12.7.07

CAPITAL WITH WINGS. Financially strapped U.S. airlines can still sell trust certificates.

Twenty years ago, U.S. carriers could be counted on to absorb nearly half the world's commercial aircraft production. That gave them preferred customer status. Today, Boeing and Airbus expect U.S. carriers to buy a quarter to a third of their future output, giving them less clout with the plane makers.

Wall Street expects U.S. airlines this year to register a second year of profitability since the post-9/11 industry crash: $6 billion before taxes, interest and accounting items. But that pales in the face of the estimated $715 billion to $950 billion worth of new planes that the manufacturers estimate U.S. carriers will need to replace and enlarge their fleets to meet travel demand. The government forecasts that the number of air travelers in the USA will double in the next two decades.

Other looming costs could easily push the airlines' essential capital outlays above $1 trillion in the next two decades. The expected increase in passengers will, for example, require more spending on terminals, training facilities and other essential infrastructure.

In addition, the Federal Aviation Administration says airlines will have to spend $20 billion to $25 billion in coming years to equip cockpits for the coming "NextGen" air traffic control system.

It's money the airlines simply don't have.

The concluding assertion is not accurate, as we shall see. I am taking this opportunity, however, to lay down a marker: if airlines go to the national government for guaranteed loans or grants to buy aircraft, I will suggest to my representatives that the money might be more efficiently spent on improving the rail infrastructure. Class Six track suitable for 110 mph passenger and intermodal trains will be satisfactory, thank you very much.

Based on their cyclical history of modest profits followed by huge losses, big airlines would seem boxed in by a need for new planes and an inability to pay for them.

But [former aviation entrepreneur Michael] Roach, the industry consultant, says that it would be "idiotic" to think that all the USA's carriers will disappear as their current planes wear out. "There will always be an air transportation system. It is too vital to the country's interest for it to be otherwise," he says. The more apt question, he says, is "Where will the money come from" to acquire those planes?

Southwest, with the deepest financial resources in the industry and strong annual cash flows, expects to continue buying most of its planes with cash generated by its operations, says CFO Laura Wright.

For many U.S. carriers, that's not an option they can rely on. Now, they'll have to get by with a little help from their friends: leasing companies.

It used to be that when the big U.S. airlines leased planes — typically via long-term deals that were nothing more than alternate ways of purchasing planes — they did so mainly for tax savings. Today, they increasingly are turning to leasing because they lack the cash or the strong credit ratings to finance conventional plane purchases.

And thanks to the strong worldwide demand for popular models from Boeing and Airbus, there's no shortage of companies willing to finance them, even for carriers whose profits are unimpressive or non-existent. Aircraft lessors are confident that should a customer default on a lease, they'll have no trouble finding other carriers to lease their planes.

"There're plenty of people out there willing to finance airplanes," [retired Boeing sales manager Randy] Baseler says. "Actually, at Boeing, we're amazed at just how easy it is to finance new planes.

That's a canonical application of contestability theory. The cost of an airplane is fixed (one requires some hull and lift capability in order to transport passengers) but not sunk, as the plane can be diverted from less productive to more productive routes, which does not preclude transferring the trust certificate to another carrier. During the sick years of railroading, roughly 1960 to 1985, some very weak carriers could put some modern power on the ready tracks by leasing the locomotives under a trust certificate. As long as some other carrier is willing to pick up the power in case the initial borrower hits a rough patch and could no longer make the payments, the investment in the locomotive is relatively safe. (A similar phenomenon is at work in the willingness of automobile dealers to extend credit to recent university graduates on the strength of a job offer.)

That line of thinking raises a question about an observation in Virgin Trains (I think I've just expanded a prior post into Book Review No. 9 3/4) about the limited capacity of the Voyager series trains. The company line, er, argument in the book, is that the lender was not willing to finance five and six car trains owing to the relatively short time limit of the initial franchises. The explanation is not completely persuasive. A new franchise operator would have to provide rolling stock to cover the schedules on the routes it acquired -- the British passenger train franchising is an application of contestability theory to the railroad network -- and the company that lost its franchise would find itself with rolling stock to dispose of. Whom better to dispose it to than to the new operator? Perhaps the lender took a look at the plans for the Voyager series and concluded no other passenger operator would be willing to use them on long-distance runs. More about that later.

No comments: