AerCap and GECAS merger:
A good idea? Apr/May 2021

The macro-trends impacting the global leasing industry, covered in the previous article, suggest why the mega-merger between AerCap and GECAS might be a good idea. Here we review some of the specifics of the proposed merger.

Positioning an expanded company to take advantage of the almost certain enhancement of lessors’ control of the global fleet is one rationale for the merger. The other is our more speculative argument that prospects of serious consolidation may be less than expected because of the geopolitical split between US and Chinese controlled lessors.

The terms of the transaction: AerCap will pay GE $24bn in cash. $1bn in bonds, and 111m new shares in AerCap (there are 127m currently trading at $58), which adds up to about $31bn. GE will hand over its aircraft leasing operation plus its Milestone helicopter leasing company and engine leasing businesses of GECAS, which means taking a book loss of $3bn on its balance sheet value of $34bn.

By aircraft units AerCap and GECAS are the number one and two aircraft lessors which, with about 2,100 aircraft, together will have a physical share of 20% of the operating leasing business, plus 550 aircraft on firm order. But Aengus Kelly, CEO OF AerCap has stated that the merger “is not about scale or getting bigger for the sake of it”. It is presumably to enhance shareholder value. A target for the merged lessor might be to emulate the financial performance of ALC. In 2018 and 2019 AerCap and GECAS both reported average net profit margins of 22% while that of ALC was 36%.

Execution risk in this case is regarded as low because AerCap has completed a series of successful take-overs, effected at low point in the aviation cycle. The major purchase was ILFC, which in 2014 had a much larger fleet than AerCap, from AIG, the US insurance giant which in the Great Financial Crisis was enmeshed by credit default swaps and collateralized debt obligations, and had to be bailed out by the US government. ILFC was rapidly integrated into AerCap in 2015 with no apparent operational or financial problems.

GE, as a result of the new AerCap share issue, will be a major shareholder in the merged lessor, owning 46%. There is a concern that GE’s other aeroengine interests might not always be aligned with those of the new AerCap. However, GECAS was free to cancel orders for 69 undelivered 737 MAXes in 2020 despite the fact that GE’s Aviation division is one half of CFM (the other half being Safran), which is the sole supplier of LEAP engines for the entire MAX fleet.

SGA (selling, general and administrative) expenses are only about 5-6% of total costs at lessors, but still there would appear to be scope for synergies in this area. GECAS has a larger footprint with 24 offices globally, while AerCap has nine offices, and both are integral parts of the Dublin aircraft financing scene.

Each lessor has about 160 airline lessees but only about 60 rent from both GECAS and AerCap, which suggests significant marketing potential. Placing aircraft that come off-lease with new clients might be easier.

In negotiations with the OEMs the combined company might have increased clout, though price discounts will have more to do with the weakness of the manufacturing business in the foreseeable future. However, their existing backlogs which include about 140 MAXs and over 300 A320neo family aircraft plus 28 787s does give the combined entity a high degree of leverage because of the threat of cancelling or postponing deliveries that are running behind contracted schedules.

Merging will not reduce the combined lessor’s cost of capital. Moody’s and Fitch have reaffirmed AerCap’s credit ratings at the lower end of investment investment grade (Baa3 and BBB-), but both add a short term negative outlook, based on uncertainties about the transaction, the overall aviation market and AerCap’s need to refinance the $24bn loan it is taking out to complete the merger.

What is the underlying fleet values for the two lessors? Using fleet compositions and estimated market values at the end of last year, we estimate a current market value of GECAS fleet of $17.8bn and $28.7bn for AerCap. So the current value of the combined fleet would be around $46.5bn which compares to GE’s book value of $20.9bn and AerCap’s book value of $33.6bn, a total of $54.5bn. Both new and second-hand prices are very uncertain in this pandemic-induced downturn, but the implication is that the two lessors may be overvaluing their fleets by 17%. (In considering the $31bn purchase price for GECAS it should be noted that GECAS also puts a book value on its helicopter and engine leasing business of $7.3bn plus other assets which bring its total book value up to $34bn.)

The structure of the combined fleet by estimated market value on broken out in the three graphs. Post the merger less than 2% will be really Old Types (mostly 737 Classics), 49% Conventional (NGs, A320 ceos, A330s, RJs, etc) and 49% New Technology (MAXes A320 and A330 neos, etc). This is a downgrade from AerCap’s existing structure with a 60% New Technology presence. AerCap has stated that the aim is to get to 75% New Technology by 2025, to be achieved mostly by new deliveries rather than an accelerated disposal programme.

Whether this will be possible is questionable, Looking at the age structure, both fleets, the narrowbodies in particular, are old in lessor terms. As noted in the previous article, 40% of the combined fleet is 15 years or over, in the scrapping zone given the need to rebalance the global aviation market and to meet the new ESG requirements.

Finally, the pie chart shows combined fleets by lessee. There is clearly a highly diverse client base but 30% of the fleet value is accounted for by nine airlines, and there are some problematic cases there. Norwegian, Hainan and LATAM are in bankruptcy reorganisations; American is the weakest of the US Legacies but has secured liquidity through the recent FFP-backed bond issue; Air France is the weakest of the European network carriers but has the French government; Egyptair is financially stressed but seems to be getting guarantees from its national government.

Assuming that there are no significant antitrust or competition issues — there is unlikely to be — the transaction will go ahead but the combined entity will have to modernise its fleet and improve profitability to match the sector leaders — ALC or BOC Aviation. A risk for AerCap/GECAS is that these two lessors will expand more rapidly than expected by picking up distressed portfolios and packages of delivery slots from cancelled orders — probably a more cost-effective way to grow than through merging two companies.