Investors examine where to infuse capital in MRO.
MRO continues to depend on a variety of investment sources for growth. Private equity firms have made moderate investments. Aircraft parts distributors have attracted interest from manufacturers and banks and are looking for novel capital sources. Much bigger investments are being made in the Middle East and in Asia. But just as important as where the money will come from is what kind of MRO models smart investors will back.
Ken Herbert, senior VP for research at Wedbush Securities, still sees more interest in parts than MRO.paid $500 million for parts distributor Satair. “There is a lot of buzz about combining parts and MRO,” Herbert notes. “But there is a question whether it makes sense as a long-term strategy.”
Hedge funds used to be interested in aircraft aftermarkets, but no longer. “There is not enough ROI in MRO for them,” Herbert says. But capital from the Middle East, China and other Asian nations continues to be available.
Kevin McFarlane, managing director in corporate finance at Deloitte, argues the aviation aftermarket needs to tap different and more patient funding sources. “MRO does not fit the risk profile for many private equity firms, but there are funding sources out there looking for different ways to deploy capital.”
New investors must have industry experience and plenty of capital. “You want to differentiate yourself by offering broader services over the whole cycle, so you can capitalize on the uptick,” McFarlane says. “Right now, we don't know if this is a V-, U- or W-shaped recession. You need to be able to handle all these shapes.”
That kind of flexibility seems to be the strategy behind combining the Mubadala Aerospace MRO network (Abu Dhabi Aircraft Technologies and) with Sanad Aero Solutions. Sanad provides long-term access to engines and components tied to Mubadala MRO. Key agreements include integrated engine solutions (IESs) for and , and integrated component solution (ICS) deals for Etihad Airways' Airbus fleet and 's Airbus , and .
“We wanted to differentiate our commercial MRO product,” explains Sanad CEO Troy Lambeth. “We wanted to leverage the strength of Mubadala by adding spare financing.” Lambeth believes that 60-70% of parts inventories lend themselves to asset management. Sanad controls nearly $500 million in assets tied to Mubadala MRO programs of more than $2 billion. It seeks to manage $1 billion in assets in its first five years.
For airlines with spares, Sanad offers IES or ICS with sale and leaseback of assets. If aircraft are ordered, Sanad can finance spares and offer access to pools. “We provide efficiencies of scale,” Lambeth says. Rotable stocks can be cut 20% with pools, and even engine spares can be trimmed.
Two-thirds of Sanad assets are components and one-third are engines. About 80% of assets come from sale-leaseback, and the other 20% from initial purchase. “In 10, years, as new fleets are introduced, this will shift toward more initial provisioning,” Lambeth predicts.
“We have a very strong pipeline of potential MRO transactions,” notes Mubadala Aerospace MRO Network CEO James Stewart. “Say we have $10 billion in the pipeline. Sixty to 70% of potential transactions have a Sanad play in them. Our win rate increases when we work with Sanad.”
Lambeth says Sanad and Mubadala are separate businesses. “We are separate companies with separate boards. We have our own metrics. We do our own due diligence and make sure we hit our metrics.”
Lambeth argues that combining MRO and asset management is more efficient. Lease rates must reflect the risk of return conditions and airline failure. Since Mubadala does repairs and manages custody of assets, risks and rates are reduced.
Sanad also has better technology to optimize inventories than many airlines. With inventory at 30 global locations, plus main warehouses, “we can locate anywhere,” Lambeth says. “We know where parts are, when they come out of repair and where they should go.”
Sanad can guarantee fill rates from 80-100%. As the pool grows, it becomes easier to guarantee higher fill rates economically.
Oliver Wyman Partner Chris Spafford sees the Sanad-Mubadala move as an aggressive extension of what major MROs, such as, Sabena Technics and AAR have long done. “This is not radical, but an evolution,” he says, calling it “a wise move for Mubadala.” Spafford estimates that a total fleet of 800-1,000 aircraft in the same region enables reduction of rotable stocks by 20-30%.
The Wyman partner agrees with Lambeth on the lower financing rates enabled by combining MRO and asset management. “The cost of capital will be in between that of the airline and the provider.”
Making pools work requires sophisticated asset management and information technology systems. But pool managers can profit by trading in and out of the pool because asset prices vary daily. “You can make money on that; AAR has done it very well,” Spafford notes.
Pools and asset management also can be executed independently of maintenance. That is the continuing strategy of major engine and rotable leasing firms.
Focus On The Core?
The Sanad-Mubadala strategy raises two issues, says Charles Willis, CEO of Willis Lease. “Access to capital and what is your core business?”
Willis argues that combining a core MRO business with non-core asset management usually results in cross-subsidy. “At the end of the day, it usually backfires. You push it in here, and it pops out there, like the Pillsbury Doughboy.”
If an asset manager buys assets and then leases them back to the airline, the critical question is sale price. If managers pay too much, they must recover the premium on the MRO side or in a higher lease rate, which means more risk at the end of the lease term.
Willis agrees that airlines want alternatives to OEMs “wrapping their arms around everything.” He says, “If you want something from an OEM, you must have a way to help them or hurt them. A pool is a non-confrontational way to do that.”
Willis acknowledges credit access and costs are issues for many airlines. With a new $400 million credit facility in place, Willis plans to stick to engine leasing. “In the end, we are a credit company. We borrow money, then lend it out in the form of engines.”
Avtrade has increased its rotable business 24% annually in the past six years, to $65 million in the past fiscal year. Marketing Director Jamie Assmann predicts turnover will hit $90 million in the next fiscal year. “We offer trades, exchanges, leasing and cost-per-hour [CPH],” Assmann explains. CPH was 30% of Avtrade business last year, headed for 35-38% in 2012.
Avtrade plans to stick with its core business. It considered buying repair shops. “We decided that is a bad deal,” Assmann emphasizes. The firm has been approached as an acquisition prospect but wants to remain an independent family business. Assmann says Avtrade has access to capital and is courted by banks, which understand the profits in parts.
Independence means Avtrade makes decisions fast and executes them quickly. Decisions need not be discussed within large bureaucracies. And with no large staff to support, the firm can walk away from unsatisfactory deals.
Assam views the Sanad-Mubadala combination as a potential customer, competitor and partner. “In a small industry, they are of course competition, but we do not feel they are much of a threat, due to our specialization.” Avtrade is tripling the size of its facilities and will eventually expand into engines.
AJ Walter Aviation has established a new unit in Hong Kong, AJW Capital Partners, to seek broader sources of capital for its parts- and engine-leasing business. Steve Williams, director of aircraft engine services, says AJW has increased asset leasing 25-30% annually since 2006.
“We have leased almost everything except engines, and now we are getting into engines,” he notes. AJW had five engines in late December, with four more on the way, and it plans to be a major engine leasing firm in five years. “We are climbing the ladder now,” Williams acknowledges. “In five years, we hope to be considered second or third.”
Ian Malin heads up AJW Capital Partners. The unit is based in Hong Kong partly to establish a presence in North Asia and partly to diversify funding sources. Malin expects to announce progress in a few months.
“We have grown a lot in seven years, so we need more capital to satisfy the demand we're seeing to support larger fleets,” Malin says. The company does one-off leases and offers pools ofand Airbus rotables. AJW manages repairs but does not own repair shops and has no plans to acquire them.
Some airframe shops also are concentrating on core or near-core businesses, rather than full-service options.
Evergreen Maintenance Center (EMC) is looking at helping end-of-life aircraft with storage, maintenance and parting out, explains Joyce Johnson-Miller, senior manager of Relativity Capital, which acquired EMC last year. “We have very strong capabilities for parting out and storage. You see aircraft that need that, like MD-80s, and particularly leasing companies that do not have long-term providers.”
“EMC is well under way and growing,” Johnson-Miller says. “I can't say anything about adding funds, but we are here to support the business.” Relativity is looking for other aftermarket opportunities, and Johnson-Miller sees other firms that are interested. “Not just private equity, but financial markets, which tend to follow private equity.”
Moelis Capital Partners acquired the heavy airframe maintenance business of Flightstar Aircraft Services in December. “Given the history of the sector, we hadn't sought opportunities in it, but as we looked at the company we were very impressed,” says Moelis principal Jim Johnston.
A favorable outlook for outsourcing and some Flightstar distinctions prompted the deal. “They had built an excellent core business in C and D checks on Boeing narrowbodies and 757 cargo conversions.” Johnston says. “Customer feedback was excellent.”
Located in Cecil Field in Jacksonville, Fla., Flightstar has room to grow contiguously, unlike some other airframe shops. Skilled labor can be recruited from nearby aviation schools and military forces, which are being drawn down.
Johnston says Moelis has not decided whether or how to grow the business beyond its airframe core, nor set any duration for holding the property. “Private equity usually holds for three to 10 years, but we have no specific plans. We will continue to evaluate opportunities in aviation aftermarkets and services as broadly defined.”
The best example of capital being poured into traditional MRO is in aviation's most booming market, China.
Guangzhou Aircraft Maintenance and Engineering Co. (Gameco) offers heavy and line maintenance, as well as component repairs on most Boeing, Airbus and Embraer jets. With two financially strong owners,and Hutchinson Whampoa, Gameco is sticking to traditional MRO as Chinese traffic soars.
“We don't do dollar-per-hour, because very few airlines in China want that,” explains David Conrad, director of international sales and marketing. “And we don't want to invest in pools.”
Gameco's priorities are expanding capabilities, infrastructure and training. The firm has hangar space for only 15 aircraft, but China Southern Airlines will grow from 450 planes to 650 in five years. “We need more space and capabilities forand ,” Conrad stresses. In five years, Gameco wants to increase third-party work from its current 2% share to 40%.
Chinese carriers have not sought part support because they carry several times the inventory per aircraft that western airlines do. “They emphasize safety and operational efficiency and don't want to risk that in a pool,” Conrad says. “Cost-per-hour will come eventually, but not tomorrow.”
Conrad thinks the Sanad-Mubadala model might be “an expensive way to get work.” The value is in asset utilization, not repairs, he says. “How are they going to get utilization? It is innovative, but will it work?”
In China, apart from building capacity to support soaring fleets, the main need is to satisfy China's desire to have repair infrastructure under Chinese control. “Then they can decide whether they want to send it out or not,” Conrad observes.