Aviation Will See More M&A and Consolidation

Approximately 50% of all aircraft are leased by airlines around the world. Airlines choose to lease aircraft instead of owning them directly because of many reasons including providing more flexibility in their operations and providing an off-balance sheet alternative to debt on the airlines’ balance sheets to finance the aircraft. Aircraft leasing also effectively cater to airlines’ short-term demand spikes. The penetration of leasing has grown significantly since the 1970s where only 0.5% of the global fleet were leased. Most aircraft lessors are financed themselves by banks or other financial institutions, with many of them headquartered in Ireland. The leading players in this industry include AerCap, GECAS, Air Lease Corporation, Avolon, among others.

The Chinese aircraft leasing industry got into high gear in 2007 when the central government allowed banks to set up leasing units. Currently, 13 of the Top 50 aircraft lessors are based in China, making China an important player in the global industry. The total number of aircraft owned by Chinese companies has reached more than 3,400 in this short time with even more on order.

While the aviation industry has suffered mightily from the Covid-19 pandemic, enthusiasm is growing among many players as vaccine rollouts continue to make progress across various markets. While underlying fundamentals of airlines are still weak, yesterday saw the announcement of the largest deal in the history of the aircraft leasing industry.

Aercap is acquiring GECAS (GE Capital Aviation Services) from General Electric in a $30 billion transaction consisting of $24 billion in cash, $1 billion in notes and 46% equity in the Aercap entity. This combination of the No. 1 and No. 2 market leaders (depending on the metric used: total portfolio value or number of aircraft) will create a new No. 1 based on market share, portfolio value and number of aircraft.

Along with the commercial aircraft portfolio and platform, Aercap is also acquiring the Milestone helicopter leasing company and engine leasing businesses of GECAS. The resultant company will have a bit more than 2,000 aircraft out of roughly 12,000 leased aircraft globally, or just less than 20% market share. Aercap’s acquisition is a story of increasing its overall size, finding additional economies of scale and increasing platform effects by enhancing utilization efficiencies. 

Prime roles of the players in the history of aircraft leasing 

They are both descendants of the same aircraft leasing firm, GPA (Guinness Peat Aviation), which along with ILFC (International Lease Finance Corporation) had been forerunners for the industry. GPA ended up selling a large part of its business in the early 1990s to GE Capital, and the remaining GPA entity was renamed and merged multiple times until it eventually became Aercap. Later, the Dublin-based company acquired ILFC from AIG after the financial crisis. 

The troubles at GE are already well-publicized with the continued downsizing and streamlining of its businesses by CEO Larry Culp. But while the leasing unt had been a capital user, it has also been a pillar of the industry and exceptionally well executed. GECAS has always been the gold standard of the industry despite its parent company’s issues. Aercap is a “self-made” company, created out of conflict, formed through multiple mergers and possessing a great deal of experience growing by acquisitions including through picking at the remains of ILFC, Waha Leasing, etc. and skillfully gaining its crown with strategies that were well-timed and innovative.

GE had shown an interest in selling earlier with previously reported negotiations with Apollo at a $40 billion valuation, but holding on for longer would not likely be to its advantage. The Covid overhang on the underlying airline industry and the size of the asset prevents many players from bidding, and values continue to adjust with up to 24 months of lag period, according to my research.

Similarly, the same dynamics are in play with Aercap as well, andit is very difficult to find significant portfolios for sale and usually for large premium. It can be argued that this is not as significant of a premium as other transactions, especially as no portfolios are perfect with significant mid-age wide-body aircraft exposure, among others. Aercap also had some trying moments with its operations, Norwegian and HNA being recent and ongoing issues for the company. So who is dominating the drive to merge? It seems that both are searching for each other.

When two large organizations merge, there will be obvious savings–operationally and financially.

GECAS has a larger footprint with 24 offices globally and about 600 staff, while Aercap has 9 offices with about 400 staff. Both have significant operating presence and staff in Ireland, what would this mean for employment?

The problem is thatwhen the businesses are virtual mirrors of each other, you may end up boxing your reflection. There is no need for two salespeople for the same airline customer and even if there is no overlap in airline customers this should still result in increased efficiencies. The same logic would apply to the technical department, which can probably absorb the additional aircraft without taking on all the incremental staff and perhaps risk management and other functions. This points to the economies of scale argument that Aercap has put forward. 

The merged entity will be bigger and the argument will be that it will have increased buying power with the OEMs–Boeing, Airbus, and the engine manufacturers. This will not go as far as some think as the original firms were already getting very competitive terms. Giving additional enhancement would also mean the OEMs will cede even more control of their order books to lessors (this trend has continued and increased significantly lately with more than 30% new orders going to lessors). In some instances, this would create another competitor to itself when selling new aircraft. Also, OEMs will want to maintain the level of competition with other investors.

From a financing perspective, being larger can provide more heft and support for capital market transactions as can be seen lately with ever-larger financings in the sector. It is a positive in this period as single-deal traditional banking markets have slowed down significantly, while capital markets are quite active and willing to find yield. But at the same time with larger sums, individual banks will more easily hit their individual credit concentration risk limits.   

Leasing aircraft is about relationships, and there is no doubt that both lessors have excellent and deep-rooted ties to their client base. In the past, if I were a client of both, I had probably played off one against the other. I love visiting my friends at Air France if only to see my competition exiting as I enter. Those savvy airlines may now be looking for an alternative stalking horse as they themselves will want more diversified sources of lessor funding. It does not necessarily follow that after the feast of merger that Goliath will be the only show in town.

Antitrust and competition laws can be a tricky issue as there are many regulators in many jurisdictions globally, and any one of them can hold up the show. There is always some uncertainty involved and this can be evident by the not yet totally complete gradual acceptance of the return of the 737 Max aircraft back into service by regulators.

There are many metrics to determine the concentration in the market. In this case, while it is a merger of the top 2 by market share, combining entities would have less than 20% market share as the rest of the market still has significant presence and fragmentation. Over the last 10 years, the top 10 lessors by value have increased threefold, it still has not reached the heavy concentration Herfindahl-Hirschman Index (HHI) limits as in other industries. Market share by itself should not be an impediment to completing the deal, but I wouldn’t be surprised if there are some divestment to show good faith to some global regulators.

This acquisition is ultimately good for both corporate parties, but not necessarily the staff at such a trying time in the industry. Given the major disruption of the status quo vis-a-vie the other competitors, this will accelerate mergers by other parties to bulk up. Not only the direct competitors, but airline customers will be stimulated to look at ways to increase their negotiating power along with increasing their efficiencies as they try to recover from the Covid demand shock effects.