Avolon confirms CIT acquisition; today’s leasing market favours the bold

As reported here and everywhere else over the past 12 months, Avolon has confirmed its purchase of CIT Group. Along the way a spanner was thrown into the works for Avolon when a Japanese lessor expressed interest in part of the CIT portfolio with a very strong offer, this not only delayed the Avolon deal but also increased the price in the end.

Avolon will acquire total assets of US$11.1 billion as of 30 June 2016 and associated liabilities of CIT Group. Avolon will pay US$10.0 billion, a premium of 6.7% to the 30 June 2016 net asset value (NAV) of US$9.4 billion. The purchase price is subject to adjustment for changes in NAV between 30 June 2016 and the deal’s closing date, which is expected to be during the first quarter of 2017. The transaction will be financed by a combination of Avolon’s cash; new equity contributed by Bohai; and acquisition debt financing of US$8.5 billion that has been committed by Morgan Stanley and UBS.

“From a standing start we will have built Avolon into a leading global player in six years,” said Avolon CEO, Dómhnal Slattery. “We are delighted to announce an agreement to acquire the CIT aircraft leasing platform. It is a strong business with an excellent reputation in the market. While this transaction is strategically compelling and will double the scale of Avolon, it is not the summit of our ambition. Avolon has a strong brand, a best-in-class fleet, a proven business model and a long-term strategic shareholder committed to the sector. We look forward to continuing to drive the disciplined growth of the business in the years ahead.”

The deal will make Avolon the third largest aircraft lessor in the world with 910 aircraft, split over 154 airlines across 61 countries with around one third of business split between each of the major regions of APAC, Americas and EMEA. Avolon now has combined orders and commitments of 349 aircraft including: 195 Airbus aircraft (A320neo family, A330neo and A350); 59 Boeing 737 MAX aircraft; and 28 Boeing 787 aircraft.

The deal is still subject to Bohai shareholder approval but HNA Group, Bohai’s largest shareholder, has agreed to vote its shareholding in Bohai in favour of the transaction.

Chris Jin, CEO of Bohai, stated: “Our vision at Bohai is to build each of our transportation finance businesses into global leaders. Our decision to acquire Avolon in 2015 was a key step towards that objective.  The Avolon team has already delivered remarkable growth in building a new platform into a leading industry franchise. They are now taking a further exciting step towards our collective goal to become a true global leader in transport finance. We are confident in the prospects for the enlarged business which has a strong, proven team and the operating disciplines to drive sustainable performance.”

Avolon’s financial advisors for the transaction were UBS and Morgan Stanley. Weil, Gotshal & Manges and Freshfields Bruckhaus Deringer acted as Avolon’s legal advisors. KPMG and E&Y also advised on the transaction.

Avolon will have an owned in-service fleet of 511 aircraft with an average aircraft age of 4.6 years, the youngest owned, in-service fleet among the world’s top three aircraft leasing companies, with an average remaining lease term of 6.7 years.

There-in may lay the problem for both Avolon and all other aircraft lessors – its average remaining lease term of 6.7 years.

It is unlikely that anyone in the aircraft leasing industry can gaze out into the future and not be somewhat worried by what they see. Right now Boeing and Airbus are sitting on the largest ever lessor orderbook of unplaced aircraft, speculative orders if you like; running at an average of 190 aircraft per annum for 2017 – 2025 from previous averages of around 125-150 aircraft for the past few years. Sure these aircraft on the whole all get placed, but at what price? The sale and leaseback market has dropped through the proverbial floor over the past decade, there is pressures on NG and Ceo aircraft and significant pressure on MAX and NEO lease rates, even though the troubled P&W-powered Neo is confirmed to be producing around a 15% cost benefit in service.

The glut of aircraft that need to be placed over the next few years is tremendous and unprecedented. Most lessors have agreements with the manufacturers to be able to change the type of the aircraft they have ordered, dramatically helping them to place aircraft. But few lessors are able to retain their delivery windows/slots when they change aircraft type from an A320neo to an A321neo, for example, or a Max 8 to a Max 9. For the very few lessors that have got an agreement from Boeing and/or Airbus to be able to change aircraft type without losing their delivery window, this is a huge benefit. Investors might wish to ask if a lessor has this agreement in future.

The leasing industry is also likely to be impacted by the likes of Lion Air and AirAsia throwing more and more aircraft onto the market. Some state that these fast-growing airlines need to add the aircraft to their own fleets and so this is not a big deal for lessors. The reality is that while many industry observers have been concentrating on load factor figures, the importance of utilization has been over looked. How many of you reading this today for example have bothered to check average utilization at airlines with very large aircraft delivery streams that are also dabbling in leasing? Lion Air, as one example, has utilization for its 737-900ERs at an average of seven hours per day. This does not include the Malindo Air or Thai Lion businesses, which we already know have weak utilization percentages that would push the whole lower. You cannot have an LCC airline with utilization that low. So what will it do? Cancel or defer orders? Increase the number leased out? Or, continue on the current growth trajectory? The latter will be the worst-case scenario for any lessor with 737-900ERs or 737-9 or A321neo on the orderbooks as it could in the end lead to significant pressure on lease rates.

We are entering the period we all knew was coming. New aircraft are arriving on the books of the global fleet every day at the same time that older aircraft are still very much in service with economics (considering purchase cost) that new aircraft can rarely match, unless the lessor takes a hit on lease rates and then tries to make this back through structuring the aircraft ownership so that taxation benefits come into play – a very common option. But of course oil still has a part to play. If oil were to recover even $20 a barrel on today’s prices then the market will swing once again with new aircraft in high demand. For those lessors with new unplaced aircraft deliveries in the next 12 or 24 months, where a deal needs to be done, many lessors are thinking again about the benefits of long-term lease versus a short-term lease. In this current market, a short-term lease agreement with a premium on rates with a high class customer with an option to extend, might well be the prudent play while the Ceo and NG fleets continue to roll toward heavy checks. Compounding this argument is the ICAO announcement that aviation is to be included from 2020 in the carbon off-set system, which should provide all new aircraft with more attractive economics. So why lock-in now for six to twelve years at a low rate of return? This market favours the bold.

Combined Business | Key Metrics

Note: Fleet numbers as of 30 June, 2016