10/05/2018

When and why size matters for leasing companies

When and why size matters for leasing companies

Is bigger necessarily better when it comes to leasing platforms? One common feature among new lessors in the market has been a voracious appetite for growth.  Bohai’s two gargantuan acquisitions—those of Avolon and then CIT—and DAE’s purchase of AWAS are reflexively attributed to a strategic pursuit of the economies of scale. 

Yet many of the industry’s new investors struggle to define the threshold at which scale is achieved, to conceptualise the benefits scale is supposed to confer and to identify the metrics which capture its efficacy.  Is it just about fleet size?

Ishka suggests that economies of scale—as expressed by large fleets—do confer competitive advantages on some operating lessors.  These relate primarily to lessors’ visibility of the global deal flow, bargaining power vis-à-vis OEMs and the cost of funding. However, not all business models in the industry critically rely on or require such scale to be profitable.

 

All lessors big and small

 

The discourse is complicated.  A cursory look at the upper echelons of aircraft leasing platforms reveals a plethora of business models.  Some platforms, like Avolon or BOC Aviation, have sizeable fleets and deep and long-dated orderbooks; others, like Aircastle or pre-2018 Fly Leasing, are consciously orderbook-free and take a constrained approach to fleet growth.  Moreover, only the top three of the world’s lessors have more than 500 aircraft under ownership and/or management, and only those in the top-20 worldwide have more than 100 aircraft each.  The last lessor to breach the 500 ceiling was Avolon upon its acquisition of CIT in 2016, the first transaction of such magnitude since AerCap’s 2013 purchase of ILFC.  Having fewer than 100 fleet is not necessarily an impediment, and has not stopped some lessors from publicly listing- as Fly’s original listing demonstrated.  At the same time, industry lore holds that credit ratings agencies deem fleets of under 200 aircraft ineligible for investment grade due to poor diversification effect and, yes, insufficient scale. 

However, economies of scale can confer an advantage in the following areas:

Spreading overhead sales and administrative expenses. Operating lessors tend to have very lean organisational structures, with SG&A expenses dwarfed by depreciation and interest expenses and large companies reporting employee-to-aircraft ratio in the region of 1:5—1:6. 

Capital A substantial scope of operations—as measured by assets and revenue base—is credit positive, especially if it translates into a meaningful market share relative to competitors’.  A strong credit profile facilitates access to a broader base of capital providers and investors.  It also allows for larger tickets in capital-raising.  Better quality credits are also positioned to command lower cost of financing

Purchasing power For lessors with an orderbook strategy, a large and consistent requirement for future deliveries confers distinct bargaining power vis-à-vis airframe manufacturers which allows for significant discounts to purchase prices on new aircraft (and lowers lessors’ capital expenditures).

Customer satisfaction. A larger fleet and a deep orderbook increase the probability that the lessor has the amount and type of equipment required to meet customer needs, facilitating new customer flow and existing customer retention.

Internal risk mitigation. A larger fleet which is at the same time subject to concentration limits by type, lessee credit quality, lessee jurisdiction is inherently less risky.

 

The Ishka View

 

Applying the above principles in turn to different business models found in leasing suggests that some platforms—such as those with an orderbook strategy—may benefit from scale more than others (through increased purchasing power).  Those originating business in secondary market may seek scale to maintain consistent visibility of the deal flow in the industry, as ad hoc trading may form a larger part of such lessors’ business model.    On the capital side, while capital markets have played an increasing role in lessors’ financing strategy, some platforms may have access to cheap funding through their parent company.   In Ishka’s view, the value of scale is not uniform and rather than driving strategy, should be driven by it.

 

 

 

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