To glimpse the impact of the coronavirus on global businesses, consider operating lessors.

After years of hum and haw, two lessor sales closed in March.

While Covid-19 was not the reason for these moves, the lessors’ desires to close sales transactions were likely amplified as the virus spread.

After years of sales talks and denials, General Electric (GE) finally secured an exit from aviation leasing on 9 March.

Rival Aercap will pay $24 billion for $34 billion of GECAS assets. GECAS will receive 111.5 million of newly issued shares and $1 billion in Aercap notes or cash.

The deal marks the largest financing in the aviation sector and underscores the strength of the debt markets.

“The debt markets are a big reason why this merger happened. The market was commenting on American Airlines’ $10 billion deal with institutional investors being the largest transaction ever. Then, a day later, Aercap was able to secure a $24 billion bridge loan, giving it the confidence to pursue the merger,” says a source.

AerCap entered into a $19 billion unsecured bridge credit agreement and a $5 billion twelve-month term loan. Both deals were provided by Citibank and Goldman Sachs and later syndicated to a total of 20 banks.

A few weeks later, on 29 March, Fly Leasing, which includes 84 aircraft and seven engines, was sold to Carlyle Aviation Partners.

Joe Donovan, the company’s chairman, told Airfinance Journal that the move resulted from years of frustration with the public markets.

The stock markets have not been an easy ride for lessors.

Fly Leasing has been trading at less than 50% to book value. It went public at $23 per share in 2007. “It was the realisation that we were probably too small to be an efficient public company. We traded at a significant discount to our NBV , so we could not economically raise new equity. And so, it really became a liquidity event,” says Donovan.

“Covid accentuated some of the trading difficulties we’ve had, but it by no means was the reason for the sale,” he adds.

GE’s sale of its leasing unit is part of a larger corporate imperative focused on deleveraging and paying down debt.

The conglomerate had already taken significant steps to reduce its aviation finance exposure and offloaded the lending business, PK Airfinance, in December 2019.

GE says it will use the GECAS sale proceeds and its existing cash sources to reduce debt by about $30 billion.

Goldilocks buyer

The merger of the world’s two largest lessors is just one example of the structural change that the Covid-19 pandemic has ignited across various sectors.

According to EY research, such disruptions have fuelled a surge in mergers and acquisitions starting in the second half of 2020. A stronger-than-expected rebound in global M&A value beginning in July 2020 is set to continue throughout 2021 and beyond “as companies position themselves for improved economic activity and reframe their future for the post-Covid-19 pandemic era."

Private equity firms were active in 2020, EY notes, and they will be more so as businesses and sectors reposition themselves during the anticipated recovery stage.

“With $2.8 trillion in dry-powder available, including nearly $1 trillion dedicated to buyouts, private capital is well-positioned to take advantage of the value creation anticipated in 2021. The growing presence of special purpose acquisition companies in the market could bring other forms of capital to the deal table next year,” adds EY.

Private equity money, however, is surprisingly absent from the leasing sector’s biggest shake-up in recent years.

Still, certain market observers argue an all-cash deal with private equity money would have been a better bet for GE in today’s market.

“I think playing off the five big PE firms against each other would drive better value and give them cash today rather than holding on and hoping to ride the convexity of share price to try and get better value seems a riskier play,” observes one lessor.

And although cash is king, it is also possible that GE did not want to sell GECAS for an all-cash deal at the bottom of the market.

Private equity money also presents other problems. “It would have been difficult to get to investment grade with PE ownership, and raising $25 billion would be a potential challenge,” says a source. “Also, there is no way that GE could have taken a public stake back. Even if GE had taken a private stake back, the exit would be very tricky. It is tough to sell a minority stake privately.”

Airfinance Journal understands that the GE board and management considered alternative sales structures.

Still, it is hard to imagine anything other than a public company as the new owner, given the size of the purchase.

Any interested party also would need to take on Milestone Aviation, which few entities, especially aircraft lessors, would want to do in the current market.

Tie-up talks with other lessors make sense, but due to the size of GECAS, any buyer would need to be prepared to lever up to pay for the purchase. Also, again due to the size, GE would likely need to own more than 50% of the combined lessor, complicating any sell-down process.

“Chinese banks could probably do it because of the number of assets on their balance sheets, but they’re out of the running for GECAS,” adds a lessor.

Aercap became a sort of goldilocks buyer with the “just right” exit strategy for GE by checking three key boxes: certainty, confidentiality and the ability to take back public stock.

The transaction allows GE to exchange 100% of its ownership in GECAS for 46% of pro-forma Aercap, which is more than twice in size while adding $25 billion in cash. Crucially, GE will own stock allowing it to participate in synergies and scale that the pro-forma company will bring. The transaction is expected to be completed by early 2022.

Still, according to a source familiar with anti-trust procedures, regulatory approvals could be extended because the parties need to file in every country where they have lessees.

There is also potential for geopolitical considerations in certain jurisdictions such as China that could further delay the process.

The combined company will have more than 2,000 owned and managed aircraft, over 900 owned and managed engines, more than 300 owned helicopters and 300 customers worldwide.

No doubt, the sheer size of the deal is likely to gain attention from antitrust regulators because the lessors are already almost twice as big in fleet size as Avolon, the sector’s third-largest lessor.

Aercap or GECAS may have to sell aircraft to shrink the combined portfolio to satisfy the regulators.

While the antitrust process is underway, lease rates could increase, notes a market observer, with GECAS and Aercap on the sidelines for the next several months.

Shareholder hopes

By merging, the combined entity will have a global portfolio that is 16% of the entire leasing portfolio, providing aircraft to more than 25% of the world’s airlines.

Aercap says the combined customer profile will provide greater diversification.

The top 10 customers of the combined company are expected to represent 30% of the company’s NBV, compared with about 45% currently for Aercap.

Airfinance Journal data shows the top four lessee exposures will account for 413 aircraft: American Airlines (194), United Airlines (93), China Southern Airlines (69) and Southwest Airlines (57).

Total assets on a pro-forma basis for the combined companies totalled $76 billion as of 31 December 2020.

At closing, the adjusted debt-to-equity ratio of the combined company is expected to be 3.0x.

Aercap recognised $25.5 million of expenses related to the GECAS transaction during the first quarter and warns the merger will increase its debt load.

“We will incur a substantial amount of debt to complete the GECAS transaction, which will significantly increase our indebtedness and debt service obligations, increasing risks relating to our substantial level of indebtedness,” says Aercap.

At the end of the quarter, Aercap’s indebtedness totalled $28.7 billion. 

To finance the cash portion of the GECAS transaction, Aercap expects to incur roughly $24 billion of additional long-term debt. The lessor says it may issue  "up to $1 billion of additional debt, which will also serve to further increase GE’s stake in the combined company."

As recovery begins, the mega lessor will be well placed to tap into fleet renewal, putting it on a more sustainable path to double-digit return on equity (ROE), says a source.

“ROE is the ultimate best way to measure a leasing company, but if you look at Aercap, it used to be in the mid-teens. Over time, the mid-teens have been grinding down to 10. Pre-Covid, Aercap was lower than 10.

“Covid is a great excuse to take some write-downs and reset. Also, Aercap is due to add a whole bunch of narrowbodies, which should help its returns,” adds the source.

Aercap has more widebody aircraft in its fleet than GECAS. At the end of the first quarter, Aercap’s 268 widebody fleet included: 19 Boeing 767s, 18 777- 200ERs, 22 777-300/300ERs, 114 787s, 68 Airbus A330s and 27 A350s.

It also has orders for 23 787s.

GECAS, on the other hand, had 123 widebodies including 10 747-400s, 11 767-200s, 23 767-300s, nine 777-200s, 33 777-300s, one 787-8, eight 787-9s, 12 A330-200s, seven A330-300s and nine A350-900s. The lessor has orders for 12 A330- 900neos and four 787-10s.

Of course, lease companies need to manage their exposure; however, critics of the merger are quick to say the deal is a tool for pro-forma Aercap to “kitchen-sink” a lot of its problems through purchase price accounting.

The lessor expects new-technology aircraft to reach 75% of the combined Aercap-GECAS in-service fleets by the end of 2024.

New-technology aircraft accounted for 56% of Aercap’s aircraft NBV at the end of 2020.

Aercap is assuming about $1 billion of sales a year.

The lessor's chief executive officer, Aengus Kelly, describes the figures on an earnings call as a "fairly diminished amount for a balance sheet of this size". 

"If we were to increase that level of sales, what you would see is a further acceleration of that 75% and further reduction probably in the debt-equity levels, and improvings in the ratings," he adds. 

Narrowbodies represent 59% of the total fleet in NBV terms, while widebodies and regional jets accounted for 40% and 1%, respectively.

By December 2024, narrowbodies will increase in NBV terms to 66% at the expense of widebodies (33%), while regional jets are forecast to remain at 1%.

On completing the integration of GECAS, Aercap expects to generate selling, general and administrative synergies (SG&A) of $150 million compared with the combined 2019 SG&A expenses for the two businesses.

Aercap insists that the takeover is at an “attractive purchase price” with a discount to the net asset value.

As of 31 December, the GECAS business had a net asset value of $34.2 billion, excluding the US deferred tax liability of about $800 million that will be eliminated as a result of elections under Section 338(h)(10) of the US Tax Code.

Based on the closing price of Aercap’s shares on 5 March, the consideration has a value of $30.6 billion, representing a discount of $3.6 billion compared with the net asset value of the GECAS business as of 31 December.

GE notes in an annual report that after completing the transaction, it will “elect to prospectively measure” the investment in Aercap at fair value and expects to have continuing involvement with the lessor, primarily through its ownership interest and ongoing sales or leases of products and services.

“In addition, we expect to sell our stake in an orderly fashion over time,” adds GE.

In connection with the merger, GECAS was moved into discontinued operations and recorded a net loss of $2.6 billion for the first quarter. This amount includes a loss on sale of $2.8 billion from the Aercap transaction, offset by about $200 million of earnings.

Size Matters

DAE CEO Firoz Tarapore describes the largest aviation merger as a “fantastic deal” for both Aercap and GECAS because it allows them to further their strategic interests.

“There are the normal set of issues around like antitrust clearance, but I am sure all of them will get appropriately resolved,” he says.

But he also warns of diseconomies of scale. “There are some legitimate questions whether there are more real diseconomies of scale in our business. Only time will tell if 2,000-plus aircraft is too big to create the right economic returns for the capital they deploy, or the risk they take by deploying capital.”

BOC Aviation agrees: “We view this combination as generally good for the major players in the industry, removing as it does an overhang. There is nothing that we have seen that suggests being a behemoth confers any benefits relative to an adequately scaled business (generally >$10 billion in aircraft assets), so we don’t see it as anti-competitive,” says Timothy Ross, head of investor relations.

Air Lease’s executive chairman, Steven Udvar-Házy, is unfazed by the news of a mega lessor. “While they will be busy and distracted, we will continue to do what we do best. All you have to do is look at our 2020 financial results versus Aercap, GECAS, Avolon, Fly, DAE , etc.,” he says.

During an online event, major rating agencies dismissed the notion that the Aercap-GECAS merger and the sale of Fly Leasing to Carlyle will lead to further consolidation among larger rated lessors.

BOC Aviation also dismisses any near term consolidation. “Our focus remains on producing the largest shareholder returns rather than having the largest balance sheet, so we are not anticipating any copycat moves right now,” adds Ross. 

But with aircraft leasing seen as integral to airlines’ recovery plans and investors sitting on mounting cash piles, perhaps Covid will help push another deal over the line.

Neither Aercap nor GECAS was available for comment.