The value of values
September 1998
Back in the yuppie late 1980s, Air Europe*, a small but high–profile UK airline, hit upon an innovative way of raising finance. It placed very ambitious orders for aircraft, including some MD–11s that it could not have used on its network, then raised loans to support its operations by refinancing several times on the back of reported increases in the value of the aircraft on order. When traffic collapsed in the wake of the Gulf war, Air Europe’s cashflow dried up, and its banks suddenly realised that its debt was very precariously supported by aircraft production slots. They called in Air Europe’s loans and the company went bankrupt.
The repercussions were widespread. Bankers suddenly became very anxious about inflated aircraft values and somewhat suspicious about the theory, touted by GPA, that aircraft were an almost risk–free investment although their operators — the airlines — could easily go out of business. Following the failure of the GPA flotation, second–hand aircraft values and lease rates declined steeply.
In the more prudent late–1990s this history will not repeat itself, we hope. But what seems to be happening is that 100%-plus aircraft financing has again become very widespread. In other words, airlines, when arranging finance for their aircraft purchases, are using this opportunity to raise additional working capital over and above the cost of financing the asset.
It’s quite easy to justify a premium. Manufacturers’ list prices are now so far above actual prices paid that almost all airlines — not just mega–purchasers — can achieve substantial discounts. Moreover, the banks rely on the appraisal companies to put a fair value on the transaction, which raises further questions.
In reality, how much do the appraisers know about the details of actual transactions? In a recent issue of the ISTAT magazine, the appraisers’ in–house publication, a leading US appraiser bemoaned the secrecy surrounding transactions, which raises some doubts. And, although appraisers may have good industry contacts, they can very rarely give specific detailed examples to support their valuations. The transactions they do tend to know about are those that they have acted on as appraisers, so creating a closed circuit.
In turn, experienced bankers know how to play the appraisal game. They know which appraisers tend to be high or low valuers and which have shallow or steep depreciation curves for future values. And they will be tempted to choose the appraiser most appropriate to the type of deal they are working on.
Does this matter? In a stable market, probably not; but in a market that is becoming edgy because of the Asian crisis, probably yes. In these circumstances, it is surely important to have more transparency on the real value trends in the industry’s fixed assets. Otherwise, the industry is too exposed to changes in the psychology of the financial markets if it perceives the physical market balance to be deteriorating. In addition, accurate information is required to focus on the divergent trends evident in the second–hand market at present. Modern narrowbody demand remains very strong; 747s are in unprecedented over–supply; and downsized widebodies, 777s and A330/340s, are in vogue although the claims made for their profit–enhancing qualities are not yet proven. How this value transparency is to be achieved is another question.
* Not to be confused with Air Europe of Italy or Air Europa of Spain, which both have their origins in the Air Europe/ILG company, but which are now successful independent airlines.
