21 August 2015, ©. Leeham Co: IndiGo Airlines firmed up Airbus’ largest aircraft sale by unit numbers in the week. The order is for 250 A320neos. This means the airline goes from 180 A320neos on order to 430. The airline is just finishing off its first order with Airbus for 100 A320ceos, the final eight being delivered over the next months.
How can an airline that did not exist 10 years ago order 430 A320neos?
There are a couple of things that makes this possible, one of them being the Sale/Leaseback. Before we go to Sale/Leaseback and how this enables this magnitude of business, let’s take a quick look at IndiGo. It has certain similarities to other airlines that also close large aircraft deals.
IndiGo started as an LCC in India in the autumn 2006. It was started by the ex-CEO and chairman of US Airways, Rakesh Gangwal, with a local partner. The airline has been professionally managed from day one and holds 36% market share in India today. It will probably pass 40% next year. Right now it serves 38 destinations with 630 daily flights and is perhaps the only profitable airline in India.
So why ordering 430 A320neos and how does one finance such an expansion? The additional 250 unit purchase on top of the 180 A320neos that IndiGo ordered at the A320neo launch 2011 are part of a 10 year fleet plan. Indigo sees an expanding market and has a policy of only keeping their aircraft for six years. The 430 A320neos are for replacement of the present 100 aircraft and expansion.
But how can a young airline that need its capital for operations and its expansion spend billions on new aircraft purchases? It doesn’t. The secret to these large aircraft deals is Sale/Leaseback. Here is how it works.
When an airline buys 180 or 250 aircraft, it of course gets a great net price. Most likely it also gets favorable deposit and progress payment conditions. The deposit is what the airline has to pay right away to secure its place in the delivery schedule of the OEM. As the delivery draws closer, there will also be progress payments, to compensate the OEM for its purchase of material and sub-supplies as part of the production of the aircraft (which lasts more than a year).
When the time comes to take title to the aircraft, the rest of the purchase price is due. This is where the Sale/Leasebacks steps in and makes sure the airline never has to find the lump-sum cash to pay for the aircraft. Instead the aircraft is immediately sold on to a leasing company, this time to a fair market price. This market price is higher than what the airline pays the OEM but better than what the leasing company could buy the aircraft for from the OEM. The leasing company also gets a contracted rental (lease) customer for the aircraft for the first six years.
The scheme is a win for the airline. It gets extra capital to run its operation and pay progress payments for each aircraft it take delivery off. The leasing company gets a new lease customer (or an expanded relationship if a leasing arrangement already exists) and an aircraft for that first lease at an attractive price.
The whole scheme works at its highest pace with airlines like IndiGo, Emirates, Norwegian, AirAsia or Lion Air that all expand very fast (Ryanair orders rather special aircraft, which are less “liquid”). Legacy carriers like Lufthansa or Delta buy in more normal quantities. They therefore have other ownership strategies and tend to finance their aircraft differently and keep them longer.
So who is taking the risks in such large deals? The deals are made (except for Emirates) around very “liquid” aircraft types, i.e., types which are popular in the market and easy to place with leasing companies and other carriers should the airline that ordered them have a slower growth and not need this quarter’s deliveries.
In a down market where even an A320neo or the Boeing 737 MAX 8 would be hard to place, the risk is shared by the airline and OEM. The leasing company comes in rather late and should be able to stay clear of any excess deliveries from such mega orders. In a global backlog of 7,000 single aisle “next-gens” (neo, MAX), the market can swallow that one or other has problems. If several of these mega purchasers run into trouble, the total market has to implode for there to be whitetails.