Merry Christmas, Ka-ching

As Santa said, if you’d like to make $100MM-$1000MMM or more than a billion dollars personally, like the Apollo guys detailed below, do the following:

The global aircraft leasing industry is mostly dedicated to new equipment. Only the larger companies, like GECAS with 1,970 aircraft, have substantial expertise in managing mature airframes and engines. Other than that, there are fewer than a dozen mostly American companies with substantial expertise in mature equipment leasing.

Some US-based mid-life aircraft lessors have scored high ROI’s on the aircraft they buy and lease. This is accomplished by a combination of higher lease rate factors, detailed technical management of the equipment, a substantial profit arbitrage opportunity on engines, and some creative financings.

Few Mature Equipment Lessors

There are a handful of companies specializing in mature aircraft leasing. One is in China, and it also leases new aircraft. Several are in the US, including Apollo Aviation, Castlelake, and Aergen. Each is a relatively young company, and has done well for its shareholders.

For example, Apollo has bought out all its common shareholders, leaving the two company founders with all the common stock and $5.6 billion in aircraft purchased over the company’s history. That company has just been sold to Carlyle Group by its two founders. Cargill-affiliated Castlelake has sometimes returned through its financings more than 100% of the equity deployed for aircraft acquisitions. The Aergen track record is similarly impressive.

Global Growth can Increase Mid-life Lessor Values

Aviation is entering a period where the need for mature equipment lessors will be higher, as aircraft need to be re-leased under increased technical and record-keeping supervision, and otherwise repositioned. Consider China alone, which is predicted to expand its airlines’ fleets 3.7x to over 11,000 planes in the next two decades. Many China lessors have 4-5 year old fleets and know little about equipment that can operate for a very long time. Air Force One, for example, is 35 years old.

A new high growth element: e-commerce

There is an important addendum today, and that is the new growth of e-commerce worldwide. Annual US growth is 15-20% but it is over 30% in India and currently 38% in China. This can create an additional boom for mature aircraft lessors.

Given such growth, Boeing forecasts a need for 2700 additional freighters in the next two decades, and 1700 of them will be freighters converted from mature passenger aircraft (P2F). This can create large additional profit opportunities for mature equipment lessors, often through the engines. On mature aircraft, engines can sometimes be half the equipment’s value, and profit arbitrage opportunities are not complicated to exploit for those who know what they are doing.

An additional growth factor is that the percentage of leased aircraft is over 40%, and this number has increased consistently since the industry was created in 1973.

Some Examples of High ROI

In an ABS offering, lessors such as Aergen, Apollo Aviation, and Castlelake offer debt securities to investors that can increase the leverage on selected equipment to around 85% of appraised value. The proceeds of the debt offerings are then used to return equity to investors that had been previously used to acquire the equipment. Since the borrowing base in the ABS deals is based on an average of three appraisals on the equipment, which can be above the actual prices paid for the aircraft, almost all of the equity used for equipment acquisitions can be refunded to investors in some cases. Also, only some of the aircraft under contract have typically been acquired on the effective date of the ABS, and so a portion of the committed equity remains unused, which can further increase ROI.

The ABS market is strong, and new offerings are announced every month. Out of the overall $237 billion ABS market in 2017, aircraft lessors accounted for 12 deals for $6.5 billion. Bankers brokering the ABS deals expect this to continue, as do credit rating firm Kroll (KRBA), Airfinance Journal, and some China experts.

In some following examples, we focus on financings, but ROI’s would be good without them as a result of higher lease rate factors, engine arbitrages, specialized equipment management techniques, as well as potential IPO or sale.

Castlelake. In 2018, Castlelake did a $911MM ABS financing for 36 aircraft, less than a year after their previous offering. Castlelake had only purchased 30% of the planes, so the equity that had been deployed was less than $140MM at 1:1 leverage. The financing was for 84% of the appraised value, so it could have approached the purchase price. The ROI on actual equity deployed at the time of Castlelake’s fifth ABS was thus over 100% on the equipment purchases, though not on the company itself, due to corporate SG&A as well as legal and financial expenses associated with asset acquisitions and ABS deal expenses. (Average equipment age was ten years in the financing.)

Apollo. In 2018, Apollo Aviation did a $442MM ABS financing, its fifth such transaction. Since the company’s founding, Apollo had raised over $1.5 billion in equity from US and international sources. Through these financings, Apollo has been able to refund external equity and the two founders now own all the common stock of the firm, which has acquired $5.6 billion in aircraft over time. Thus the ROI to the founders would appear to be over 100%. (Average equipment age was fourteen years in the financing.) In October 2018 Apollo announced its acquisition by Carlyle Group; financial terms were not disclosed.

Aergen. Aergen is the fourth leasing company created by Bob Genise and his team who have done over $23 billion in leases worldwide. The others are Boullioun Aviation Services in Seattle, S.A.L.E. with Singapore Airlines, and Dubai Aerospace Capital in the UAE. S.A.L.E. was founded in 1993 and is now owned by Bank of China. Less than two years after the company’s creation, Aergen did a $325MM financing transaction that returned to Private Equity firm Greenbriar much of the equity used to acquire 19 aircraft, as well as equity that had not yet been invested in aircraft acquisitions. (Average equipment age was thirteen years in that financing.)

An airframe and engine parts company can be valuable to MLL

As noted, lease rate factors for mature aircraft are typically higher than those of new equipment. This can create a more profitable company than a new equipment lessor, even though there are higher expenses, since more technical record-keeping, engineering, and other expenses are incurred. In that regard, we note that companies specializing in parts and engine trading, engine leasing, record keeping for MRO events, etc., can be a high value added proposition for a lessor. These include companies such as NTE Aviation, Willis Lease, and Aergen’s Avioserv subsidiary.

It is MLL’s plan to consider acquiring a small aircraft and engine aftermarket company similar to Avioserv, and, just as Aergen did, offer an equity stake but no cash to the owners. A small aftermarket company might have $30 million in sales and pre-tax profits of several million dollars, and MLL has some candidates identified.

We note that there can be an additional opportunity created by having an aftermarket engine and airframe parts trading and record-keeping company under MLL’s ownership. New equipment lessors often have little experience in managing airframes and engines over ten years old, and MLL will be able to offer advanced management techniques to the currently newer equipment lessors on a fee-for-services basis. These services may prove to be attractive to lessors in some of the fastest growing aviation markets, such as exist in Asia and elsewhere.

IPOs can create substantial value

Companies with average growth often have had EV/EBITDA ratios in the high single digits, and the growth companies have had multiples as high as 20x at certain times. Examples from the recent past include: Air Lease 9.3x, AerCap 8.2x, FLY 8.5x, Aircastle 8.3x, AVAP around 11x, BOC 11.2x, China Aircraft Leasing Group (CALC) 19.6x, Bohai 17.9x, etc. These figures have been subject to change of course depending on market conditions, and are not as favorable at this moment in the current market.

Some hypothetical numbers in a MLL IPO

Initial aircraft acquisition example: If MLL were to acquire for $500 million a package of 22 narrowbody and widebody aircraft from several leasing companies with an average age of 14 years, annual revenue could approximate $65MM. If MLL is leveraged 70% in senior debt, and the $350MM in debt has a 5% yield, that would be $17.5MM in interest expense. If MLL’s SG&A to manage the company were $10MM, and the aftermarket management company contributed an incremental $3MM, MLL’s pre-tax income would be around $40MM. Assuming $45MM PTI, a PE ratio of 15x PTI, and annual PTI was deployed to reduce debt, the $150MM in equity would have a return in year five of 2.7x, assuming zero growth in the business.

MLL’s growth of course will be managed to create a lessor of scale, such as Apollo and Castlelake have become, but it is useful to focus on the scenario above to generate some simple numbers. We note that using all free cash flow to reduce debt is inconsistent with an IPO scenario, and that we assumed a strong PE ratio, but under most scenarios the financial results are attractive.

Another way to realize ROI: Third Party Sale

Given the environment described in the sections above, in which the need for the skills and capabilities of a mature aircraft and engine manager and lessor will increase substantially, we believe that MLL could potentially be sold in within 5 years to a larger lessor in need of these capabilities for perhaps 10-15x EV/EBITDA, which would generate both high ROI and high MOIC to equity. There are a number of acquisitions in the last few years with the multiples we refer to.

Convert and lease freighters (P2F) for high ROI

P2F. FedEx grew from 7 to 700 aircraft over a period of decades. Now we are seeing global e-commerce giants like Amazon in the US and Brazil, JD.com, Google, Walmart in India, and Alibaba (with affiliates YTO, ZTO, etc) investing in this space. Thus new FedExes are being created at a much faster pace around the world, often to serve the 30% or higher annual e-commerce growth, and MLL can also take advantage of this global growth opportunity.

Creating and leasing P2F aircraft has special profit advantages, notably: (a) the revenue generating life of the aircraft can be increased by 15-20 years (FedEx has operated 35 year old freighters); and (b) depending on the return conditions on passenger aircraft that MLL acquires that are currently on lease to leading airlines, an attractive engine profit arbitrage can sometimes be created, since freighters fly a small fraction of the daily cycles (takeoffs and landings) of passenger aircraft. Apollo Aviation, which has bought out all third parties holding common stock, takes aggressive advantage of this arbitrage and has 30 engines on lease.

We note that MLL benefits in Asia from its relationships with HAECO and GAMECO in China, which can do many of the P2F conversions and can also function in a semi-marketing capacity with the future operators of converted freighters.

Merry Christmas! BTW, we understand that Jesus was hot on aircraft leasing too.

Leave a Reply