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Analysis – AerCap and ILFC Merge Amidst the Specter of an Aircraft Orders Bubble

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Analysis – AerCap and ILFC Merge Amidst the Specter of an Aircraft Orders Bubble

Analysis – AerCap and ILFC Merge Amidst the Specter of an Aircraft Orders Bubble
May 19
14:13 2014

MIAMI — Aircraft lessor AerCap Holdings completed a $7.6 billion purchase of International Lease Finance Corporation (ILFC) from American International Group (AIG) late last week. The deal created the world’s second largest aircraft lessor (and largest independent one) by both fleet size and fleet value.

ILFC is best known as the brain child of founder Steven Udvar-Hazy, who was one of the first innovators in building the aircraft-leasing business model that is so prevalent across the world today. Mr. Udvar-Hazy ran ILFC from 1973 to 2010 (serving as CEO when the business was owned by AIG from 1990-2010). In 2010 however, Udvar-Hazy retired from ILFC in a dispute with the financially troubled AIG, then almost immediately founded Air Lease Corporation, which has become a large player in aircraft leasing in its own right. In 2013, Air Lease was the world’s ninth largest lessor by fleet value and thirteenth by fleet size (with a portfolio of 151 aircraft worth $5.62 billion).

AIG had initially planned to sell a 90% stake in ILFC to a consortium of Chinese companies, but that deal fell apart in August 2013 and the deal with AerCap was announced soon after on December 16th.

The $7,6 billion deal was split between $3 billion in cash and 97.6 million shares of AerCap. This cash net of some intercompany loans and proceeds from the sale of AerCap stock will be used to help repay a portion of AIG’s $182 billion bailout from the federal government in the wake of the 2008-9 financial crisis.

The combined company will have a combined fleet of close to 1,400 aircraft worth more than $35 billion. At the time the merger was first proposed, the combined fleet included the following aircraft.

  • 147x Airbus A319
  • 252x Airbus A320
  • 94x Airbus A321
  • 124x Airbus A330
  • 293x Boeing 737NG
  • 51x Boeing 767
  • 2x Embraer E170
  • 33x Boeing 737 Classic
  • 14x Boeing 747
  • 71x Boeing 777
  • 37x Boeing 757
  • 3x McDonnell Douglas MD-11
  • 2x Airbus A300
  • 1x Airbus A310
  • 27x Airbus A340
  • 4x Bombardier CRJ-900

Additionally, the combined lessor had the following order book of aircraft:

  • 54x Boeing 737NG
  • 77x Boeing 787
  • 2x A320ceo
  • 155x A320neo
  • 15x A321ceo
  • 3x A330
  • 29x A350
  • 25x Embraer E190
  • 25x Embraer E195

On a pro-forma (combined basis), AerCap projects to earn annual revenue of $5 billion and and annual run-rate net profit of $1 billion ($4.00+ per share). The biggest financial challenge for the combined company will be its debt load of nearly $31 billion. Indeed, interest payments were a major driver behind ILFC’s slide to a net loss in 2013 after two consecutive year’s of profitability. However, the company’s mix of secured versus unsecured debt is strong, at roughly a 40-60 ratio (secured : unsecured) moving forward, providing a good mix of relatively cheap financing versus asset valuation for investors.

From a strategic perspective, the deal makes a lot of sense for several reasons, but perhaps most important is increased scale, which will give the new AerCap the ability to deal with what we view as a growing threat of a narrowbody aircraft bubble. Recent economic events in Asia have called into question not necessarily the long term trajectory of fleet growth in the region but certainly the present orderbook of Asian carriers. With Asian economic growth slowing, especially outside of China, the massive narrowbody backlog currently held by Southeast Asian airlines is in threat of at the very least deferral, if not outright cancellation. This is part of the bubble – over-ordering on the part of Asian (and potentially Latin American) carriers.

The other component of the bubble is a bit more nuanced, but it has to do with how aircraft are financed. During the global financial crisis of 2008-9 and in its aftermath, lots of global liquidity (in particular from emerging markets) flowed into aircraft as a safer asset than equities, asset backed securities, or derivative that still offered higher returns than the bond market. Essentially, there was a scenario where investors had lots of cash, and not many safe ways to generate a return on that cash beyond aircraft and a few other niche products. But global equity and financial markets have largely recovered, and increasingly investors are moving into riskier assets. At the same time, the pressure of massive pools of liquidity emerging in Asia are declining to some degree with the economic slowdown. And emerging market banks are increasingly waking up to the fact that the 737NGs and A320s that they financed are going to decline sharply in value with the emergence of MAX and neo (as well as the precarious financial position of Asian carriers), and are increasingly moving away from the aircraft financing business.

All of this creates a scenario where financing costs are set to rise sharply for lessors, even as the value of their 737NG and A320ceo fleets continues to decline in tandem. But the combined scale of AerCap and ILFC is useful in combating this. Increased size gives the combined lessor a more favorable negotiating environment with banks. Moreover, the ILFC orderbook for new widebodies and the combined widebody fleet provide a bit of a natural hedge against value decay of the narrowbody fleet. And of course the combined company will have increased leverage in winning discounts from manufacturers. In today’s operating environment, the combined scale driven by this merger will position the new AerCap well in the worldwide leasing market.

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A Global Review of Commercial Flight since 1994: the leading Commercial Aviation publication in North America and 35 nations worldwide. Based in Miami, Florida.

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