Airfinance Annual

Airﬁnance Annual

2018/2019

www.airﬁnancejournal.com Contents

3 Editorial 80 Airasia portfolios help FLY transition to new- technology aircraft

4 Contents 82 A cradle of Chinese civil aviation?

6 DVB: Industry review and outlook 84 Narrowbody trading buoyant: Fleet Tracker

32 Alton Aviation: Untangling the growing web of aircraft transactions and values 86 How will AFIC impact the market?

45 Zeevo: Delivering inance integration success 88 Airbus to hit market with Balthazar through lawless execution: strategic value of IT in M&As 89 Airbus backing will boost CSeries 54 GECAS: What’s on the mind of GECAS’s leaders? 91 Chinese lessors opt for Jolcos 60 KPMG: Cyber resilience – prepare, withstand and recover 94 Returns forge ahead

Arthur Cox: Jolco rides the wave 64 96 High-tech takes over

67 Tyabji Dayabhai: Aviation in India – a constant 98 Manufacturers continue to open new markets change

101 Airﬁnance Journal’s 2017 Deals of the Year 69 IBA: Redeliveries – the picture in 2018 Awards

75 Chorus Aviation Capital: Delivering creative regional aviation inance solutions to the world 107 Directory

Editor Greater China reporter Managing director, Directors: John Botts (Chairman), Andrew Jack Dutton 管沁雨 (GUAN Qinyu); Elsie Guan The Airline Analyst Rashbass (CEO), Sir Patrick Sergeant, The +44 (0)207 779 8734 +852 2842 6918 Mike Duf Viscount Rothermere, Colin Jones, Paul [email protected] Zwillenberg, David Pritchard, Andrew Ballingal, [email protected] +44 (0)207 779 8058 Tristan Hillgarth [email protected] Asia inance editor Head of subscription sales Printed in the UK by Buxton Press, Buxton, Michael Allen Derbyshire. Chris Welding Divisional director +852 2842 6941 T: +44 (0)207 779 8015 Danny Williams No part of this magazine can be reproduced [email protected] without the written permission of the Publisher. [email protected] Production editor The Airﬁnance Journal Ltd. Registered in the Consulting editor Tim Huxford United Kingdom 1432333 (ISSN 0143-2257). Geof Hearn Account manager Airﬁnance Journal (USPS No: 022-554) is a full Oliver Goodwin Subscriptions / Conferences Hotline service business website and e-news facility with Managing director T: +44 (0)207 779 8868 +44 (0)207 779 8999 / printed supplements for $3,565/€2,854/ £2,095* Laura Mueller E: [email protected] +1 212 224 3570 a year by Euromoney Institutional Investor PLC. +44 (0)207 779 8278 [email protected] (*£ and € prices are subject to VAT). [email protected] Publishers Although Euromoney Institutional Investor PLC Chris Gardner Customer Services has made every efort to ensure the accuracy of Managing director +44 (0)207 779 8231 +44 (0)207 779 8610. 8 Bouverie this publication, neither it nor any contributor can Olivier Bonnassies accept any legal responsibility for consequences [email protected] Street, London, EC4Y 8AX +44 (0)207 779 8062 that may arise from errors or omissions or any [email protected] opinions or advice given. Sam Fairburn This publication is not a substitute for speciic Group sub editor +44 (0)207 779 8257 professional advice on deals. ©Euromoney Peter Styles Wilson [email protected] Institutional Investor 2013

4 Airinance Annual • 2018/2019 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

Untangling the growing web of aircraft transactions and values There are many factors that inluence aircraft values, but these factors can be complex, says boutique advisory irm Alton Aviation Consultancy.

ll along the aviation value chain, occurrence of single-aircraft pure This trend of increased trading Aa wide range of participants is metal trades, as well as conidentiality of assets with attached leases revelling in the sustained favourable and opaqueness in transaction prices, is expected to grow given the market conditions. This year is mean market value is an increasingly increasing proportion of the global expected to bring a record ninth elusive concept. leet inanced by lessors, now consecutive year of airline proits, and For diferent market participants, exceeding 40%. Therefore, published additional new investor interest in even the purpose of the valuation and blue book values are not suicient for aircraft as an asset class. intended use of the resulting igures valuing most types of transactions. As manufacturers churn out aircraft may difer. Another layer needs to be added; the at record rates, airlines and lessors For an airline, an accurate value associated with future income are buying and selling aircraft among valuation might be most pertinent for as determined by the lease. and between each other in increasing insight into residual value risk or for It is time that valuation practices numbers to curate what they perceive insurance purposes; for an investor, kept pace with the growing and to be their optimal portfolios. the income-generating ability of the evolving aircraft transaction market. In the secondary markets, the asset – the stream of cash lows that If more investment and new investors normal transaction has evolved; can be expected, and with what risk, are to continue to be attracted to the singleton trades of aircraft on is paramount to values. market and participate in a well- a standalone basis are few and Over the years, aircraft valuation informed capacity, then investors far between. With the increased practices have been primarily focused need to understand not only the proliferation of aircraft operating on metal values but as the market has appraised dollar value of the physical leasing, the majority of aircraft evolved, because few transactions asset, but also the upside and transactions – on a unit and value are straightforward metal single-asset downside risk of their investments. basis – now involve attached leases. trades, there may be an increasing This involves logical but rigorous The increasingly complex web of disconnect between these outright methodology; a wholistic approach transaction types and the decreasing values and the real world. that is the norm will make for more

About Alton Aviation Consultancy Alton Aviation Consultancy is a to operational improvement and industry executives and consultants, boutique advisory irm dedicated to implementation support. Clients Alton’s team is globally recognised serving the aviation and aerospace include airlines, original equipment for thought leadership, quantitative industries. manufacturers (OEMs), maintenance, analytics and innovative solution Our engagements span the repair and overhaul and other development. Alton’s professionals aviation and aerospace value chain service providers, lessors, lenders, highly value personal relationships to include commercial, inancial and and the broader inancial and and continuously strive to deliver technical aspects – from strategy investment community. individual attention and white-glove and business plan development Founded by seasoned aviation client service.

Laetitia Achille Enda Clarke Adam Cowburn managing director managing director managing director

John Mowry Adam Guthorn Isobel Fenton managing director director senior associate

32 Airinance Annual • 2018/2019 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

informed investors. Discussion on and understanding of lease encumbered Exhibit 1. Global airline net proﬁt margins, 2000-2018F valuations need to become as Source: Alton Aviation Consultancy analysis; Airlines for America; Iata industry statistics June 2018 prevalent in the market as lease Global Net Proit Margin trades. 6%

This multi-part paper provides: 4%

2% 1. An overall assessment of the industry; 0 2. Analyses observed trends in aircraft transactions over the past decade; (2.0%) and

3. Ofers perspective to investors as (4.0%) they consider how to best ascribe

value to today’s transactions. (6.0%)

2001 2010 2011 2012 2013 2014 2015 2016 2017 2000 2002 2003 2004 2005 2006 2007 2008 2009 2018F Part 1: The air transport and leasing industries have enjoyed periods of volatile and elevated fuel through the 1990s and accelerating favourable dynamics prices. through the 2000s. Today, aircraft Recent airline proitability contrasts Strong air traic demand growth has leasing accounts for about 40% of with historical trends. been driven by sustained expansion the commercial aircraft leet. Leasing Many industry participants question of global economic activity and an is a major source of inancing for whether the renaissance of airline increasing propensity to travel of the aircraft; lessors are likely to inance proitability has arrived: has there growing middle class, particularly in some 35% to 45% of the current order been a structural change in the emerging markets. backlog, including expected sale and industry that has formed a more stable Additionally, low-cost carriers (LCCs) leasebacks at delivery. foundation or are we just enjoying an have proliferated; enabled by their Leasing appeals to airline lessees above-average peak in the cycle? lower cost base to lure passengers and lessors with attractive but difering The optimists include those with lower fares than full-service characteristics on both sides. For the that may have a vested interest in competitors. LCCs have stimulated airline lessee, the of-balance-sheet believing the former, such as airlines new demand and driven down fares in proposition of an operating lease frees and enthusiastic airline industry the markets in which they operate. up capital while keeping leverage groups; the International Air Transport down and alleviates aircraft residual Association (Iata) director-general Leasing is booming, with appeal to value risk. It also allows lexibility and chief executive oicer declared: both lessors and lessees in aircraft acquisition timing and “Airlines are deining a new epoch in Aircraft leasing has evolved over the capacity management, enabling trial industry proitability”. But not everyone past decades from virtually non- of new aircraft and routes with lower is singing the same tune; some are existent in the 1970s, to gaining traction commitment. pointing to signs that the peak has passed, noting that, while still strong, 2018 proits are forecasted to be lower Exhibit 2. Changes in leased ﬂeet as a proportion of total than the preceding three years. While air traic growth over the years ﬂeet over time Source: Iata has more than kept pace with economic growth, there has not always been Units % of Total Fleet 16,000 60% such a correlation between economic Leased Aircraft 50% growth and airline proitability. However, 14,000 the challenging market conditions % of Total Fleet 50% 12,000 during and after the 2007-08 inancial 40% 35% 40% crisis forced airline discipline in mature 10,000 markets, particularly in terms of capacity 8,000 30% growth and cost management. Many 25% weak airlines undertook restructuring, 6,000 20% while others consolidated to make 15% a stronger combined entity, better 4,000 prepared for future turbulence. 10% 2,000 Continued replacement of older aircraft 2% with younger, more fuel-eicient aircraft 0 0% assisted airlines in managing through 1980 1990 2000 2010 2015 2020F

www.airﬁnancejournal.com 33 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

Lessors, on the other hand, enjoy a margin between the cost of capital Exhibit 3. Top 10 global lessors by estimated portfolio and the returns achieved through value, 2017 leasing, along with tax beneits. Bulk Source: Alton Aviation Consultancy analysis; Airfinance Journal Leasing Top 50, November 2017 purchasing helps the largest lessors Lessor Headquarters Owner Estimated Portfolio Fleet enjoy favourable pricing from OEMs Country Country Value ($ billion) Size while superior creditworthiness 1 AerCap Ireland USA $35.1 1,121 (frequently as a result of ailiation 2 GECAS USA, Ireland USA $28.3 1,271 with large, stable inancial institutions) provides large and established lessors 3 Avolon Ireland China $21.3 572 with low inancing costs. A mobile 4 BBAM USA Multiple $19.8 404 asset with a global customer base and 5 SMBC Aviation Capital Ireland Japan $17.4 437 often-large contractual future cash 6 BOC Aviation Singapore China $13.9 299 lows when a lease is attached makes 7 Air Lease Corporation USA USA $13.8 278 aircraft an appealing investment. 8 ICBC Leasing China China $11.8 250 Lessors pursue diferent strategies 9 DAE Capital UAE, Ireland UAE $11.7 334 with their portfolio proiles. Some 10 Aviation Capital Group USA USA $8.5 274 specialise in new or young aircraft, others in mid-life while some smaller lessors deal in niche categories, focusing on placing aircraft that are Exhibit 4.Top 10 versus other lessor fleet portfolio values Note: unless otherwise cited, fleet analysis is based on CAPA database. older, less liquid, or in less-active Source: Alton Aviation Consultancy analysis geographical markets. Leased Aircraft Value ($bn) Top 10 Share of Lessor Value Scale of the largest lessors increases, 350 60% but concentration does not 49% 300 47% 46% 50% Within the leasing industry, some 44% 43% 42% 41% 41% 41% 41% 42% 250 behemoths dominate. The two largest 40% – AerCap and GECAS – are leagues 200 Other ahead of their closest rivals, with leets 30% more than double that of the third- 150 Top 10 place holder, Avolon. Top 10 Share 20% 100 Lessors in Asia, particularly China, are relatively new capital 50 10% providers to the leasing industry. 0 0% Relaxed regulations a decade ago 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 by the China Banking Regulatory Commission cleared the path and China’s top banks promptly started followed by Avolon’s acquisition of CIT Part 2: Aircraft trading activity developing their capabilities and Aerospace and DAE’s acquisition of has grown in most market formed dedicated aircraft-leasing AWAS. segments divisions. They enjoy low cost of Despite the signiicant consolidation capital, increasingly so with size. that has taken place, the overall While OEMs are sellers and specialist Top lessors are enjoying economies share of the 10 largest lessors as a part-out companies are buyers in of scale and borrowing power to percentage of the total leased leet is the market, airlines and lessors (and achieve wide margins on very large not meaningfully diferent today than it equity investors behind lessors) are investments. According to Airfinance was ive year ago. both buyers and sellers. A web of Journal, the average cost of debt for More players have been attracted primary, secondary and tertiary aircraft some of the leading lessors has been to the space, enabled by high liquidity transactions take place between these about 4% to 4.5% in the past few and low interest rates and encouraged market participants: years, while some have achieved rates by the attractive returns the market as low as 2.5% to 3%. Return on equity leaders have achieved. They are • primary transactions are those achieved by the top lessors has been comforted by the backing of an involving new aircraft sales direct in the range of 9.5% to 10% over the underlying hard asset and returns that from the OEMs to airlines and past three years. have historically outperformed many lessors; Many of the largest lessors other asset classes and demonstrated • secondary transactions, between have achieved such scale through low volatility as well as low correlation airlines and lessors, are those aggressive acquisition on top of to broader market indices. Aircraft involving not only direct sales organic growth – AerCap’s acquisition liquidity has generally been viewed as between the parties, but also sale of ILFC completed in 2014 remains positive for the most common aircraft and leasebacks between airlines the largest in the industry, and was types. and lessors (both new and used

34 Airinance Annual • 2018/2019 OBJECTIVE. COLLABORATIVE. GLOBAL.

Clients rely on Alton to provide by data-driven guidance and insight to better inform their business strategies, allocate capital, and manage risk. Our aircraft-related advisory services include:

• Market research and analysis • Aircraft ﬂeet selection and sourcing • Investment strategy and business planning • Commercial and technical due diligence • Financial investment analysis • Asset management and technical services • Cash ﬂow forecasting • Appraisals and valuations

AltonAviation.com NEW YORK | DUBLIN | HONG KONG | BEIJING | TOKYO

AIRCRAFT LEASING & FINANCING | AIRLINE | AVIATION & AEROSPACE INVESTMENT | BUSINESS & GENERAL AVIATION AEROSPACE MANUFACTURING & SUPPLY CHAIN | MRO & AFTERMARKET Aircraft transactions and values: ALTON AVIATION CONSULTANCy

aircraft) and sales with leases Exhibit 5. Aircraft transaction ecosystem attached between lessors; and Source: Alton Aviation Consultancy • tertiary transactions typically involve airlines and lessors selling to specialised part-out companies at the end of an aircraft’s life.

Overall transaction volumes have more than doubled over the past decade, amounting to more than $160 billion annually in the past few years, up from $84 billion in 2007. Primary market transactions have expanded with industry growth. In the primary market, the vast majority of the new aircraft sales by OEMs is directly to airlines, accounting for about 80% of the volume. Direct sales to aircraft lessors account for the remaining 20% of total delivery volume.

OEM sales to airlines The most common aircraft sale and purchase transactions is directly Exhibit 6. Aircraft transactions by market segment by between the manufacturer and the aircraft value end user, the airline. While airlines Source: Alton Aviation Consultancy analysis of all types do acquire aircraft from the OEMs, those that purchase Value of Transactions, $ Billions aircraft have a tendency to be $180 Tertiary, $ larger, well-capitalised airlines which $160 Secondary, $ primarily intend to keep aircraft $140 for the duration of the economic Primary, $ 63 60 61 55 $120 life, or airlines with strong growth 38 $100 36 aspirations or leet-replacement 35 $80 requirements, requiring the certainty 26 29 27 24 of securing aircraft capacity that $60 99 98 105 88 95 comes from a larger orderbook. With $40 81 67 57 57 63 61 increasing growth rates in terms of $20 volume and value, OEM deliveries to $0 airlines reached 1,298 units at a total 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 value of $83.4 billion in 2017. OEMs have enjoyed a non- concentrated airline customer base, with the largest 10 airline customers Exhibit 7. Primary market aircraft transactions by aircraft value accounting for just 30% of total Source: Alton Aviation Consultancy analysis airline delivery value over the past 10 years, led by Emirates Airline, Value of Transactions, $ Billions American Airlines and China Eastern $120 Airlines. OEM Lessor, $ $100 22 OEM Airline, $ 18 18 OEM sales to lessors 20 $80 16 While OEM direct sales to airlines 14 have nearly doubled, direct sales to $60 14 16 15 lessors have grown signiicantly as 15 14 83 well over the past decade. In 2017, $40 75 81 81 67 71 direct deliveries to lessors accounted 52 47 46 $20 42 43 for a volume of 401 aircraft at a value of $21.7 billion, an increase of more $0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 than 50% compared with a decade earlier, as measured by value.

36 Airinance Annual • 2018/2019 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

The lessor customer base has been signiicantly more concentrated than Exhibit 8. Distribution of OEM deliveries to airlines, by that of the airlines, with the largest 10 lessor customers accounting for more aircraft value, past 10 years than 70% of total lessor delivery value Note: includes new deliveries to acquired companies. Source: Alton Aviation Consultancy analysis for the OEMs, led by AerCap, GECAS Emirates 5% American 4% and BOC Aviation. China Eastern 3% The still substantial but lower Qatar 3% growth rates in sales to lessors may China Southern 3% be attributed to dynamics at both the OEMs and lessors. While recognising Air China 3% the value brought by lessors to Ryanair 3% the market, OEMs have sought to Lufthansa 2% manage the volume of the aircraft Cathay Paciic 2% orderbook held by lessors so as to Turkish 2% maintain aircraft availability for its end- user airline customers. OEMs have recognised the value in maintaining Others 70% direct relationships with their end users, not only for the manufacturer- customer relationship aspect but also to manage pricing across the totality of their orderbook, since Exhibit 9. Distribution of OEM deliveries to lessors, by large lessors can enjoy particularly strong bargaining power and place aircraft value, past 10 years speculative orders in bulk volumes. Note: includes new deliveries to acquired companies. For their part, savvy lessors, well Source: Alton Aviation Consultancy analysis aware of the transition underway in AerCap 17% the OEM production from current- Others 27% generation to next-generation aircraft, have had some hesitancy in acquiring the last-of-the-line models delivering in the past few years. Airlines with long anticipated hold periods for the GECAS 17% aircraft have been less concerned, particularly when ofered attractive NAC 2% pricing. ICBC 2% SMBC 3% Secondary trading has increased ACG 4% signiicantly in the past few years BOCA 8%

OEMs deliver new aircraft to airlines DAE 5% ALC 8% but have limited direct participation Avolon 7% in the secondary market, where the airlines and lessors transact among themselves. In this secondary market, the vast majority of transactions Exhibit 10. Secondary market transactions by aircraft value involve lessors and come with Source: Alton Aviation Consultancy analysis attached leases – ranging from sale Value of Transactions, $ Billions and leasebacks and portfolio sales to $70 mergers and acquisitions. $60 Outright Lease Attached 8 9 Among these secondary transactions, 14 the vast majority of trades have been $50 7 55 with a related lease agreement. 52 47 $40 48 4 5 Airline and lessor sale and $30 10 4 3 leasebacks 3 8 34 $20 30 25 25 New/young aircraft 24 $10 21 19 The volumes of new/young sale and leasebacks have accelerated $0 signiicantly since 2013, amounting 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

www.airﬁnancejournal.com 37 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

Lessors will sell aircraft as a means Exhibit 11. Secondary market lease attached transactions by of rebalancing their portfolio to aircraft value increase or decrease exposure to Source: Alton Aviation Consultancy analysis a certain credit or aircraft type, to

Value of Transactions, $ Billions manage their leet age, as well as $60 to demonstrate the appropriateness of their depreciation policies. SMBC Lessor Lessor $50 Aviation Capital, in adhering to its Airline Lessor(Used SLB) young, modern leet strategy, sold Airline Lessor (New SLB) 29 22 $40 14 a 20-narrowbody aircraft portfolio 25 to Aircastle in 2017 as the aircraft $30 7 7 passed a target age threshold. 2 4 10 3 Aircastle sought value from 8 5 3 $20 6 3 1 1 2 diversifying its leet mix, particularly 2 3 3 3 25 25 with the geographical diversity of 13 20 23 $10 17 25 20 of those aircraft and their leases in 16 15 16 14 place. $0 Some lessors have raised 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 dedicated funds to focus on aircraft- leasing opportunities, frequently to 295 aircraft valued at nearly $20 residual value risk or leet capacity. acquiring assets from a range of billion in 2017. They have become an The well-publicised transaction other lessors, and then eiciently increasingly popular means for airlines between Easyjet and Aircastle for 10 inancing them through asset-backed to inance their leet acquisitions. For Airbus A319s (about 12 years average securitisation vehicles. Apollo large airlines with strong bargaining age) in a rolling sale-and-leaseback Aviation Group, which specialises power, signiicant gains on the plan as an exit strategy for the leet in mid-life, in-production aircraft, purchase price can be made through is representative of these types of acquired 59 aircraft in 2017 from sale and leasebacks while using the transactions. other lessors such as AerCap, Orix transaction as a method of inancing, Aviation and Incline Aircraft Holding – releasing equity and removing the Lessor-to-lessor lease-attached all with leases attached – for a gross asset from the airline’s balance sheet. transactions purchase price of $965 million. Sale and leasebacks free liquidity Sales between lessors have seen Year-to-year luctuations in overall for an airline’s operational needs so the most notable growth in recent trading are principally the result sale-and-leaseback activity can be years, a relection of increased of the timing of large portfolio seen to rise in cyclical downturns or liquidity, trading and also merger and transactions. There was a spike in invoked by individual airlines sufering acquisition activity. In 2017, 844 aircraft activity in 2014 as a result of AerCap’s challenging conditions and tight with leases attached, valued at $25.1 acquisition of ILFC while, in 2016, liquidity. The transactions have been billion, were sold between lessors. Avolon’s acquisition of CIT drove attractive to lessors also given the Those sales occur often as a higher volumes, followed by DAE’s predetermined customer and terms, result of lessors’ portfolio strategies. acquisition of AWAS in 2017. compared with the speculative risk of an unplaced orderbook. Exhibit 12. Secondary market outright transactions by aircraft Used aircraft value Sale and leasebacks are primarily Source: Alton Aviation Consultancy analysis undertaken for new or young aircraft. Value of Transactions, $ Billions Of the transaction types examined, $16 the volume of used aircraft sale and Airline Lessor, $ $14 leasebacks has shown the most Lessor Lessor, $ 1 Lessor Airline, $ volatility over the past decade, albeit $12 of a relatively low baseline. In 2017, Airline Airline, $ 2 these transactions totalled 65 aircraft $10 1 2 at a value of $3.2 billion. 1 1 $8 The sale and leasebacks of a 1 0 0 1 1 1 2 used or older aircraft is complex and $6 1 1 unique. It is not only a function of the 1 8 5 $4 7 1 1 2 aircraft’s age but also of its condition 1 4 1 0 1 1 5 1 1 1 and the negotiated lease terms, such $2 1 0 1 3 3 as maintenance reserves. These 0 2 2 2 2 1 1 transactions are primarily undertaken $0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 by airlines wishing to manage their

38 Airinance Annual • 2018/2019 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

Few outright transactions in secondary market Exhibit 13. Tertiary market aircraft transactions by aircraft value The volume of aircraft transactions Source: Alton Aviation Consultancy analysis in the secondary market sold on an outright basis is substantially lower Value of Transactions, $ Billions than those sold with leases attached. $1.6 Lessor Partout, $ These transactions involve airlines and $1.4 lessors acting as buyers and sellers, Airline Partout, $ with no particularly type of transaction $1.2 dominating. $1.0 0.6 1.0 $0.8 Airline-to-airline transactions 0.9

Transaction volumes between $0.6 0.4 0.5 airlines are volatile and seemingly 0.5 0.6 $0.4 0.1 uncorrelated to the industry cycle, 0.3 0.4 0.6 with signiicant bumps coming in years $0.2 0.1 0.4 0.4 0.3 0.3 0.3 0.2 where large mergers and acquisitions 0.2 0.2 0.1 0.1 $0.0 have closed. In 2017, just 225 such 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 transactions were recorded, at a value of only $2.7 billion, with a low average value indicative of the older age of strong air traic demand, low to of which were to exit by the end of proile of the aircraft involved. moderate fuel prices, and sustained that year and the other half in 2018. Airlines may wish to oload a inancial proitability, carriers such as Azul is in the process of up-gauging to certain aircraft or model not aligned Delta Air Lines, Southwest Airlines larger next-generation aircraft, while with future leet and network plans. and United Airlines have found used the lessor had plans to remarket the In many instances, aircraft lown by aircraft attractive. As a result, they aircraft to new lessees, amid strong carriers in developed markets have a have acquired used assets from other demand for the type. preference for younger aircraft, and airlines and lessors. sell to carriers in emerging markets Retirements/part-outs in the tertiary where the aircraft still has signiicant Lessor-to-lessor outright transactions market have declined operational life remaining. While total trading activity between A part-out is an end-of life sale in Some airlines have employed this lessors has grown in recent years, the which the usable, saleable parts as a primary leet-acquisition strategy. volume of outright sales (without lease are extracted from an aircraft. It is Until 2016, Allegiant Air exclusively attached) have been limited to about conducted when the disassembly will purchased used aircraft (initially $1 billion a year. Many lessors perceive yield more value than the aircraft as a ageing McDonnell Douglas MD80s the sale of an aircraft without a lease whole. These end-of-life transactions and subsequently Airbus A320s) from attached as being a type of distress can be conducted in two ways: other airlines and thereby built its leet sale given the uncertainty around the outright sale, where the aircraft is sold opportunistically as these came on the timing of future lease rentals income whole (or as whole airframe and whole market. In contrast, Air Berlin’s aircraft and the credit of the next lessee. engines) – it will then be dismantled were sold recently under bankruptcy by the purchasing parts-trading conditions with speculation that one Airline-to-lessor outright transactions specialist; or by consignment sale, in of the largest purchasers, Lufthansa, Secondary market transactions on an which the seller maintains ownership achieved favourable pricing on the deal. outright basis from airlines to lessors of the asset but consigns it to the are small. In 2017, the 39 aircraft parts-trading specialist. Lessor-to-airline outright transactions transactions accountant for $545 Part-out transaction levels vary year Aircraft sales from lessors to airlines million. to year, driven over the medium term have historically been limited, but Lessors may opportunistically by leet demographics but, in the short volumes have increased recently. purchase older aircraft from airlines term, aircraft supply-and-demand In 2016, lessors sold 285 aircraft to when it no longer its with the airline’s balance, fuel prices and underlying airlines, at transaction values of about leet strategy and they do not want demand for aircraft components are $5 billion but the following year’s 194 the residual value exposure. Because the drivers. Both airlines and lessors sales, valued at $2.5 billion, shows the of their signiicant sales and marketing sell aircraft for part-out: in 2017, volatility of these transactions. reach, lessors will most frequently airlines sold 101 aircraft, valued at The rationale for such trades acquire these aircraft when they have almost $128 million, while lessors sold are broad and can include airlines lined up a downstream lessee, or have 174 aircraft at an estimated value of exercising their purchase option as a high degree of conviction on their more than $600 million. part of Japanese operating leases with ability to secure attractive lease terms. Strong growth in this market was call options (Jolcos), as well as airlines Lessor Nordic Aviation Capital observed between 2008 and 2015, but and lessors agreeing to lease buy- purchased 10 ATR72-600s from Azul volumes have fallen signiicantly in the outs. Moreover, in the environment Linhas Aereas in October 2017, half past few years amid a strong aircraft

www.airﬁnancejournal.com 39 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

demand environment. While this strong Most traded Airbus A320-200 (single lessee) demand has been good for the overall Source: Alton Aviation Consultancy analysis industry, participants in the end-of- Years Status Operator Owner Transaction life segment have noted challenges Delivered; sold with lease sourcing assets at attractive prices. 1996-1998 On order N/A GECAS attached Part-outs have historically been Pegasus Capital Sold with lease attached undertaken at retirement age but 1998-2006 In service China Eastern Corporation (M&A) there has also been an increasing 2007-2011 In service China Eastern AWAS Sold with lease attached trend of parting out some younger, 2012-2013 In service China Eastern Aircastle Sold with lease attached mid-life aircraft. In these cases, the Arena Aviation demand for parts is high, with their 2014-2015 In service China Eastern Sold with lease attached Capital value as parts being greater than the 2015 Retired N/A AerFin Sold prospect of their continued operation and maintenance expenses in the context of the expected residual value of the aircraft. As an example, CAPA’s Most traded Boeing 737-800 (multiple lessees) leet database reports that AerFin Source: Alton Aviation Consultancy analysis purchased two Boeing 737-800s of Years Status Operator Owner Transaction about only 17 years old from another lessor, Investec’s Global Aircraft Fund, 1996-1999 On order N/A Itochu Airlease Delivered; leased which it then retired and presumably 1999-2002 In service Air Europa Itochu Airlease Sold with lease attached dismantled for their components. Lombard Global Sold with lease attached 2002-2003 In service Air Europa Finance Co (M&A) SMBC Aviation Part 3: Today’s trading 2004-2006 In service Air Europa Sold with lease attached Capital marketing has signiicant Baker & Spice 2006-2010 In service Air Europa Sold with lease attached implications for valuations and Aviation investors Leased; sold with lease 2010-2014 In service Jet2.com Fly Leasing attached Comparable outright aircraft Element transactions are limited 2015-present In service Jet2.com Financial Sold with lease attached Corporation While the market has grown substantially over the past decade,

Exhibit 14. Average annual primary/secondary transaction volume by unit, 2013-2017 Source: Alton Aviation Consultancy analysis

Primary Transactions: 1,603 Secondary Transactions: 1,650

OEM Lessor, 362

Lessor Lessor, 688

Secondary, 1,650 Airline Lessor (New

Leases Attached, 1,144 SLB), 366 OEM Airline, 1,240

Airline Lessor (Used SLB), 90

Airline Airline, 198

Lessor Airline, 186

Outright, 506 Lessor Lessor, 82

Airline Lessor, 40

40 Airinance Annual • 2018/2019 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

reasons may also come into play, Exhibit 15. Past ﬁve years average secondary market outright such as gaining an established airline transactions by age, 0-20 as a new customer whose existing Source: Alton Aviation Consultancy analysis leet is entirely (or mostly) comprised of a competitor’s aircraft. Conversely, Number of Outright Trades OEMs may be less incentivised 50 to sharpen their pencils for some 16-20 45 customers that exclusively operate 11-15 their aircraft, taking advantage of 40 6-10 the high switching costs for training, 35 0-5 inventories and ground-support 30 equipment. 25 Outright transactions in the 20 secondary market would seem to 15 align most closely with the Istat deinition of market value, and Alton’s 10 research suggests that an average of 5 just more than 500 such transactions 0 have been recorded over the past A320-200 A330-300 ive years. While this may appear to be a it has evolved such that few adjustments for speciication, healthy volume of activity, when transactions are well-represented escalation and credits attracted by considered for an individual aircraft by the criteria associated with volume purchasing power, as well model and across a wide range of the deinition of current (or fair) as intangibles such as perceived aircraft ages, the limits can be seen. market value, as established strategic value to the OEM at the time For the most liquid narrowbody by the International Society of of the order – frequently years in aircraft with the largest leet in Transport Aircraft Trading (Istat), the advance of delivery. service, the Airbus A320-200 model, organisation that accredits appraisers The beneit of pricing opaqueness an average of just 17 aircraft aged in the aircraft leasing and inancing can be debated, and certainly between six to 10 years old, has industry, including one author of this diferent participants take diferent traded on an outright basis without article. views. For the OEMs, opaqueness leases attached over the past ive Istat deines the market value allows for price discrimination across years. For the A330-300, one of as the appraiser’s opinion of the customers, while for customers, those the most liquid medium twin-aisle most likely trading price that may with signiicant bargaining power aircraft, an average of just two be generated for an asset under are able to secure prices lower than aircraft has traded over the past ive the market circumstances that are what the OEM would publish, thereby years. Such paucity of transactions perceived to exist at the time in setting a low-price precedent. does not provide a statistically question. Market value assumes It is not only the largest orders that signiicant number of comparables for that the asset is valued for its attract the best prices – strategic valuations. highest, best use, that the parties to the hypothetical sale transaction are willing, able, prudent and Exhibit 16. Distribution knowledgeable, and under no of secondary market unusual pressure for a prompt sale, transaction values Outright and that the transaction would (ﬁve-year average) 15% be negotiated in an open and unrestricted market on an arm’s- length basis, for cash or equivalent consideration, and given an adequate amount of time for efective exposure to prospective buyers. $55bn In the primary market, OEM sales to airlines and lessors almost always involve multiple aircraft and, for a variety of reasons, the transaction price is not commensurate with Lease Attached the market value. The aircraft are 85% very rarely purchased from the manufacturer in single quantity Source: Alton Aviation Consultancy analysis and the net price paid relects

www.airﬁnancejournal.com 41 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

On a value basis, those secondary transactions with leases attached, Exhibit 17. Representative valuations, eight-year old Boeing were over ive-fold the value at 737-900ER $47 billion compared with those Source: Alton Aviation Consultancy analysis unencumbered at $8.3 billion. Given the high proportion of Metal current market values Lease encumbered value transactions with leases attached, @ $26.2m-$33.7m @ {7%} Discount rate = $30.2m traditional metal valuations are $m $m insuicient to assess the majority of $40 $25 today’s aircraft transactions. Half-Life Maintenance Adjustment from Half-Life Maintenance Adjusted $35 Half-Life Residual Value Full-Life $20 Transaction data is elusive and Transition Costs $30 challenging to normalise Maintenance Cash Flow $15 Perhaps even more impactful than $25 Security Deposit the sparse volume of comparable transactions, the transaction $20 $10 Rent conidentiality culture within aviation $15 inance creates opaqueness. The $5 market consists of a low volume of $10 directly comparable transactions $0 $5 compared with selected other asset classes with a high proportion of $0 -$5 conidential transactions. There is 2018 2018 2019 2020 2021 2022 low incentive to share and publish trading prices and an inherent conlict of interest in appraisers providing In other instances, the willing acquisitions transactions, value may transparency of methodology out of sellers will have experienced inancial be allocated to the current leet of protection of intellectual property. or other pressures prompting the aircraft, an orderbook and the leasing Even if these transactions had sale. Others will have been part of platform. perfect visibility in terms of trading small portfolio sales, making it hard to In sale and leasebacks and lessor prices, other limitations in normalising ascribe market value to an individual trades – both in the primary market those would still exist. Some of these aircraft or the discount for volume. for new aircraft and secondary market trades would not be considered at Normalising the prices based on for older aircraft – the very nature arm’s-length but between related maintenance status to a theoretical of the lease-attached transaction parties (such as within an airline half-life condition adds additional makes it challenging to discern true group). variables. In lessor mergers and market value. In these transactions,

Exhibit 18. Components of lease encumbered valuation Source: Alton Aviation Consultancy analysis

• rental income is contracted between the lessor and lessee for initial lease; and Lease rentals • depending on the aircraft, lessee, and lease terms, an extension or re-lease may be considered most likely.

Security • a cash security deposit may be required of the lessee; and deposits • Modelled as a cash inﬂow to the lessor at beginning of the lease and outﬂow at the end of the lease.

Maintenance • typically monthly reserve payments for weaker credits to protect lessor from maintenance exposure in the event of default; and cash lows • stronger credit lessees are frequently able to secure terms requiring end-of-lease payment in lieu of monthly reserves.

• transition costs reflect an expectation of at least one other lease in the aircraft’s economic life – as such, between leases, downtime Transition and cost will be incurred; and costs • assumptions made to estimate – varies depending on aircraft specification, lease return conditions and future lessee aircraft specification requirements.

Residual • the projected value of the asset at the time of sale; • sale may be assumed at the end of the lease, at the end of an extended or follow-on lease – or as a lease encumbered asset; and values • inﬂation and haircuts may be utilised for sensitivity and conservatism.

Discount rates • discount rates should be a function of both asset and credit risk; and • the rates are applied to the relevant cash ﬂows to determine the net present value.

42 Airinance Annual • 2018/2019 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

Exhibit 19. Maintenance-related lease cash ﬂow terms Source: Alton Aviation Consultancy analysis

LEASE CONTRACTUAL TERMS

Maintenance Financial Compensation Compliance Minimum Return Conditions Requirements (Major Components)

Maintenance End-of-Lease Reserves (MR) Adjustments (EOL)

and others where the lease is sold Understanding cash inlows and industry methodology but LEV is attached to the aircraft, the price outlows over the lease duration is calculated using an income valuation paid is not purely a measure of the critical approach covering at a minimum the asset’s intrinsic value but also of its While typical metal valuations quantify components in Exhibit 18. future income-generating ability to the half-life current market value of an The LEV is determined by irst the buyer. aircraft adjusted for its maintenance projecting each of the forward On these trades, a wide range of status, the lease encumbered cash lows (lease rental revenues, factors comes into play, including valuation (LEV) considers the maintenance cash lows, security the seller’s acquisition price or projected cash lows and determines deposits, transition costs and the book value, credit and jurisdiction the aircraft value based on the estimated proceeds that would be risk proile, lease duration, aircraft income earning potential during the generated from the asset’s sale). coniguration, maintenance provisions lease and from the residual value. Then, discounting these cash lows in the lease (including reserves or Valuation diferences are represented at an appropriate discount rate that end-of-lease payments), anticipated in Exhibit 17. is relective of the cost of capital, transition costs, expected residual The representative cash-low riskiness of the asset, and credit values and lessor capital costs/return projections illustrate what is expected quality of the lessees, as described hurdles. over the term of the lease (from the below. owner/lessor prospective). In the case Additional transaction data and where the lessee pays maintenance Lease rental cash lows are not pricing knowledge beneicial reserves, the cash lows throughout guaranteed All of these factors that inluence the term of the lease include not only While lease rates are contractually pricing are under constant evaluation rents but also maintenance reserves agreed by the lessee and the lessor by those in origination, pricing and payments/end-of-lease maintenance prior to the start of the lease (typically trading roles at the leading aircraft compensation adjustments. At the as a ixed monthly amount for the lessors – informed by live deals won end of the lease, the half-life residual duration of the lease), some variation and lost. value is claimed and supplemented does exist such as quarterly payments While access to underlying by the maintenance adjustment from and loating or stepped rents. transaction information remains half-life (which could be positive or It should be noted that cash-low a challenge for those not actively negative), and the security deposit forecasts are the best estimate of the trading in the market, some of the is returned. Transition costs should future at that point in time, but during factors inluencing aircraft values also be considered as part of any the term of the lease, it is entirely along with aircraft leasing and expected onward usage of the possible that unforeseen events will inancing economics are also not well aircraft. take place that will have an impact understood by all participants in the on the subsequent cash lows. For sector. Lease encumbered values depend example, if an aircraft is returned from In an industry environment that on interconnected cash lows lease early, this will not only have an may be closer to a cyclical peak Lease encumbered valuations are impact on transition costs, but also than trough, astute investors must increasingly relevant and used by future lease revenues, which are a develop a deep understanding of the lessor community for pricing, but function of market conditions at the the myriad of valuation deinitions, requires a signiicantly more complex time. Some lessees, when faced methodologies and underlying cash approach than traditional metal with challenges, seek to renegotiate lows driving value. valuations. There is not one standard commercial terms of the lease,

www.airﬁnancejournal.com 43 Aircraft transactions and values: ALTON AVIATION CONSULTANCy

leaving lessors with a decision about after a qualifying maintenance event, have corresponding maintenance whether it is best to acquiesce or wherein the asset is returned to reinvestment outlows. potentially incur costs and transition full-life condition. In all instances, the the aircraft to a new home. aircraft owner is fully protected. Transition costs are often a Furthermore, after the contractual From a lessor’s perspective, neglected factor lease expiry, assumptions need to maximising maintenance cash Aside from the aircraft being sold be made regarding lease extension, lows features more prominently at the end of the lease, another aircraft sale or re-lease and the terms as the aircraft ages, with astute alternative is an assumed re-lease. and timing. These are also functions lessors becoming signiicantly more While the costs associated with this of market conditions. actively involved in maintenance transition should be considered, their Net sales proceeds, the ultimate events, which potentially quality for forecasting requires assumptions. cash low, are likewise subject to risk maintenance reserve drawdowns. In Transition cost assumptions should The proceeds from sales depend many instances, lessors try actively capture the following elements, on a wide range of factors. The supply to negotiate such reimbursements, based on the precise speciication and demand dynamics for the aircraft and try to identify other creative of the aircraft, its minimum return type as well as that for the speciic solutions to avoid. conditions and the standard generally model at the time of disposition anticipated in the market: are a major factor. Additionally, the End-of-life adjustments condition of the speciic aircraft (age, Another mechanism through which Maintenance speciications, maintenance status, the lessor can be compensated for • bridging maintenance programmes; records and pedigree), as well as the maintenance value deterioration and efectiveness of the sales campaign, is end-of-lease adjustments. In the • airworthiness directive compliance. will have an impact on the proceeds event that a lessee does not pay Reconiguration realised. reserves throughout the course • interior and seats, galleys, toilets, From a forecasting perspective, of the lease, a compensation in-light entertainment, soft goods. one or more valuation methods may adjustment is instead enacted at the be utilised: end of the lease. This equals to the Upgrades delta in the maintenance condition • engine thrust; and operating weights • top-down approach, whereby of the asset versus its lease delivery • reference values are utilised with status. Remarketing expenditures. adjustments made for maintenance For end-of-lease paying assets, the and conservatism; lessor bears the risk of maintenance • bottom-up forecast that considers exposure over the course of the the green-time of major lease and in the event of a default. Conclusion components and part-out values; This is typically extended either The typical aircraft life is 25 and to strong airline credits, or to years. During that period, many a lease encumbered value, wherein competitive markets for new assets, • transactions typically take the aircraft is assumed to be sold where the risk of default is lower. place and many factors can with a lease attached. Lessees can procure a letter-of- inluence the aircraft values credit from a third-party institution along the way. Investors must Maintenance-related lease cash providing a backstop to the lessor be extremely cognizant of how lows are a major driver of value against a potential default, thereby they value each transaction. Leases specify maintenance giving the lessor inancial security to Published blue book appraisal compliance requirements during waive the maintenance reserves. data such as full-life/half-life the lease, and minimum return Generally, the net positive base, current market and soft conditions by which the lessee must maintenance cash lows generated market values are data points abide while inancial compensation by a leased aircraft over its life only of the metal, and somewhat for the maintenance deterioration compensate for the asset’s value simplistic data points at that. of the major components is made deterioration through its use, rather As new investors continue either through maintenance reserve than providing extraordinary income to expand into the market, payments throughout the lease to the lessor. participating in a well-informed term or an end-of-lease adjustment. When aircraft are young, lessors capacity increasingly requires Typically, less creditworthy airlines anticipate utilising the accumulated developing a sophisticated are obliged to pay reserves maintenance cash lows to reinvest understanding of the total value throughout the lease for the in the aircraft through heavy of the transaction including the protection of the lessor’s exposure to maintenance. Aircraft (and their lease, not only the appraised the maintenance value deterioration. components) approaching the end dollar value of the physical If there is no default and the of their useful life are frequently asset. lessee adequately maintains the retired and parted-out rather than asset, the reserves are reimbursed restored, such that lessors do not

44 Airinance Annual • 2018/2019 OBJECTIVE. COLLABORATIVE. GLOBAL.

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