Those of us who are intimately familiar with commercial aviation will find this as no news. For those who don’t deal in this business every day, this will provide a better understanding of how deals are won in aviation.
This is the story of the GE Powerhouse and how family ties combine to enable GE Aviation and CFM International to win deals that might otherwise go to competing engines.
None of what we’re about to tell you is to suggest that the GE/CFM engines are inferior (though, obviously, some might dispute this), because they are superb engines. But a telling comment came from CFM’s Sandrine Lacorre, product marketing director, who said at a UBM Aviation conference, “What we can’t do technically, we will do commercially.”
Aeroturbopower and AirInsight beat us slightly to the punch on this thesis, but neither went in-depth with what we’re about to describe. And let’s be clear: we are in no way suggesting or implying criticism of GE or CFM; this is simply a report of “how the game is played.”
We’re going to focus on last week’s Republic Airways Holdings order for 40 Airbus A319neos and 40 A320neos. CFM LEAP engines were selected, which contrasts with the PW GTF engines on Republic’s previous order for 40 firm and 40 options for the Bombardier CSeries. The market believes Republic will cancel the BBD order; Republic says it’s intact. One would have thought that RC would have ordered GTF for the neos for commonality. But the Airbus deal was wrapped up in a financial restructuring package for Republic’s subsidiary, Frontier Airlines, which is headed toward financial disaster. We expressed our thoughts as to why in this post, under the Bombardier section.
To understand how CFM is well positioned to win deals, one must first understand the make-up and philosophy of GE’s aviation units. There are several but the three relevant ones to this story are:
GE offers customer financing for airlines and usually “parks” the deal in GECAS, though not always. At one time GECAS was considered the financier of last resort, but this was in the heydays of the 1980s and 1990s when many airlines were investment grade credits and the poor credits could find financing only at GECAS, with its expensive pricing in lease rates and fees. As the airlines overall became worse credits and when capital markets began to contract, GECAS increasingly became a more common source of financing, mostly in the form of operating leases but sometimes in the form of finance leases.
As a matter of policy, GECAS will generally only originate deals on airplanes operating GE engines if there is one offered so as to not enrich the coffers of PW or Rolls-Royce. In the secondary market, GECAS is more willing to do deals involving airplanes with non-GE engines; or if such airplanes are part of a larger transaction. GECA has a large portfolio of Boeing 757s, which are powered by RR or PW engines, for example.
Finally, GE corporate has a policy that it wants to be #1 or #2 in every market it serves.
The history of Republic
As we noted, both before and after the Air Show, Republic’s financial condition is tenuous, dragged down by the sorry performance at Frontier Airlines. Frontier is squeezed at Denver by United and Southwest; and at Milwaukee by AirTran, which was acquired last month by Southwest but remains AirTran for another year, and by Delta. No city has ever been able to support three hub carriers and few support even two. The original Frontier Airlines went bankrupt facing United and Continental Airlines (which itself later abandoned Denver as a hub). An entirely new airline adopting the Frontier name came along a decade later and created a good if small alternative to giant United, whose service was so bad that Colorado residents were aching for a travel option.
For a variety of reasons, Frontier declared bankruptcy a few years ago. Southwest, which by then had begun service to Denver, made a bid to buy Frontier but its pilots squelched the deal. Republic bought Frontier and took it out of bankruptcy.
Midwest Airlines, which had carved a niche in Milwaukee before failing to respond properly to changing market conditions, was sold in a bidding war to Republic which merged Midwest into Frontier. AirTran was the losing bidder and went ahead to begin over-laying service vs. Midwest.
Republic acquired the two airlines in a bold move to diversify its reliance and destiny on major carriers. RC was, until the acquisitions, simply a regional service provider. Some questioned the moves strategically, some questioned the move for Midwest specifically and some thought RC was nuts to take on UA and LUV in Denver. And all pretty much turned out to be correct.
As Frontier’s fortunes declined, the very existence of RC was threatened. In came The Seabury Group, a consulting firm that specializes in corporate restructurings, in or out of bankruptcy. What transpired is the deal that became public last week.
The Republic Deal
Republic CEO Bryan Bedford publicly said the very viability of Frontier was at stake and on the most recent earnings call that $100m in cost cuts were needed. What emerged was “classic Seabury:” employee concessions, vendor cuts, restructuring airplane deals. Republic’s 8K, a required filing with the US Securities and Exchange Commission, outlined the broad stokes of the deal. The 8K is reproduced at the end of this post.
What’s important in the thesis of this post is what the RC spokesman said upon the announcement of the Airbus deal (CFM offered “great incentives” for the deal) and the GE family role: CFM offered deals, GECAS cut lease rates, CFM cut financial terms of the deal with the CFM56 on the current Airbus fleet; and separately, the credit agreement with Airbus Financial Services was also amended.
This ability to provide a broad, comprehensive GE Family deal–whether in a financial restructuring as with Republic or in a standard transaction that includes aircraft leases, goods and services and the engine selection, is a major advantage that neither PW nor RR can match.
The Airbus/CFM deal keeps Frontier–and Republic–alive for now. The Airbus deal, frankly, makes no sense at all outside of it being a rescue package. We don’t see the need for 80 firm orders of new airplanes at RC on top of the 40 firm and 40 option previously entered into with Bombardier, and we certainly don’t see the need for 120 firm orders of mainline jets. While people are questioning whether RC will cancel the CSeries order, the larger question should be, “Will Frontier be around to take delivery of any of these airplanes in 2015/16?” We have our doubts.
RC’s deal with the pilots means RC is reducing its stake at Frontier to a minority position, and market information is that RC is trying to peddle the airline altogether. Given Frontier’s market position against United and Southwest in Denver and AirTran/Southwest and Delta in Milwaukee, we think Frontier is a goner–the only question is how soon.
As for stand-alone engine/services packages that don’t involve restructuring or lease rates, “buying” market share is pretty common. Although CFM told our partner, Addison Schonland of AirInsight, last week that it doesn’t “buy” deals, there is solid evidence to the contrary. David Cush, CEO of Virgin America, said GTF was ahead until CFM came in with an economic package that was superior. There’s the Republic deal. And there’s the comment from CFM’s Lacorre, noted above.
In the battle between PW and CFM for neo orders, CFM’s large, installed base vs. the PW indirect share through the IAE consortium for the V2500 engine means a huge advantage for CFM to cut package deals for previous MRO and financing packages, as with Republic. Where GECAS leases aircraft to the airline, or may take on neos in a future financing for the customer, CFM can offer a “family package;” and if the airline needs GECAS for financing, the GE policy of buying only airplanes with GE engines forces a decision in favor of CFM’s LEAP engine.
CFM’s LEAP-X engine clearly fell short of fuel burn vs. the GTF until it was revamped, after losing every competition in early going. After revamping the engine to narrow the fuel burn gap (depending on who is doing the talking), coupled with the muscle, the resources, the incumbency and the family packaging, CFM came roaring back at Paris.
We expect going forward CFM will have a larger market share for these reasons. But there is also no question that PW is back as a viable engine provider in the single-aisle catergory.
Republic Airways 8K SEC filing:
In connection with the term sheet the Company entered into (i) an amendment to the Credit Agreement with Airbus Financial Services, dated as of October 30, 2009 between the Company, Frontier and Lynx Aviation, Inc., a subsidiary of the Company, and (ii) an amendment to Frontier’s purchase agreement with Airbus.
On June 21, the Company entered into a memorandum of understanding with CFM International, Inc., related to the selection of the LEAP-X engine on its Airbus NEO order. The MOU, which is subject to final documentation, covers, among other things, a fuel burn guarantee, future spare engine pricing, and a reduction in the overhaul cost of existing Airbus engines.
On June 21, the Company also entered into a term sheet with GE Capital Aviation Services LLC (“GECAS”) to amend the terms of certain A319 leases between Frontier and GECAS. The parties agreed to, among other things, the return of four Frontier A319 aircraft to GECAS during 2012. The remaining 18 A319 GECAS leases will each be extended for a period of 3 years and the average monthly lease rate will be reduced. The term sheet is subject to, among other things, final documentation and approval by GECAS’ board of directors.