Aercap is currently facing one of its biggest crisis ever, along with the aviation sector. Investors are pricing the company at bankruptcy as its base case.
It is interesting to note that Aercap, like a phoenix, was born out of the ashes of the largest commercial aircraft sales and leasing company which collapse as a business in the 1990s. That company is an Irish company called Guinness Peat Aviation (GPA).
GPA plunged into crisis during the aviation downturn following the 1992 Gulf War. Here I would be exploring the downfall of GPA and whether there are any similarities that Aercap could be facing now.
The Rise and Fall of GPA
In the mid 1970s, Tony Ryan, then a mid-level executive from Ireland’s national airline Aer Lingus, had the idea of financing and operating planes for other airlines. It came to him when he found out how much money could be made after brokering a deal with Air Siam to lease a plan from Aer Lingus.
He founded GPA in 1975 and hired a team of ambitious young executives. These men traveled all over the world to match parked plane with expanding airlines. GPA became the world’s largest commercial aircraft lessor. They had shareholdings in various airlines like Air Canada and even companies like General Electric and Mitsubishi group. The company was valued at $4b at its peak,and churning profits at $265mil in the FY ending 31 Mar 92. Here was a super stock, growing at 25% a year.
Too Close To The Sun
In 1989, GPA placed an order for 308 aircrafts valued at about $17B. This is also the largest plane order ever.
GPA also set up a joint venture with CHC Helicopters called GPA Helicopters to acquire, own and lease helicopters worldwide.
That’s when everything started to fall apart.
By the 1990s, there were signs of major stresses in GPA’s business model. The aviation industry was on the cusp of a major recession due to the first Gulf War and other external economic factors at that time. In spite of this, Ryan gambled that GPA should continue to spend big on securing new aircraft to expand. The good times finally ended when GPA’s IPO failed as investors refused to buy shares. Unable to raise the capital required to fund its $17B purchase, GPA plunged into crisis.
The company’s poor health of its balance sheet was the proximate cause of failure. The ultimate cause of failure is management. They took the risk to overload the balance sheet with no contingency plan.
What Were The Problems?
Excess inventory of questionable quality
GPA grew too aggressively, purchased too many planes which most of them were not easily leased out.
“First we have ordered a huge number of aircraft – too many. Some types will not be leased easily. The md-80 series in particular concern me. These are old technology aircraft which barely meet the current noise regulations and there is only a small customer base worldwide for these aircraft.” – Excerpt from Crash Landing: An Inside Account of the Fall of GPA
When GPA holds too much inventory, they suffer losses from maintenance and parking fees etc, etc. Not to mention that planes are depreciating assets and every day spent mothballed at their hangars are considered as losses.
Uncollectible receivables & poor credit quality of customers
Many of the airline’s GPA leased planes to had poor credit quality.
Their rivals at that time, International Lease Finance Corporation (ILFC) in the United States, chose to only deal with credit worthy customers. But GPA accepted deals with airlines of all sizes all over the world. The history of corporate finance is littered with failed airlines. GPA prospered when times were good but suffered the consequences when a recession occurred.
Poor decision making due to aggressive expansion
Due to their thirst for more growth and to keep their planes in the air instead of hangars, GPA had to lease aircraft to increasingly unreliable airlines so as to maintain their top and bottom line. This meant that the risk of not getting payment is very high and their trade receivables became unreliable.
Financial Engineering at its best
While much of the press coverage at the time painted the collapse of GPA as a shocking plunge into crisis, it was actually a story of long-term decline. A lot of GPA staff and even the management loaded up with debt to buy stock. Some paid as high as 21% interest on loans to purchase stock. They believed that the shares would trade at a premium when they float it on the exchange and this would cover the interest and then some. So can you imagine what happens when the company experiences a downturn and a failed IPO at the same time?
They also found out that GPA’s stated cash and cash equivalents on their balance was not really their cash. The cash could not be used as liquidity or to redistribute to their shareholders. A large portion of the cash did not belong to them but to the airlines which they leased planes to.
“When GPA says today that it has $510 million in cash, $500 million of it is really the airlines maintenance money we are holding”. – Excerpt from Crash Landing: An Inside Account of the Fall of GPA
Is Aercap Any Better?
Aercap was formed after GPA went through a restructuring and selling part of its fleet to GECAS, a aircraft leasing division of General Electric. In a surprising turn of events, Aercap acquired its long-time rival ILFC after their parent company AIG was desperate to sell the aircraft leasing unit away. With the merger of the two inventors of the aircraft leasing business, has Aercap learnt anything from their past experience and be able to weather the current storm?
Well positioned for the future
Going into Aercap’s aircrafts, they are ordering the most fuel efficient aircrafts with the narrowbody planes taking up a majority part of their assets, including the Boeing 737 Max and Airbus 320Neo. Narrowbodies are much more liquid for lessors compared to widebodies. This is because widebodies require more effort to refurbish and modify when transferring from 1 airline to another.
From their latest presentation slides, they have already contracted 97% of their lease rents through 2022 so we have some visibility in their earnings. Going into this crisis, Aercap’s situation is slightly different from GPA as they are focusing on narrowbodies and new technology, aircrafts that are the most in-demand by the industry. If i might add, they are also lowering their fleet age by selling their mid-life planes in the secondary market.
Having a global platform
Aercap has a global platform formed by their 200 customers over 80 countries. This means that they have easy access to information about each and every transaction in the market. Just to give you a picture, they are able to lease out 1 aircraft every day and sell or buy an aircraft every 2 days. So at the end of they day, they are able to know which airlines want to lease, buy or sell in almost real time.
This reduces the risk of having assets that airlines do not want like what happened to GPA.
Management knows risk management
Aercap also has a very conservative risk management policy in place. They have written into their lease contracts strict lease payment schedules and has the right to repossess the assets if they misses the payments.
I have also mentioned in my previous post about Aercap’s balance sheet and how they can survive the year without any incoming cashflow (https://mopiglet.com/2020/04/16/aercap-nyseaer-drunk-as-hell-but-no-throwing-up/)
In 2016 when they had a light year for capital investment, the management paid down $1.4B of debt. This goes to show that they are serious in maintaining a relatively strong balance sheet.
GPA is a case of Icarus flying too close to the sun whereas Aercap is more of like his more conservative dad Daedalus.
The management’s direction has so far proved Aercap to be resilient. They have rode through several crisis with almost 100% utilization rates.
The trouble with GPA is that we are greedyChristopher Brown, Crash Landing: An Inside Account of the Fall of GPA
GPA’s fall was not due to the recession. The fact is that they risked everything without any contingency plan and then compounded that error (which we now know as fatal) with poor management decisions.
Aercap has many of the checks and balances that were brought to the industry after GPA’s implosion. This combined with the financial portfolio skills with the international reach and customer focus of the old GPA.
Even with those checks, the margin for error is still slim.
An accelerated slowdown in the economy like Covid-19 pandemic could still possibly upset the fine-tuned calculations in an industry that depends heavily on access to the cheapest possible financing.
Both GPA and ILFC succumbed to their own temptations. It is to maximize margins by borrowing short and laying themselves open to a liquidity crunch. Fast forward to today, I do not think that anything has changed that makes like more of less likely Aercap will fail. History should not repeat itself. However, the risk of a prolonged global shutdown could still be disastrous for Aercap.
The fact remains that it is ultimately liquidity that drives these aircraft lessors to the wall.
The Moss Piglet is vested in AER.