by PETER MAESTRALES
July 14, 2013 –
Simply put, the decline in
values of pre-owned business
jets since 2008 is astounding.
It’s been a prolonged trend and now with increasing concerns of a failed
global economic recovery, many professionals within the General Aviation
industry are feeling anything but optimistic about a reversal occurring anytime
in the near future. However, I have a
counter viewpoint and will refer to indications that this market is finally bottoming
out. There are various market conditions
currently being overlooked by many within the industry. These conditions have
played a key role in depressing this market but I will explain why there is a
sharp reversal at hand that I believe has already begun.
To make my case, I won’t bother analyzing graphs, charts,
recent sales data, or any other statistics because this information is already
heavily cited in other market forecasts.
Furthermore, relying on “hard data” as a key market indicator is
illogical because it’s simply a report of sales activity from the past. It is irrelevant because the past is already
“priced in” to the current market.
Therefore, to gain insight into the future, just knowing data from the
past will not suffice. To see the future
we must understand the past on a much deeper level.
HOW WE GOT HERE
As was the case with most major asset classes, prices for
all business jets were increasing at an unsustainable pace prior to the
financial crisis of 2008. In addition,
participation in fractional ownership programs increased exponentially and
resulted in massive orders for new aircraft by companies such as Net Jets, Flex
Jet, etc. These jets eventually ended up
in the used aircraft sales market, and are responsible for much of the supply
pressure we see in today’s market.
Looking back, it was without a doubt a bubble just as US
real estate was a massive bubble, both of which were fueled by cheap money and
debt. But bubbles burst, and when they
do its always ugly for the people who did not see it coming. On the other hand, we also know that markets
are cyclical, and their cyclical nature is simply a result of ever unwinding
imbalances in the economy. The unwinding
of these imbalances always carries the potential for side effects, or what is
sometimes referred to as “economic phenomena”, where the price discovery
process is unable to function normally, often due to an irrational fear amongst
potential buyers. When a market lacks
or has lost a functioning price discovery mechanism, the result is usually
extreme price volatility. This is
exactly what we have witnessed over the past decade with aircraft values. As the debt bubble inflated the market to
extreme highs, it was followed by the ongoing crash back down to the current
levels that have proven to be just as extreme to the downside. Ultimately, a reversal will take place as the
market seeks equilibrium and stability.
IS THE SMART MONEY?
Identifying when a reversal will take place in a market
where prices are rapidly falling is no easy task, because fear is usually
present and typically results in irrational behavior. Therefore the buyer who is most likely to
overcome the fear of entering a Bear Market is usually the buyer with the most
knowledge and understanding of that particular market, simply because they are
most capable of recognizing when the market is undervalued. This also known as the “smart money” and is always
the key ingredient needed to spark a market reversal.
Unlike other asset classes such as real estate with which
all are familiar, business jets are complex machines that are operated,
maintained and managed by aviation professionals only. Therefore, aviation professionals and
companies are actually the “smart money” in this particular market because they
possess the expert knowledge and understanding of these amazing machines. However, General Aviation companies do not
purchase jets as they once did decades ago.
For example, my family has worked in General Aviation for
nearly 40 years now and I have witnessed first-hand how the ownership dynamic
in the market has evolved.
As a child I grew up watching my father, a small-business
owner and professional pilot, successfully grow his Part 135 Air Charter Company that he built
from scratch. From the very beginning,
he sold charter flights only on aircraft that he owned, which is in contrast to
the standard model of most of today’s Part 135 Charter companies who typically
sell charters on managed aircraft since they do not own any of their own
Like most entrepreneurs of that time my father started
small, giving flying lessons in single engine piston aircraft. When he had saved enough, he moved up to a
Cessna 310 twin-piston and began selling charters on it. After that came Cessna 340’s, 402’s, Bell helicopters, and ultimately
business jets. In total my father has
owned and operated nearly 50 different aircraft. Executive
air charter, air
freight, and air-ambulance
were among the ways these aircraft were utilized in order to generate income
for our business and the many families of employees it supported. These airplanes were not purchased for
personal enjoyment or convenience. They
were the tools with which we earned a living.
This made buying and selling aircraft fast and easy, there was no fear
involved. We knew value when we saw it
because we work with these machines every day.
Over time the prices of business jets increased to levels
that made it impossible for charter companies to own aircraft, much less turn a
profit with them. Naturally, air charter
companies adapted to the trend and as a result became Aircraft Management companies,
who operate and sell charter on aircraft that are owned by HNWI’s and corporations. This change appeared to be a good thing as
the industry grew at an incredible pace resulting in many new jobs.
Unfortunately the growth came to an abrupt end, and now that
the dust has settled it is painfully obvious that the years of prosperity removed
something very important to the business jet market specifically, the “smart
money”. General Aviation companies are
no longer legitimate market participants as they once were long ago. As a matter of fact, the ownership dynamic
has slowly evolved to the point where now it’s bizarre to think that a General
Aviation company was ever a legit market participant.
The fact that today’s Air Charter Companies sell charters on
managed aircraft is supposed to offset the overall cost of ownership for those individuals
or entities. The concept is much like
utilizing an agent to sell time shares on a vacation property that would
otherwise not be utilized during certain time periods. However, if the aircraft management company/air
charter company was also an owner of aircraft within their fleet of managed
aircraft, there would be a conflict of interest present with regard to the
designation of aircraft for revenue flights, especially during slow travel
With the “smart money” no longer being a legitimate market
participant, fear continues to dominate the pre-owned business jet market. I believe it is this dynamic, in particular,
that is responsible for the continued weakness in the pre-owned sector, while
at the same time helping to support demand for factory new aircraft. This trend has proven to be a saving grace
for Original Equipment Manufacturers (OEMs).
Fear is not a driving force in acquisitions for new aircraft
because prospective buyers are more confident and comfortable making choices
based on apples to apples comparisons in which the choices are all “0” time
aircraft, and come with a factory service warranty. The pre-owned market is just the opposite as
there are numerous variables to be considered, all of which effect a
valuation. Terms such as Avionics, Hot
Sections, Mid-Life, Pre-Buy, Engine Programs, Maintenance Records, Log Books,
Inspections Schedules, Airworthiness Directives are unfamiliar to buyers
looking to enter the market for the first time.
And as a result, many potential buyers are understandably frightened out
of the pre-owned market.
While an analysis of these variables does require a
qualified professional or at the very least a knowledgeable and seasoned buyer,
an aircraft acquisition is actually not as complicated and risky as many of
these same professionals would like consumers to think. Ironically, aircraft brokers and acquisitions
consultants have essentially become a victim of the same fears they promoted.
Now, I am in no way saying that they do not bring value to their customers, as
I believe they are invaluable to the acquisition process. I’m simply pointing out the fact that during
the boom years, over-hyping the complexities and risks associated with pre-owned
aircraft acquisitions was utilized as an effective marketing tool and
ultimately became the basis for the aircraft sales broker business model. But this strategy only worked in the past
because buyers couldn’t be scared out of a Bull Market. However, promoting fear in a Bear Market
simply will not work.
Now that we have a better understanding of the factors
responsible for depressing the pre-owned business jet market, we can begin to
explore the future. The reason this
knowledge is of critical importance is because in order for the downward trend
to reverse, each of these negative forces must be resolved. Therefore, with a comprehensive understanding
of the problems, we will naturally be more capable of recognizing how these extreme
imbalances will begin to unravel as the market seeks equilibrium. In addition to the resolution of negative
forces, we will also examine some current and future trends that are already
pointing to a sharp reversal in the used aircraft market.
Basic economic theory tells us that markets are ruled by
supply & demand forces. We also know
that the new aircraft of today will become the used aircraft of tomorrow. With this in mind, the best place to start
when determining future supply is with the Manufacturers (OEM’s).
As I have already pointed out, consumer demand for factory
new aircraft has remained somewhat stable when compared with pre-owned aircraft
where demand has essentially vanished completely. However, this sharp divergence in demand is
relatively minimal compared to the extreme divergence in price. Without significant innovation to serve as
justification, this extreme divergence is totally unsustainable.
In the next decade OEM’s will face monumental challenges
that will undoubtedly result in the failure of some brands, as already
witnessed in the 2012 bankruptcy of Hawker
Beechcraft Corporation which was founded in 1932 by Walter H. and Olive
Ann Beech. These failures will not be
related to product quality, but rather will be attributed to weak business
leaders, lack of innovation, and an explosion in production costs.
Increasing costs of energy, commodities, debt service,
labor, R & D, and airworthiness certification will continue to push new
aircraft prices to ever higher levels, thus slowing demand for new jets. Decreased demand will result in a reduction
in output. A decrease in current output
of new planes now will ultimately
tighten future supply in the pre-owned market, as the new airplanes of today
become the used planes of tomorrow.
Unfortunately, this is not good news for an industry that
has suffered both economically and from a Public Relations perspective ever
since the CEO’s from the “Big Three” automakers flew their “corporate
jets” to Washington D.C. in 2008 to plead for public funds to save
their companies. Ironically, some OEM’s
will soon find themselves in very similar circumstances, but with zero hope of
a Government brokered bailout courtesy of the US taxpayer. But there are no victims in a free market,
just winners and losers. Over the long
term, markets will ensure that the winners are deserving of their title, as are
the losers. This spirit of competition
requires leadership, discipline, vision, and ingenuity in order to
prevail. In other words, the health and
success of an organization always begins with its leadership.
The biggest challenge facing today’s business-jet makers is
that they are being cornered by market conditions for which they simply aren’t
prepared but should be, if not for weakness in leadership. For example, I was disappointed when I read a
recent article in which Scott Donnelly, CEO of Textron Inc. (NYSE:TXT), Parent company of Cessna, offered
his outlook on the future of the business jet sales
market and how he plans to lead the Cessna
brand into the future. Donnelly, who has
been predicting a turnaround in the business jet market for the last few years,
said that he’s “not guessing anymore.
Mr. Donnelly’s admission is indicative of the overall lack
of leadership currently coming out of the General Aviation community. Furthermore, as Chief Executive Officer of a
Fortune 500 company, Donnelly probably shouldn’t be “guessing” about anything
because as leader of a company with over 30,000 employees, planning for the
future is not a guessing game, it is serious business. Mr. Donnelly may also think that “nobody knows”
where the market is headed in the future but obviously doesn’t realize the fact
that HE is actually the person that is being paid to “know” where the market is
headed in order to best position the company for the future. Now I’m not saying he needs to be the next
Lawrence Bell or that his job is easy, but I do feel Textron’s investors,
customers, shareholders and employees should certainly expect more from the
While many corporate execs such as Donnelly may honestly be
under the illusion that future market trends cannot be predicted, the reality
is that they are wrong. In fact, markets
are only unpredictable in the short term, while longer term trends are very
predictable. In finance this concept is
similar to the difference between “traders” who look to capitalize on
short-term market moves and “investors” who tend to be long-term thinkers. So rather than confronting these challenges
with innovation and imagination in order to salvage the future of their brand,
those who lead these companies will instead do what they do best, which is play
with the numbers.
In my opinion, general aviation leaders of today have been
relegated to roles more fitting of general managers that specialize in mergers,
acquisitions, investor relations, profit margins, and of course share
price. Gone are the days in which
airplane manufacturing companies were led by pioneer aviators and innovators
such as Lawrence Bell, Clyde Cessna and Walter H. Beech who were driven by
their passion and imagination as opposed to the price of a share of their
As we know from earlier, if this market is really going to
turn around, the fear factor must be resolved and will ultimately happen by way
of a “smart-money” comeback. But we also
know that the days in which US based General Aviation companies acquired jets
for operational revenue are likely gone forever. Therefore, the key question for the future is
when, where, and in what form will the “smart money” show up?
The answer is to this question is of course very simple, as
logic tells us that “smart money” will only appear when, where, and in any form
in which it makes sense to do so economically.
In other words, profitability is all that matters to industry
professionals who are seeking opportunity.
If we look closely, we can already see signs that the General Aviation
Industry itself has identified pre-owned aircraft as being significantly
undervalued at current levels, and is looking to capitalize.
In the coming years the “smart money” will re-enter the
pre-owned aircraft sales market in two specific forms. First, an increasing number of General
Aviation companies will identify the profit potential in acquiring aircraft for
part-out. This is a normal stage in the
industry cycle and is overdue. It is
easily identified and occurs when the value of the aircraft, even a relatively
young one, is exceeded by the value of its major components, especially
engines. Second, significant demand will
come by way of cross-border transactions in which Air Charter Companies based
outside of the US & Europe look to acquire additional aircraft in order to
satisfy the growing demand for ad-hoc charters in emerging markets. Many regions such as Latin America, Africa,
Asia, and Australia are just beginning to be introduced to private jet travel. Adding to this potential is the fact that
certain areas within these regions are extremely difficult, or in some cases
nearly impossible, to access via Commercial Air Carrier.
Over the long term, both of these trends will have a
positive impact on the value of all types of aircraft. The increased presence and utilization
internationally will result in increasing awareness and interest into the benefits of
flying private. The part-outs
will assist the market in reducing supply of pre-owned aircraft available for
sale, thus supporting values of the remaining fleet. In addition, the increased supply of
replacement parts will ultimately lead to reduced maintenance costs for
servicing the active fleet. The lower
maintenance costs will in turn make ownership more appealing to potential
buyers, which will also increase demand for pre-owned aircraft.
In addition to the Air Charter Companies based
internationally, many corporations and HNWI’s will also begin considering
pre-owned aircraft options for acquisition.
This will be a new trend because over the last decade, the tremendous
increase in foreign and emerging market demand for private jets has essentially
been focused almost exclusively on factory new aircraft only. The reason for this is OEM’s have marketing
capabilities and access to markets abroad, while individual owners of pre-owned
aircraft typically do not. However, the
end result of the marketing efforts of OEM’s combined with the presence of
their product in these markets has naturally resulted in more educated buyers
who are seeking value or may be limited by budget.
The most obvious factor pointing to a reversal in the pre-owned
aircraft market is the fact that much of the age-based depreciation has already
been satisfied by way of market depreciation.
When using the standard 30-year lifecycle for age based depreciation,
all pre-owned jets are significantly ahead of their lifecycle depreciation,
especially if inflation is factored in.
For example, if a corporate jet that was manufactured in 1998 sold for
$12M new, sells for $1.2M now, it would mean that the asset has already lost 90%
of its value, but is only halfway through its lifecycle. With this in mind, potential buyers are in a
very good position in terms of investment risk.
Unfortunately this indicator, as extreme as it is, is rarely acknowledged.
Pre-owned aircraft will also experience increased demand in
the future as a result of the ever increasing difficulties associated with
Commercial Air Transportation. Mergers
of major Airline companies will naturally result in higher fares and a
reduction, or in some cases elimination, of service into smaller airports and
less populated region. In addition, TSA
screening procedures will likely become more problematic, time-consuming and
humiliating for travelers in the future.
These issues as well as countless other problems will continue to deteriorate
consumer demand for commercial flights and will in turn support any
Another factor that I will investigate in detail in a future
article which will further reduce supply of pre-owned inventory will be
courtesy of the US Congress and the FAA, who are banning all Stage II aircraft
from operating from the contiguous U.S. after December 31, 2015. The new law, which is included in the “FAA
Modernization and Reform Act of 2012”, will eliminate nearly 600 U.S.
registered and privately owned early-model aircraft from the General Aviation
fleet. The ban will significantly reduce
used aircraft inventory which in turn will support prices within the remaining
The future of General Aviation is bright. All airplanes are truly amazing machines with
many productive applications. The unique
characteristics of these assets is rarely acknowledged and vastly
underappreciated. Airplanes do not age
quickly like cars do. In fact, it’s very
seldom that you'll ever wear an airplane out. This is evident in the fact that there are
commercial airframes currently in service which have over 80,000 hours on them
and have the potential to continue on for many more hours. Airplanes are also portable assets and they
sell on a global market, thus making them immune to regional and geopolitical
risks that affect other asset classes such as businesses and real estate.
Across the globe the scramble for tangible assets is on, as
we are witnessing a major shift in how the world measures wealth. And even in an environment of rising interest
rates, political instability, and economic uncertainty, the fact is that
pre-owned business jets are grossly undervalued at current levels. I am advising all of my clients who have been
considering buying a jet that now is the time.
© Copyright 2013. Airstream
Jets Inc. All Rights Reserved.
# # #