Business Today

Aircraft shopping for dummies

Sales and leasing of airplanes are in the spotlight. A guide to the complexities involved.

Kushan Mitra | December 9, 2011 | Updated 17:43 IST

Kingfisher Airlines, in deep trouble, is set to return two of its Airbus jets to Irish leasing company AerCap. A senior executive at one of Kingfisher's rival companies said more of Kingfisher's jets would be returning to the leasing companies that own them in coming days. In fact, Kingfisher owns just two aircraft out of its fleet of 65, shows data available with the Directorate General of Civil Aviation. The data further reveals that, with the sole exception of state-owned Air India, which owns all its planes, almost all the aircraft used by Indian airlines belong to leasing companies.

Welcome to the curious world of aircraft buying. Aircraft do not come cheap. The average list price for a brand new Airbus A320 in 2011 was $85 million. Boeing has the 737-800 listed for $84.4 million. These two 180-seater aircraft are the workhorses of airlines across the world. In India GoAir, Indigo, Kingfisher and the domestic flights of Air India all use the A320 extensively. Jet Airways and SpiceJet use the 737-800.

There are variants of these airplanes, the slightly smaller Airbus A319 being currently priced, on average, at $77.7 million, while the slightly larger Airbus A321 sells for $99.7 million. The same goes for comparable Boeing models.

However, almost no aircraft ever sells at its listed price. Airbus and Boeing negotiate hard for large orders and offer massive discounts to get them. Discounts range from 10 to 40 per cent depending on the type of aircraft ordered, delivery dates requested, the engines selected and the interior options specified. Thus, for example, while Indigo and Kingfisher have similar A320 aircraft running the same IAE V2500 engine, Kingfisher's planes would have cost more as they are outfitted with galleys and in some cases with seat-back personal TV screens.

Airlines pay, on average, only one per cent of the cost of the aircraft at the time when the deal to buy them is signed. At pre-determined timelines before the delivery date and during the lead-up to constructing a plane, they have to fork out small percentages of the cost to the manufacturer. A big tranche of up to 10 per cent usually has to be paid when the three-month long assembly process for a narrow-body jet commences.

Much of this financing is provided by banks, from which airlines usually take long-term loans at pre-negotiated rates. Often, if the manufacturer so requests, the Export-Import Bank of the country where the aircraft are being made - France or Germany in the case of Airbus and the United States in the case of Boeing - also finances part of the purchase at a favourable interest rate.

Enter the leasing companies. Aircraft leasing companies are often divisions of large banks. The UK-based Royal Bank of Scotland, or RBS, and the US-based Wells Fargo have large aircraft divisions. But such companies can be standalone entities as well, or divisions of large non-financial corporate firms. The world's two largest aircraft leasing companies are GECAS, part of the General Electric group, and International Lease Finance Corporation, or ILFC, part of insurance company AIG. (It is being spun off as an independent company.)

Often, leasing companies buy aircraft directly from Airbus and Boeing - at times for particular customers to whom they lease them once the aircraft are delivered. Indian airline companies, however, follow a different path. They buy most of their aircraft directly from the manufacturer, but before the aircraft are delivered, they also often conclude deals with leasing companies to sell them those aircraft. In times of financial difficulty, airlines in India have even sold their positions on the production line to leasing companies. Air Deccan did so to RBS, treating the delivery position as a fungible asset - though this is a development manufacturers privately admit they are not happy with.

"The deal with the leasing company is concluded before delivery," says the former boss of an Indian airline. "It hands us a cheque before the delivery. When we get the plane, we pay the manufacturer with that money. The manufacturer gives us the ownership papers and we in turn hand those over to the leasing companies."

Now comes the sleight of hand. An airline buys an aircraft for a certain pre-negotiated price, but often sells it to the leasing company at a higher price. Suppose an airline pays the manufacturer $50 million, it in turn may sell the plane to the leasing company for $60 million, netting the $10 million as profit. Not a single flight has been operated yet using the newly acquired aircraft, but it has already turned a profit for the airline. The airline then promptly leases the aircraft back from the leasing company, thus concluding a 'sale-leaseback' deal on the aircraft for a pre-determined period of time. This could be for just a year, but is usually for 10 years or so.

Again, airlines often do not buy aircraft engines from the aircraft manufacturer. They negotiate separate deals with engine manufacturers. (However, all aircraft prices quoted so far in the story include those of the engines in them.) Airlines can conclude 'per-hour' deals with engine companies, paying them for every hour an engine is used, rather than buy the engine outright. Engines are easily swapped around between aircraft, so the plane you fly next could well be using engines other than the ones it had when it was delivered. The engines could even be older than the aircraft.

But what is in it for the leasing companies? Why would they let airlines book profits at their expense? In fact, when an airline strikes a sale-leaseback deal, the profit the airline made is factored into the lease. If an airline company sells an aircraft to a leasing company at a relatively small profit, the monthly lease rental is lower. Book a higher profit during the sale and the airline pays a higher lease rental. The average lease rental on a brand new A320 or 737-800 ranges between $500,000-750,000 per month. Again leasing companies also offer 'per hour' deals for aircraft, as well aircraft on monthly rentals, the rental ranging between $2,500 to $3,000 with a minimum number of hours of use - between 200-250 hours every month - guaranteed. They also take a month's rental as deposit. While the airline takes care of routine maintenance, essential heavy maintenance is the leasing company's responsibility.
But the airline still benefits because it does not have to factor in a depreciating asset on its books. The lease payments become an operating expense. But with such an arrangement, managing costs becomes vital. When a leased aircraft flies between Delhi and Mumbai, for instance, a flight that in low-congestion conditions takes two hours, the lease fee for a fairly new A320 would be around  $5,500. Assuming 90 per cent of the 180 seats on the A320 are filled and the average fare is Rs 5,000, or $100, the airline makes an estimated $16,000 from the flight (in some cases, it would earn a bit more from freight revenue). Be warned these are inexact numbers; but calculating average fuel-burn, an airline would spend around $4,000 on fuel to operate this flight.

There are other costs as well. Pilots are expensive, as are costs at Indian airports - navigation charges as well as other intangible costs. But an airline should still be able to make a fair operating profit on this particular flight of at least $5,000. However, fuel costs do not really go down for each less passenger carried, and competition means that the assumed average fare of Rs 5,000 could be off the mark. While lower fares mean a fuller plane, most other costs are fixed. If fares are raised, fewer passengers might board. The operating profits calculated above also do not include the costs of over the top marketing campaigns, or the losses incurred due to delays and diversions.

Thus buying aircraft and running an airline is not as simple as it seems, although it is not impossible to make money either.

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