700s were in active service, yet the MAX 7 had only secured 60 orders. With this limited sales traction, Boeing unveiled a re-design of the MAX 7 at the 2016 Farnborough Air Show. The changes from the original MAX 7 version of the MAX 8, the MAX 200 was launched in 2014; a stretched MAX 7 was announced in 2016, and a brand included a 76-inch stretch of the fuselage, use of the MAX 8’s wing and landing gear, additional over wing exits and new model, the 737 MAX 10, was launched at the 2017 Paris Air Show. structural strengthening. The aircraft is now just under 13 feet shorter than the MAX 8, similar to the gap between the A319neo and A320neo. The Maximum-Take-off-Weight (MTOW) was increased to overcome the additional empty weight of the aircraft allowing more range than the original MAX 7 and 800nm more range than the 737- 700, almost two hours flying time. From a passenger perspective the aircraft can accommodate 12 more seats in a two class layout and up to 23 seats in a high density configuration.

The 737 MAX 8

The MAX 8 represents the largest opportunity for the 737 MAX family due to the popularity of the 737-800 and its 8 size positioning at the heart of the market. The aircraft will fly over 500nm further than the -800 with a 7% lower cash operating cost. At the time of the MAX launch, Brent Crude prices were in excess of $100/barrel meaning that an average operator would save over $1.2 million per year per aircraft. Key customers were quick to order the MAX 8 and a year after the program was launched it had secured over 1,200 orders from 19 customers.

The 737-800 has a seat mile cash operating cost advantage over the heavier A320ceo as illustrated in Appendix A. The extra weight added to the MAX 8 along with its ground clearance restrictions helped Airbus reduce this lead. For the low-cost carrier market, which is laser-focused on seat mile cost, Boeing wanted a solution to restore their original advantage which led to the development of the MAX 200.

10 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

The 737 MAX 7 The 737 MAX 8 The original MAX 7 had 400nm more range than The MAX 8 represents the largest opportunity for its NG predecessor, allowing operators to serve the 737 MAX family due to the popularity of the new city pairs and to continue to use the aircraft’s 737-800 and its size positioning at the heart of the performance to add hot and high airport capability. market. The aircraft will fly over 500nm further than By July 2016, approximately 1,200 737-700s were the -800 with a 7% lower cash operating cost. At the in active service, yet the MAX 7 had only secured time of the MAX launch, Brent Crude prices were 60 orders. With this limited sales traction, Boeing in excess of $100/barrel meaning that an average unveiled a re-design of the MAX 7 at the 2016 operator would save over $1.2 million per year per Farnborough Air Show. The changes from the aircraft. Key customers were quick to order the MAX original MAX 7 included a 76-inch stretch of the 8 and a year after the program was launched it had fuselage, use of the MAX 8’s wing and landing secured over 1,200 orders from 19 customers. gear, additional over wing exits and structural strengthening. The aircraft is now just under 13 feet The 737-800 has a seat mile cash operating cost shorter than the MAX 8, similar to the gap between advantage over the heavier A320ceo as illustrated in the A319neo and A320neo. The Maximum-Take-off- Appendix A. The extra weight added to the MAX 8 Weight (MTOW) was increased to overcome the along with its ground clearance restrictions helped additional empty weight of the aircraft, allowing Airbus to reduce this lead. For the low-cost carrier more range than the original MAX 7 and 800nm market, which is laser-focused on seat mile cost, more range than the 737-700, almost two hours Boeing wanted a solution to restore their original flying time. From a passenger perspective the advantage, which led to the development of the aircraft can accommodate 12 more seats in a two MAX 200. class layout and up to 23 seats in a high density The 737 MAX 200 configuration. In September 2014, Ryanair, became the launch customer for the MAX 200, a derivative of the MAX 8, with an order for 100 aircraft. Prior to this, Boeing, offering the MAX 8, had lost a series of key sales campaigns to Airbus. Boeing used the extra length “”From a passenger perspective of the MAX 8 airframe over the A320neo to enable the accommodation of up to 200 passengers by the aircraft can accommodate adding a mid-cabin exit door to the MAX 8 (Exhibit 12 more seats in a two class 5) along with local cabin modifications and a flight layout and up to 23 seats in a attendant station. high density configuration. Avolon estimates that the aircraft will be approximately 600lb heavier with 300nm less range compared to the MAX 8. The additional seats on the aircraft will reduce galley space and overhead bin space on per passenger basis, and will also begin to encroach on the advantages of the larger MAX 9. Nevertheless, the capacity increase adds a significant incremental revenue opportunity over the MAX 8, with Ryanair expecting the higher seating capacity to add $1 million per aircraft of annual revenue. The 737 MAX – Taking Flight 11 A PRODUCT ASSESSMENT Taking Flight: An assessment of the Boeing 737 MAX

The 737 MAX 200

In September 2014, Ryanair, became the launch customer for the MAX 200, a derivative of the MAX 8, with an order for 100 aircraft. Prior to this, Boeing, offering the MAX 8, had lost a series of key sales campaigns to Airbus. Boeing used the extra length of the MAX 8 airframe over the A320neo to enable the accommodation of up to 200 passengers by adding a mid-cabin exit door to the MAX 8 Exhibit 5: Boeing 737 Max(Exhibit 5) 200 New along with local cabin modExit Door Location ifications and a flight attendant station. Source: Boeing.com

The 737 MAX 9 Exhibit 5: Boeing 737 MAX 200 New Exit Door LocationThe 737 MAX 10 The predecessor of the MAX 9, the 737-900ER,(Source: Boeing.com) To address this market share gap, Boeing required has not commanded the same success as Airbus’ a low-investment, low-risk development option large narrowbody variant, but in the rush to get the to match the A321neo across the characteristics 737 MAX to market Boeing neglected to consider that airlines care about most: seat count and unit Avolon estimates that tand counter Airbus' he aircraft will be approximately 600lb heavier withkey strength, the A321, instead cost. The aircraft 300nm less range compared to the will have 300nm less range than MAX 8opting. The additional seats on the aircraft to maintain the dimensions of thewill reduce galley space 737-900ER. the MAXand 9,overhead bin space on however range in excessper ofpassenger 3,000nm basis Although the MAX 9 offers over 500nm more is only required for niche single-aisle markets. The and will also begin to encroach on the advantages of the larger MAXrange as well as improved performance, the variant MAX 10 9. Nevertheless, the capacity increase adds a was launched in Paris, securing orders and significant incremental revenue opportunity over the MAX 8, with Ryanaihas not been a success. Prior to the 2017 Paris Air commitmentsr expecting for 361 aircraft the higher seating capacity to over the Air Show week add Show,$1 milli Boeingon per aircraft of had secured annual revenue. 231 announced orders from a diverse mix of 16 customers including nine compared to over 1,100 for the A321neo and the MAX airlines. 9 continued to suffer the same market pressure as the 737-900ER. As the market share gap with the The aircraft has a comparable seat count to the A321neo and transcontinental range. It will complete The 737 NEO widened,MAX 9 this weakness in the portfolio urgently needed to be overcome. the MAX family with equally spaced seating capacities between the MAX 7, MAX 8 and MAX 10. The predecessor of the MAX 9, the 737-900ER, has not commanded the same Its flexibility in seatingsuccess capacityas Airbus’ large narrowbody and range capability variant. In the rush to get the 737 MAX to market Boeing neglected to consideravoids the mistakes and counter Airbus' of the original 737-900 key strength, design, the A321, instead opting to maintain the dimensions of the 737which-900ER. deliveredAlthough t only 52 he MAX 9 offers over 500nm units. Design changes for the MAX 10 include a fuselage stretch of 66 inches more range as well as improved range and performance, the variant has not been a success. Prior tocompared to the MAX 9 and semi-levered the 2017 Paris main Air Show, Boeing had secured 231 announced orders compared to over 1,100 for the A321neolanding gear to enhance low-speed performance. and the MAX 9 continued to suffer the same market pressure as the 737-900ER. As the market share gap with the NEO widened, this weakness in the portfolio urgently needed to be overcome.

The 737 MAX 10

To address this market share gap, Boeing required a low-investment, low-risk development option to match the A321neo across the characteristics that airlines care about most: seat count and unit cost. The aircraft will have

12 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

The 737 MAX Market and Competition

Both manufacturers have been successful in selling their re-engined narrowbody families. Together, enough NEO and MAX aircraft have been sold to replace 80% of today’s in service CEO and NG fleets. By the time of Boeing’s first firm MAX order in December 2011 Airbus had already received over 1,100 orders for its newly re-engined A320neo. Nevertheless, the total order book for the 737 MAX now stands at approximately 4,500 aircraft, 19% less than the A320neo, with an overall family market share split of 54/46 in favour of Airbus. The current market shares for each model (post-Paris Air Show) is shown below in Exhibit 6.

Exhibit 6: NEO v MAX MarketTaking Flight: An assessment of the Boeing 737 MAX Share by Type In Service, On Order and LOIs included The 737 MAX Market and Competition

Both manufacturers have been successful in selling their re-engined narrowbody families. Together enough NEO and MAX aircraft have been sold to replace 80% of today’s in service CEO and NG fleets. By the time of Boeing’s first firm MAX order in December 2011 Airbus had already received over 1,100 orders for its newly re-engined 58% 50% 50% 29% 54% A320neo. The total order book for the 737 MAX now stands at approximately 4,50071% aircraft, 19% less than the 42%A320neo, with an overall family market share split of 54/46 in favour of Airbus. The current market shares for each 46% model (post-Paris Air Show) is shown below in Exhibit 6.

737-7 v A319NEO 737-8/200 v A320NEO 737-9/10 v A321NEO All MAX and NEO Types 737-7 v A319neo 737-8/200 v A320neo 737-9/10 v A321neo All MAX and NEO Types 112 AIRCRAFT 8,146 AIRCRAFT 2,065 AIRCRAFT 10,323 AIRCRAFT

29% 42% NEO MAX 50% 50% 54% 46% 58% 71%

112 Aircraft 8,146 Aircraft 2,065 Aircraft 10,323 Aircraft Analysis of the cumulative orders booked from the date of the first order for each type confirms Airbus to be the market leader,MAX however,NEO by subtype,MAX theNEO A320neo and 737MAX MAXNEO 8 are trackingMAX a veryNEO similar path, whilst the A321neo has pulled significantly ahead of the 737 MAX 9 Exhibit( 7), a gap that the 737 MAX 10 is designed to rectify. Exhibit 6: NEO v MAX Market Share by Type In Service, On Order and LOI’s included

Analysis of the cumulative orders booked from the date of the first order for each type confirms Airbus to be the market leader with over 5,500 aircraft Exhibit commitments 7: NEO, however, v MAX b y Orders subtype , the A320neo and 737 MAX 8 are tracking a very similar pathBaselined, whilst t from datehe A321neo has pulled of the first orderforsignificantly ahead of the 737 MAX 9 each respective program (Exhibit 7) , a gap that the 737 MAX 10 is designed to A319neorectify. and 737 MAX 7 not included

4500

4000 737 MAX 8 737-9/10 3500 A320neo A321neo

3000

2500 Cummulative Orders 2000

1500

1000

500

0 0 200 400 600 800 1000 1200 1400 1600 1800 2000 2200 Days Since First Order of Each Respective Program Exhibit 7: NEO v MAX Orders Baselined from date of the first order for each respective program A319neo and 737 MAX 7 not included.

The 737 MAX – Taking Flight 13 A PRODUCT ASSESSMENT

A key metric supporting aircraft residual values and Entering the 2017 Paris Air Show, Boeing had a 15%1 investor appetite – is market liquidity. Airbus has share of the total A321neo and 737 MAX 9 order positioned its A320ceo family well. The A319ceo, book. By the close, with the MAX 10 included, this had A320ceo and A321ceo have all exceeded over grown to 30% (Exhibit 9). It is too early to know how 100 operators (in service, on order and letters of the operator base will develop for the MAX 10 but it intent) whereas Boeing has only achieved this with has already surpassed three of the re-engined models the 737-800 (Exhibit 8). The re-engined versions and is tracking closely behind the MAX 9 which, along have not yet had the benefit of secondary market with the MAX 8, is expected to experience further order conversions to the MAX 10. If the MAX 10 sales transactions to increase their operator base but it is momentum continues it will result in two strong family apparent that the A320neo, A321neo and 737 MAX members and a product line that is better able to 8 have a clear lead over all other MAX or NEO types. compete with the A320neo. The MAX 9, MAX 200, A319neo and MAX 7 all have a lot of ground to make up on their siblings and it might be already too late for these models to gain Taking Flight: An assessment of the Boeing 737 MAX Exhibit 9: MAX 10 Paris Air Show impact the momentum they need to be considered widely on large segment market share investable assets.

A key metric supporting aircraft residual values and investor appetite is market liquidity. Airbus has positioned its A320ceo family well. The A319ceo, A320ceo and A321ceo have all exceeded over 100 operators (in service, on order and letters of intent) whereas Boeing Exhibithas only achieved this with the 737 8: Airline Operators-800 (Exhibit 8). The re-engined versions have not yet had the benefit of secondary market transactof A320 & 737 familyions to increase their operator base but it is members apparent that the A320neo, A321neo and 737 MAX 8 have a clear lead over allIncludes in service, on order and LOI other MAX or NEO types. The MAX aircraft 9, MAX 200, A319neo and MAX 7 all have a lot of ground to make up 737-600 and A318 excludedon their siblings and it might be already too late for these models to gain the momentum they need to be considered widely investable assets.

Exhibit 8: Operators for A320 & 737 family members Includes in service, on order and LOI aircraft 300 737-600 and A318 excluded

250 240

200 178

150 114 102 100 76 68 Number of Operators 54 47 50 22 12 9 3 3 3 0

Source: FlightGlobal Ascend

1 “”The re-engined versions have Entering the 2017 Paris Air Show, Boeing had a 15% share of the total A321neo and 737 MAX 9 order book. By the close, this had grown to 30% (Exhibit 9). It is too early to know how the operator base will develop for the MAX 10 not yet had the benefit of but it has already surpassed three of the re-engined models and is tracking closely behind the MAX 9 which, along with the MAX 8, is expected to experience further conversions to the MAX 10. If the MAX 10 sales momentum secondary market transactions continues it will result in two strong family members and a product line better able to compete with the A320neo. to increase their operator base but it is apparent that the A320neo, A321neo and 737 MAX 8 have a clear lead over all other MAX or NEO types.

1 Including firm orders, MOUs and LOIs

1. Including ﬁrm orders, MOUs and LOIs 14 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Avolon’s World Fleet Forecast (Exhibit 10) projects Comparing the mix of the smaller variants of the that the MAX 10 will account for approximately 20% current 737 NG and A320ceo family fleets with their of all 737 MAX family deliveries, which would equate re-engined successors, it is apparent that demand to around 2,000 aircraft. This compares to the has shifted – the smaller variants of both families A321neo, which is forecast to account for 40% of the have all but disappeared from the order books. A320neo family, with over 4,000 deliveries. Whilst the 737-700 and A319ceo hold a combined 17% of the current fleet, the MAX 7 and A319neo account for a mere 1% of family orders (Exhibit 11). Exhibit 10: Forecast 737 MAX Family Production Share Source: Avolon World Fleet Forecast 2017-2036 Exhibit 11: A320 and 737 familyTaking Flight: An assessment of the Boeing 737 MAX share mix by size

Exhibit 11: A320 and 737 family share mix by size

100% 16% 90% 18% Large: 737-900/ER, MAX 9, MAX 10, A321 80% 70% 60% 50% 67% 40% 81% Medium: 737-800, Max 8, MAX 200, A320 30% 20% 10% 17% 0% 1% Small: 737-700, MAX 7, A319 A320CEO & 737NG A320NEO & 737MAX

Small Medium LargeLargre

This shift in demand hAs detailedas been driven by several factors on page 15, this - t shifthe rise of internet and mobile bookings in demand has with increasing load factors focusing been drivenLCCs on larger aircraft by several; the factorsaverage size of narrowbody aircraft today is significantly larger - the rise of internet compared to and when mobile the 737NG bookings was launched; with the A320neo increasing and MAX load 8 offer factors enhanced take-off performance limiting the number of markets where performance aircraft like the Mfocusing LCCs on larger aircraft; theAX 7 a averagend A319neo are needed. size of narrowbody aircraft today is significantly larger

compared to when the 737NG was launched; the A320neo and MAX 8 offer enhanced take-off The LCC Revolution Turnaround Time Improvements We have experienced a structural change in fares and nonperformance limiting the-fuel number Less passengers on the aircraft means less boarding and of markets where related costs. Since 2000, in the US domestic market alone, performance aircraft like the MAXdeplaning time resulting 7 and A319neo in higher utilization and in some cases “”Whilst the 737-700 and airfares (including fee revenue) net of taxes and adjusted for an additional revenue flight per day. inflation have fallen 22%. With this the ability of the are needed. LCCs to fill Reducing turn-time by 10 minutes with an average trip length A319ceo hold a combined seats is impressive of 500 nautical miles can improve airplane utilization by 8 The ease at which travelers can now purchase airline tickets percent2. has been a shot in the arm for airlines. With efficiencies in passenger boarding and aircraft handling 17% of the current fleet, the Larger aircraft carry an additional trip cost however the trip airlines are getting close to maximum turnaround efficiency fuel cost difference between a 737-700 and 737-800 on an even from the larger models. MAX 7 and A319neo account average sector is approximately $250, a small amount considering the larger aircraft typically carries 30 to 35 more passengers. for a mere 1% of family orders (Exhibit 11). Airframer Profit Margins Ancillary Revenue

2 http://www.boeing.com/commercial/aeromagazine/articles/qtr_4_08/pdfs/AERO_Q408_article03.pdf

The 737 MAX – Taking Flight 15 A PRODUCT ASSESSMENT

Drivers of the Up-Gauging Trend

The LCC Revolution Turnaround Time Improvements

• We have experienced a structural change in • Less passengers on the aircraft means less fares and non-fuel related costs. Since 2000, boarding and deplaning time resulting in higher in the US domestic market alone, airfares utilization and in some cases an additional (including fee revenue) net of taxes and revenue flight per day. adjusted for inflation have fallen 22%. With this the ability of the LCCs to fill seats is impressive • Reducing turn-time by 10 minutes with an average trip length of 500 nautical miles can • The ease at which travelers can now purchase improve airplane utilization by 8 percent2. airline tickets has been a shot in the arm for airlines. • With efficiencies in passenger boarding and aircraft handling airlines are getting close to • Larger aircraft carry an additional trip cost maximum turnaround efficiency even from the however the trip fuel cost difference between larger models. a 737-700 and 737-800 on an average sector is approximately $250, a small amount considering the larger aircraft typically carries 30 to 35 more passengers.

Airframer Profit Margins Ancillary Revenue

• Although driven by the LCC revolution the power • The incremental cost to manufacture a of ancillary revenue is immense and it has driven larger variant within the same family is far up load factors. outweighed by the incremental revenue potential the airframer can achieve. • A recent study by IdeaWorks3 shows that in 2015 airlines such as Spirit, Jet2 and Qantas earned • This is evident across several programs. Even over $40 per passenger in ancillary revenue. if the market demanded smaller aircraft the The average operating cost4 per passenger on airframers’ ability to upsell the larger variants board a 737-800, flying an 800nm sector, is knows no bounds. approximately $51. • The following chart shows how the fortunes • Due to the unbundling of fares there are of the smaller variants of the 737, 787, 767, incremental revenue benefits to having more 777, A320 and A330 programs have fared passengers on board the aircraft. This is driving since 2000. airlines to larger variants.

Number of Annual Aircraft Deliveries Ancillary Revenue Per Passenger Smaller Family Members 1180 1199 Larger Family Members 1100 $60.00 1034 963 795 808 $40.00 726 577

558 $51.80 $50.84 $49.94 441 $20.00 417 $44.16 375 $42.70 333 308 322 282 271 245 278 263 284 207 229 219 200 151 168 161 190 157 83 $0.00 Spirit Jet2.com Allegiant United Qantas

2. http://www.boeing.com/commercial/aeromagazine/articles/qtr_4_08/pdfs/AERO_Q408_article03.pdf 3. http://www.ideaworkscompany.com/wp-content/uploads/2016/07/2015-Top-10-Airline-Ancillary-Revenue-Rankings- Final.pdf 4. Direct Operating Cost (included lease / capital cost) assuming a jet fuel price of $2.00 /USG. 175 pax 737-800, 10 year old aircraft, lease rate of $200,000 / month, assuming industry average taxi times. 16 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Aircraft Performance Replacement Market Dynamics

• The smaller variants of aircraft families typically • The average seat size of the narrowbody aircraft enjoy longer range and better low-speed fleet at the time of the launch of the 737 NG was performance compared to their larger siblings considerably different to when the 737 MAX was due to the fact that the families typically share launched. the same wing and engine hardware, but smaller aircraft carry lighter payloads. • Airlines considering the 737 NG at that time were operating narrowbody aircraft such as the 737 • This holds true for the 737 MAX and A320neo Classics and MD80s with an average seat count of programs, however the A320neo and 737 109 seats compared to an average seat count of MAX 8 offer enhanced take-off performance 149 at the time of launch of the 737 MAX. due to aerodynamic, engine and control law improvements resulting in up to several • It was natural for the airlines operating 737 tons more take-off weight compared to Classics to grow smoothly into the 737-700 rather their predecessors on occasions when those than taking a bigger jump toward larger variants, predecessors would have been otherwise such as the 737-800. limited.

“”It was natural for the airlines operating 737 Classics to grow smoothly into the 737-700 rather than taking a bigger jump toward larger variants, such as the 737-800. The 737 MAX – Taking Flight 17 A PRODUCT ASSESSMENT

Risks and Mitigants

Investing in aircraft requires an in-depth appreciation for the competitive, technical and commercial risks specific to the aircraft model being considered. The 737 MAX faces emerging competitors who are encroaching on their market. Its unit cost leadership in the market place has been challenged and has obliged CFM to push the boundaries of their engine design. For lessors, a host of new entrants with MAX orders could impact the ability to place aircraft and their profitability.

Aircraft Competition Engine Maintenance Cost New and established manufacturers have emerged The predecessor of the LEAP, the CFM56 is a trying to compete in the lucrative narrowbody well understood and widely accepted engine - its market. Irkut and COMAC are making a direct play reliability and time-on-wing characteristics are against Airbus and Boeing whilst Bombardier and second to none, a reputation earned over two Embraer are aiming, at least in part, to take a share decades. Investors must also be mindful that the of the A319 and 737-700 replacement market. It is LEAP engine will be challenged to match the CFM56 difficult for new entrants to gain market traction as right out of the box. The engine will continue to be airlines are concerned that they will not produce developed and improved as CFM learns more about reliable aircraft or have the network to support them. its operational characteristics. However, while there are many factors working against these new entrants, they also have strengths. All indications are that CFM and Boeing are Government support for both COMAC and Irkut achieving their fuel burn targets for the LEAP-1B. will seed their home market, enabling them to Fuel efficiency is key for airlines regardless of fuel build a customer base and to lower production unit price, however in today’s lower oil price environment costs. A large installed fleet with global customers other cost elements are moving higher on the enables Bombardier and Embraer to make credible list of airlines’ concerns. To achieve its fuel burn sales pitches to smaller customers with growth performance, CFM had to raise temperatures and ambitions that may not be deemed important by pressures on the LEAP which could impact the the Big Two. The new entrants have normalized engine’s time on-wing. Once off-wing and in the Airbus’ and Boeing’s engine advantage; COMAC overhaul facility, cost is predominantly driven by selected the LEAP engine to power the C919 and the hot section of the engine. To achieve better Irkut, Bombardier and Embraer selected Pratt and fuel burn performance, the LEAP engine has an Whitney to power their offerings. additional stage of high pressure (HP) turbine. For a narrowbody aircraft engine, a set of HP turbine It will take time, perhaps decades, for the new blades and associated parts can cost well in entrants to materially change the market, but the excess of $1m. CFM has committed to keep LEAP duopoly is being challenged. maintenance costs at CFM56 levels, which will oblige them to continue to innovate and offer competitive aftermarket packages.

Commercial guarantees and commitments will provide comfort to airlines, but do not deliver equivalent benefit to lessors and investors, who require whole-life coverage. Leased aircraft transition from operator to operator and can be sold multiple times over the course of their life. If the right commercial packages are not in place for investors, demand for leased aircraft will reduce, lease rates will follow, and a valuable distribution channel for the manufacturers and source of financing for the airlines will be constrained. CFM and Boeing will be focused on, and must ensure, a comprehensive solution for investors.

With the potential for higher maintenance costs, lessors may also be under-reserved when airlines make maintenance claims. This could strain relationships, creating risk for lessors when negotiating extensions and additional business with the airline. 18 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Leasing Competition A key issue being debated by the industry is the level of orders being placed by leasing companies, which hold 21% of the entire NEO and MAX order book. Four lessors, Avolon, GECAS, AerCap and ALC, each have over 250 aircraft on order, including letters of intent (LOIs), and memorandums of understanding (MOUs), and account for 50% of the entire leasing order book. New entrants are also emerging, with CDB and CALC in particular having significant orders, as shown inExhibit 12.

Exhibit 12: Lessor NEO v MAX Current Order Books Includes LOIs and MOUs (as at 30th June 2017)

All data is from FlightGlobal Ascend except for Avolon which is company data

However, even with the increased number of aircraft on order, the ratio of lessor orders to the overall narrowbody order book has remained stable. Since 2005 lessor orders have averaged 20% of the total order book (Exhibit 13) demonstrating that as the market grows lessors continue to take a consistent share.

“”However, even with the increased number of aircraft on order, the ratio of lessor orders to the overall narrowbody order book has remained stable. Taking Flight: An assessment of the Boeing 737 MAX

Leasing Competition

A key issue being debated by the industry is the level of orders being placed by leasing companies, which hold 21% of the entire NEO and MAX order book. Four lessors, Avolon, GECAS, AerCap and ALC, each have over 250 aircraft on order, including letters of intent (LOIs), and memorandums of understanding (MOUs), and account for 50% of the entire leasing order book. New entrants are also emerging, with CDB and CALC in particular having significant orders, as shown in Exhibit 12.

400 737 (Max) 350 300 A320NEO Family 209 250

200 189 148 137

150 110 61 The100 737 MAX – Taking Flight 61 45 19 170 83 68 A PRODUCT ASSESSMENT130 132 50 100 90 80 71 76 20 40 50 35 0 20 22 20 20

Exhibit 12: Lessor NEO v MAX Current Order Books Includes LOIs and MOUs (as at 30th June 2017) Exhibit 13: Lessor Narrowbody Orders as a Percentage of the Entire Order Book Includes LOIs and MOUs However, even with the increased number of aircraft on order737 NG/MAX and A320 CEO/NEO, the ratio of lessor orders to the Families Only overall narrowbody order book has remained stable. Since 2005 lessor orders have averaged 20% of the total order book (Exhibit 13) demonstrating that as the market grows lessors continue to take a consistent share.

40%

30%

22% 21% 21% 21% 21% 20% 20% 19% 20% 20% 20% 20% 19% 17% Book (%)

10% Lessor Share of the Order

0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Exhibit 13: Lessor Narrowbody Orders as a Percentage of the Entire Order Book Includes LOIs and MOUs 737 NG/MAX and A320 CEO/NEO Families Only 18 Despite the scale of the lessor backlog, demand for Exhibit 14: Over half of Boeing's direct 737 customer lessors’ MAX order books is expected to be robust; airlines have not placed MAX orders 65% of all airlines currently operating 737NGs have Source: FlightGlobal Ascend no commitments, either directly or through the lessor channel, for MAX or NEO – well over 100 in total. Over time, the majority of these airlines will want to re-fleet with new generation aircraft and, given the long-dated nature of the OEM backlogs, will look to the lessor channel to satisfy their No Max Max requirements. Orders Orders 54% 46% Even amongst the airlines that have historically been direct customers of Boeing for 737NGs, over half have not placed orders for MAX aircraft (Exhibit 14). The ten largest of these, which include Delta, Shenzhen Airlines, Qantas, ANA and Japan Airlines, together operate 800 NGs and a further 37 airline customers have NG fleets totalling 400 aircraft. The full list of uncommitted direct NG customers is in Appendix B. 20 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

The 737 MAX Investor Proposition

With common family design principles, it’s logical for Boeing to offer a wide choice to airlines, however the family should reflect actual market demand and too much choice can be a negative factor in the minds of investors. Although lessors finance over 40% of the world’s commercial aircraft deliveries, they do not support all models and family members equally, with asset liquidity being a key determinant of investment appetite. Airlines should therefore expect to look further afield to finance some of the more marginalized MAX family members. As summarized below, in Exhibit 15, the investment strength of the MAX 8 is not yet evident in the other MAX variants.

Exhibit 15: Summary of Investor Proposition

Variant Investor Proposition Key Investment Considerations 737 MAX 7 Small operator base. Highest unit cost member of the MAX Caution family. Performance advantage weakened by more capable MAX 8. Pricing incentives may stimulate demand

737 MAX 8 Invest Large operator base. Large incumbent 737-800 fleet. Heart of the narrowbody market. 737 MAX 200 Small operator base. Unit cost leader in the medium Watch narrowbody market. Unproved reconfiguration. Lack of orders from its target market. Expect a small operator base 737 MAX 9 Small operator base. Marginalized by the launch of the MAX Caution 10. Limited role in the family. 737 MAX 10 Successful launch. Good growth vehicle for large 737-800 Watch and MAX 8 fleets. Engine maintenance cost and performance concerns.

The 737 MAX 7: Serves a Niche Since its redesign, Boeing has secured one additional The additional seats in the stretched MAX 7 have firm order for a single aircraft along with MOUs increased its operating cost-per-seat advantage over from Kunming Airlines for ten units and Air Lease the A319neo (Appendix A), however, this segment of Corporation for five. Whilst the -700 was the right- the market will not be where the “NEO v MAX” battle sized aircraft to enable fast turn times and replace 737 is won or lost. The MAX 7 will retain some 737-700 Classics, airlines are trading less time on the ground for customers with an offering that competes on trip and the lower unit costs in the air of the larger types seat cost, airfield and range capabilities. However, the improved airfield and range performance of the MAX The 737 MAX 8 - Heart of the Market 8 reduces the number of markets in which, on the The MAX 8 has incrementally grown its operating cost other hand, a high performance aircraft like the MAX advantage over the 737-800 it replaces. Its 50% market 7 is required. While Bombardier and Embraer will take share versus Airbus in the medium narrowbody market a share of the small narrowbody market segments, is a testament to the flexibility of the 737 platform and the MAX 7 offers full commonality with larger family the ability of Boeing’s engineers to squeeze efficiency members and will serve as a sub-fleet for airlines. out of their design. With average narrowbody seat counts trending towards 160, the MAX 8 is now the With a common wing and landing gear to the MAX 8, right-sized aircraft, with exceptional range and airfield production of the MAX 7 will be simplified, enabling capabilities, positioned at the heart of the narrowbody marginal cost pricing to aggressively defend Boeing market. customers from defecting and stimulate sales in a way not achieved with the 737-700. Based on Avolon’s Boeing argues that its customers have larger installed proprietary Aircraft Economics Model, in order to fleets than Airbus’ which will lead to more follow-on equalize the seat cost difference between it and the orders. Airbus counters that their order book contains MAX 8, and so reduce the operating cost risk for more faster-growing LCCs. Both arguments are valid. operators, Boeing would need to price the aircraft at The ratio of narrowbody aircraft on order to in-service least $10m dollars below the MAX 8, which is in line with for Boeing’s Top 10 MAX customers is half of Airbus’ appraisers’ views of the difference between similarly (0.6x vs 1.2x) whereas 66% of Airbus’ orders are from sized narrowbody aircraft in today’s market. LCCs vs 57% for Boeing. The 737 MAX – Taking Flight 21 A PRODUCT ASSESSMENT

The extra take-off weight added to the 737 MAX The 737 MAX 10 – Taking Off 10 will raise the prospect of a “flow-back” of these In 2016, the A321 outsold every other commercial enhancements to the MAX 8. Generally this is good aircraft variant5. The MAX 10 will serve as a crucial gap news for investors and airlines, however, if the upgrades closer to take market share back from the A321neo are not applicable to pre-delivered MAX 8 aircraft, they and is expected to be a compelling unit cost aircraft. could impact residual values. Network carriers, such as United and Air Canada will be attracted to the MAX 10. Low-cost and hybrid carriers, The 737 MAX 200 – Limited Traction such as Lion Air and Alaska will benefit from its lower With only three firm customers secured in three years, unit costs. Charter carriers, such as TUI will find the the MAX 200 raises questions for investors. MAX 10 an attractive 757 replacement for popular leisure markets. Although the MAX 200 offers more seats, Boeing’s Taking Flight: An assessment of the Boeing 737 MAX promise of the aircraft being a “game changer” for hot and high airfield performance will better serve these customers rather than the potential for weak residual the LCCs has not come to fruition. Since its launch, values driven by a more limited operator base and small installed fleet. The MAX 9 is unlikely to attract new several LCC sales campaigns have come and gone with customers or additional ordersExhibit 16: , Newwith airlines opting for the MAX 10 instead. Technology Narrowbody Market the airlines ultimately choosing the MAX 8 or MAX Family Share 10. The MAX order book contains orders for yet to be Large: 737-900/ER/9/10, A321ceo/neo, Medium: 737-800/8, The 737 MAX 10A320ceo/neo, – Taking Off MC21, and C919 Small: 737-700, A319, CS300 announced family members which could ultimately end In 2016, the A321 outsold every other commercialIn Service, On Order and aircraft variant LOI/MOU5. The MAX 10 will serve as a aircraft quantitiescrucial gap closer to up being MAX 200 aircraft, however, the MAX 10 will take market share back from the A321neo737-600, A318, CS100 Excluded and is expected to be a Unannouncedcompelling unit cost aircraft. Network carriers, types assumed to decrease the likelihood of this occurring. such as United and Air Canada will be attracted to the MAX 10. Lowbe most popular family member i.e. 737-8,-cost an A320neo,d hybrid carriers, such as Lion Air and CS300 Alaska will benefit from its lower unit costs. Charter carriers, such as TUI will find the MAX 10 an attractive 757 replacement for popular leisure markets. Although the market acceptance of a MAX 200 retrospectively, reconfigured as a MAX 8, is yet to be 100% proven. Inexpensive and timely retrofit solutions will 80% MC-21 be important to ensure a healthy secondary market 60% CSeries C919 that spans both network and low-cost carrier business 40% models. A320NEO 20% 737 (Max) 0% The 737 MAX 9 – At Risk Small Medium Large Even before the launch of the MAX 10, the market’s Exhibit 16: New Technology Narrowbody Market Family Share reception to the MAX 9 was lukewarm. United Airlines Large: 737-900/ER/9/10, A321ceo/neo, Medium: 737-800/8, A320ceo/neo, MC21, and C919 Small: 737-700, A319, CS300 Many incumbent 737-800In Service, On Order and LOI and/MOU future aircraft quantities MAX 8 operators decision to convert orders for 100 MAX 9s to the MAX 737-600, A318, CS100 Excluded will likely embraceUnannounced types assumed to be most popular fami the MAX 10, inly member i.e. 737 the way-8, A320neo, CS300 that A320 10 demonstrates the aircraft’s vulnerability. It will no operators embraced the A321. Fifteen 737-800 longer serve as the lowest unit cost family member and Many operators incumbent 737 -800 fly and overfuture MAX 800 8 operators A321s will today, likely embrace a strong the MAX 10, indication in the way that A320 whilst airfield performance is expected to be superior to operators embraced the A321. Fifteen 737of the lack of a suitable-800 operators 737 family fly over 800 A321s member today, a strong indication of the lack to grow the MAX 10, it is inferior to the MAX 8. The A321ceo has of a into,suitable 737 family member but no shortageto grow into of. demand. attracted five times the number of operators as the 737- There are still limitations to what the MAX 10 can achieve, however. With the same engine thrust options as the 900ER. The A321neo is maintaining that advantage with MAX 9There (up to 28,000 are lbstillf), but a fuselage stretched to fit two additional seat rows, the limitations to what the MAX 10 canMAX 10 will have airfield performance limitations. With engine thrust options of up to 35,000 lbf, the A321neo will continue to win in five times the number of announced operators as the markets where airfield performance and capacity is important. The Aachieve, however. With the same engine321LR’s 97t maximum take thrust options-off weight will MAX 9. Appraisers assign a higher value to an A321ceo also ascreate a range advantage the MAX 9 (upfor a small number of operators and missions to 28,000 lbf), but a that Boeing will not be able to matchfuselage . over a 737-900ER despite the 737-800 garnering a The MAX 9stretched has been untoable to consistently compete against fit two additional the A321neoseat rows,, taking a meagre the MAX 15% market share in 10 higher value than an A320ceo, based on the average of the large willnarrowbody have airfield segment. The MAX 10 has already increased that share to 30% performance limitations. . With engine four appraisers. thrust options of up to 35,000 lbf, the A321neo will continue to win in markets where airfield performance The MAX 9 incurs a significant operating cost per seat and capacity is important. The A321LR’s 97t maximum penalty when compared to the A321neo, particularly take-off weight will also create a range advantage for with Airbus’ 240 seat configuration. This difference, 5 Announced orders accounting for type swaps and cancellations.a small number of operators and missions that Boeing almost 7%, is untenable and ultimately led to the will not be able to match. The MAX 9 has been unable launch of the MAX 10. To avoid fragmenting the large 22 to consistently compete against the A321neo, taking narrowbody market, Boeing will have to consider the a meagre 15% market share in the large narrowbody future of the MAX 9. While some operators may value segment. The MAX 10 has already increased that share the additional performance of the aircraft over the to 30%. MAX 10, packages to improve hot and high airfield performance will better serve these customers rather than the potential for weak residual values driven by a more limited operator base and small installed fleet. The MAX 9 is unlikely to attract new customers or additional orders, with airlines opting for the MAX 10 instead.

5. Announced orders accounting for type swaps and cancellations. 22 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Conclusions

Boeing’s MAX product strategy Boeing has secured only three decisions have been reactive, customers in three years for resulting in lower market share and the 737 MAX 200 rendering it a plethora of variants which do not questionable from an investor all reflect actual market demand. perspective. A proven, cost efficient and timely MAX 8 reconfiguration package may assist residual values, In launching the A320neo, however, airlines will have to carry Airbus presented Boeing with approximately 600lb additional both a technical and commercial weight compared to a factory built dilemma. The MAX was Boeing’s MAX 8. only option to compete against the A320neo in a timely manner. A clean-sheet design would have The 737 MAX 9 no longer serves entered the market several years as the lowest unit cost family after the A320neo and Boeing’s member and is severely impacted ability to match the A320neo MAX 9 by the launch of the MAX 10. production rate with that of a new With only slightly improved program would have taken several unit cost over the MAX 8 it is years to achieve, at the cost of unclear what role remains for market and customer share. the aircraft which is expected to have a very limited future.

In the rush to get the 737 MAX to market, Boeing neglected to The 737 MAX 10 will complete the consider and counter Airbus' key MAX family and will be a much strength, the A321. improved competitor compared to the MAX 9. It will be a capable seat cost machine for operators The recent launch of the MAX looking to grow beyond the 737- 10 has strengthened the MAX 800 and 737 MAX 8, however, it family and has already doubled will some have airfield performance MAX 10 Boeing’s market share in the large limitations. The A321neo will remain narrowbody segment. the high density seat cost leader in this market.

The 737 MAX 8 remains the heart of the MAX family and a key target 54% of 737NG operators who for investors. The aircraft has have previously taken ordered MAX 8 maintained its Cash Operating Cost new aircraft directly from Boeing, (COC) advantage over the A320neo do not have commitments for on a per seat and trip basis, the 737 MAX. With delivery slots although only by a small margin. unavailable, pent up demand exists which supports the placement of lessors’ speculative orders. The MAX 7 is a niche product when performance and range is required. The market shift away from smaller CFM will deliver on its fuel burn MAX 7 variants has been driven by several commitment for the Leap engine, factors, including unit price and the which will, however, be challenged focus of the LCCs on larger models. to meet the cost performance A change in pricing strategy could of its predecessor, the CFM56. stimulate further demand. It is imperative that CFM puts commercial measures in place to allow the benefit of maintenance agreements to survive multiple operators and owners. The 737 MAX – Taking Flight 23 A PRODUCT ASSESSMENT

Appendix A Taking Flight: An assessment of the Boeing 737 MAX Aircraft Cash Operating Cost Appendix A – Relative aircraft Cash Operating Cost positioning

Notes Data Source: Avolon Aircraft Economics Model LOPA –Layout of Passenger Accommodations, COC –Cash Operating Cost, P&W powered A320 Family

24 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

Appendix B Airlines without MAX Commitments that have previously ordered 737NGs

NG Orders NG Orders placed with Boeing placed with Boeing

Delta Air Lines 262 Hebei Airlines 9

Air Berlin 91 Tassili Airlines 7

Shenzhen Airlines 78 Luxair 6

Qantas 74 South African Airways 5

Shandong Airlines 65 TAAG Angola Airlines 4

All Nippon Airways 54 TAROM 4

Japan Airlines 46 Austrian Airlines 3

Pegasus Airlines 46 Belavia 3

KLM 42 Ceiba Intercontinental 3

Shanghai Airlines 38 SonAir 3

UTair Aviation 36 Air Austral 2

Jet2.com 34 Biman Bangladesh 2 Airlines

SAS 33 Buraq Air 2

easyJet 32 Kenya Airways 2

Royal Air Maroc 31 Lineas Aereas Azteca 2

Air Algerie 27 RwandAir 2

Transavia Airlines 26 S7 Group 2

Egyptair 25 Sky Airlines 2

Air India 18 Somon Air 2

China Airlines 13 Sriwijaya Air 2

EL AL 13 Air Senegal International 1

Germania 12 Mauritania Airlines 1

Maersk Air 12 Midwest Airlines (Egypt) 1

Turkmenistan Airlines 12 The 737 MAX – Taking Flight 25 A PRODUCT ASSESSMENT 26 The 737 MAX – Taking Flight A PRODUCT ASSESSMENT

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