TEAL GROUP BUSINESS AVIATION OVERVIEW (PART 2)
Category: Aircraft Sales – Forecasts
Author: Richard Aboulafia
Teal Group Business Aviation Overview (Part 2)
A closer look at the driving factors.
Looking at the trends (see Part 1 to this Outlook in World Aircraft Sales Magazine, July issue, p64 to recap), and at the current state of the market and the very strong econometric drivers behind it, we have formulated a forecast that makes the following assumptions:
• A market peak in 2008. This is a very unusual event – usually you can see a peak coming. Among all the aerospace markets, business aircraft were hit first and fastest by the downturn.
• A 40% peak-to-trough ratio (by total market value of traditional business jets) in a three-year downturn (2009-2011). The last downturn (2002-2003) saw a 34% peak-to-trough by value, but over a two-year period. The market fell by 39% in 1981-1986, and 53% in 1968-1971. None of these experiences provide adequate guidance, particularly since the economy is in uncharted territory, but we feel that a 40% downturn over three years is a respectable assumption based on the general economic outlook.
• A post-downturn recovery period starting in 2012 with a 10% CAGR over the following five years in our forecast. Past recoveries have generally been faster, so you can regard this as a conservative assumption. The 2003-2008 recovery saw a 17.1% CAGR. The great 1991-2001 market transformation exhibited a 14.3% CAGR. The other growth cycles were much shorter-lived – the 1976-1981 period also saw a 14.3% CAGR, while the 1986-1988 period saw a 12.8% CAGR. Given the remarkable transformation of the market after 1995, and given uncertainties about finance and other factors, we believe that it’s best to be prudent about further growth. The last year of our forecast is flat.
For an interesting guideline, the private aircraft market is now worth approximately one-third as much as the commercial transport market ($21 billion compared with $63 billion in 2008 deliveries). However, the private aircraft fleet now transports approximately 0.1% of the traffic accommodated by the world’s commercial transports. While this ratio is best regarded as an anecdotal metric, it illustrates why business aviation has attracted enemies.
It's an easy target for populist politicians, and user fees and carbon emission costs are readily imposed when there's a small user demographic.
The lines between business jet segments in our forecast are imperfect. We had to demarcate somewhere between classes of jets; inevitably competing aircraft were separated. But these are the categories we used to break down the market:
• Turboprops: Single and twin engine planes including the King Air, Avanti, PC-12, and TBM 700/850. Total value in our forecast: $12.4 billion.
• Very Light: Small jets commonly called VLJs, selling for $1-4 million. Players include Cessna’s Mustang, Embraer’s Phenom 100, the HondaJet and multiple new market entrants, none of which really has much of a chance. Total value in our forecast: $7.2 billion.
• Class One: Until recently this was the low-end. Prices are in the $4-8 million range. Players include the Hawker 400, Premier I, CitationJets 1-3, Citation Bravo, SJ30 and Phenom 300. Hawker Beechcraft and Cessna dominate this segment, but Embraer has targeted it as a new entrant. Total value in our forecast: $9.4 billion.
• Class Two: The workhorses. Prices range between $8-18 million. Players include all the Learjets, Hawker 800, Citation Sovereign, Encore, XLS, Legacy 450 and G150. Total value in our forecast: $32.4 billion.
• Class Three: The Upper Middle segment (see further discussion of segments, below). Prices fall between $18-25 million, and the players include the Falcon 50, Falcon 2000, Challenger 300, G200/G250, Citation X, Legacy 500 and Hawker 4000. Total value in our forecast: $25.9 billion.
• Class Four: Priced in the region of $25-37 million, players include the Falcon 900, Challenger 605, Global 5000, and G350/G450. Total value in our forecast: $36.7 billion.
• Class Five: The highest segment for dedicated business jets, prices are at $37+ million. Players included are Gulfstream’s G500/G550/G650, Dassault’s Falcon 7X and Bombardier’s Global Express. Total value in our forecast: $42.3 billion.
• Business Jetliners and RJs: Add-on lines comprise the ACJ, A318 Elite, BBJs, Challenger 800 series, Airbus and Boeing wide-bodies, and Legacy 600 and Lineage 1000. Total value in our forecast: $29.6 billion.
WHAT THIS OVERVIEW COMPRISES
This overview looks at all fixed-wing turbine- powered aircraft that are mostly (but not exclusively) used by private operators (businesses and rich individuals) and fractional ownership providers.
WHAT THIS OVERVIEW EXCLUDES
For the most part, this overview does not cover business variants of aircraft not primarily used in this role. Many companies and people choose business variants of older airliners, such as the A310, Jetstream 41, or anything. Xerox, for example, uses a Bombardier RJ, while Corning purchased a Dornier 328. The Sultan of Brunei ordered an A340, and Airbus is even working on a version of its A380 as a VIP transport. The Prime Minister of Lebanon has a 777-200ER.
If you want to promote an image of corporate parsimony, consider CASA’s executive C-212, which isn’t even pressurized. It’s better than going Greyhound!
Caveat: In 1996 Boeing announced a dedicated long-range bizjet variant of its new 737-700, and Airbus followed with its A319CJ. Because they are covered in our jetliner forecast, they are not included in our quantitative market forecast. The same is true for corporate variants of regional jets, such as Embraer’s Legacy and Lineage, or Bombardier’s RJ SE (now Challenger 800 series), which are counted in our regional aircraft forecast.
BUSINESS AIRCRAFT MAKERS & THE MARKET’S FALL
As the world economy struggles to recover from the massive shock of late 2008 and early 2009, the business aircraft market has found itself in free-fall. All the leading indicators of market health – used aircraft availability, aircraft prices, and utilization – point to a severe downturn. Broader economic indicators that drive business jet demand, particularly corporate profits, are also falling fast, implying that this will be a prolonged downturn.
The market’s collapse, coming after five years of record growth, means big changes for the business aircraft industry. With no hope of new entrants and the real prospect of mergers, there is a good change that this industry will see fewer manufacturers.
Meanwhile, until the market recovers, industry players will have limited resources for new products.
NO NEW ENTRANTS
In 2008, five major players controlled the business jet market. Bombardier, Dassault, Gulfstream (GD), Cessna (Textron) and Hawker Beechcraft held 99% of deliveries that year. However, Embraer has successfully diverted resources from its regional jet business to a line of new business jets.
The first, the Phenom 100 Very Light Jet (VLJ), entered service in December 2008. The Phenom 100 and 300, and the Legacy 450 and 500 will establish Embraer as a sixth major manufacturer, with a 7% market share by value by the end of Teal Group’s ten year forecast period.
In terms of market participants, the business aircraft industry is quite large by aviation standards. There are only two jetliner primes, Airbus and Boeing. Most other aviation market segments have between three and five players. But there are six business jet and three business turboprop manufacturers. More importantly, there have been over ten new attempts at entering the market over the past ten years. All of these have failed.
The cause of these failures is the same factor that keeps aviation a relatively elite industry, with very high barriers to entry. There are enormous capital requirements needed to not just develop, test, and build new products, but to create the elaborate sales and support networks needed to satisfy demanding customers. New companies also need to generate the cash to develop ever-important new models, and to withstand market downturns.
The few new manufacturers that have delivered actual aircraft have quickly proven to be unsustainable enterprises. Since 1960, just one new player – Embraer – has succeeded as a new aircraft producer. With that background, a plunging market removes any hopes for a new aircraft manufacturer.
The prospects for new entrants have been further damaged by some recent high profile business failures. The most spectacular was Eclipse Aviation, which went bankrupt in 2008 after spending about $2 billion and delivering 258 jets that will now be orphan planes. The past two years have also seen costly business plan failures at Sino-Swearingen and Adam Aircraft. Just before those, Aviation Technology Group and Avocet both failed, wiping out hundreds of millions in investment dollars.
All of these failures, but especially the very heavily hyped and vaunted Eclipse, have a chilling effect on funding for new ideas in this business. They also reduce investment enthusiasm for the sector in general. Yet there is one exception to the bias against new players. Japan’s Honda has designed its HondaJet and is building a plant in Greensboro North Carolina which will serve as headquarters, production and delivery facility. This will be completed in 2010.
The HondaJet project is unusual in many ways. It was designed by a car company with no previous interest in aviation and it features engines mounted above the wings. This configuration hasn’t been seen since the VFW614, built in Germany in the 1970s. Even more curiously, Honda built this airplane in conjunction with its own new turbofan engine, making it the only vertical airframe/ engine jet of the modern aviation era.
Most unusual of all: this project will succeed. Unlike all the other new market entrants, Honda has all the resources necessary to make this happen. The development costs are almost a rounding error in the company’s finances. There have been some recent signs that Honda was scaling back its ambitions. It had planned on an annual production rate of 100 planes, but in February the company reduced this plan to 70-80. Still, Honda represents the best sign that an innovative approach can work in this industry, albeit only if it has virtually unlimited resources.
INDUSTRY RESTRUCTURING PROSPECTS
While we don’t see any new players introducing new aircraft, it is possible that new owners play a role in any industry restructuring that might take place. From an acquirer standpoint current market conditions have created an ideal buying opportunity. From the standpoint of some business jet manufacturers, there’s the strong prospect of needing new sources of capital.
Looking at the restructuring question with an eye on possible target companies, there are two big prospects. The first is Hawker Beechcraft, owned by Goldman Sachs and Onex, and deeply in debt. The weakest of the big six players, Hawker is also vulnerable to Embraer’s aggressive moves to enter its market space.
Cessna is the biggest unknown variable. The company has first rate management, a seamless and popular product line that allows it to dominate the bottom half of the business jet market, and an enviable track record of pleasing customers and generating profits. Unfortunately, it is owned by Textron, an industrial conglomerate which has been rendered vulnerable by its large finance side.
In January, the company’s stock tumbled the most in two decades after executives said 2009 profits would be below expectations. In January, Standard & Poors lowered the company’s long-term credit rating to junk status. In February, CEO Lewis Campbell said the company might need to sell Cessna or Bell Helicopter to raise cash by next year.
Then, during April, rumors emerged that Textron would be purchased by a United Arab Emirates-based investment bank. If this happened, the defense assets would be sold to other US companies, but Cessna would be retained, rapidly elevating the new investors into a strong business jet and general aviation market position.
In terms of acquirers, defense companies might play a key role in Cessna or Hawker Beechcraft’s future. Many of the defense corporations have had experience with business jet company ownership. Perhaps the most intriguing player is General Dynamics, which has had a generally very happy experience owning Gulfstream for over ten years.
It also acquired Galaxy Aerospace, and in 2008 purchased Jet Aviation. A Cessna acquisition would give it nearly half of the market, and position the company very nicely for a market recovery. Private equity is also a highly likely player in any acquisition. Onex and Goldman Sachs were certainly not the first private equity players to own a business jet company.
Most notably, Gulfstream was owned Forstmann Little between 1990 and 1998. Also, it’s possible that current turboprop manufacturers obtain investment backing to enter the jet arena. Piaggio, in particular, has plans for a new family of light/medium jets, and while they have yet to find the resources to accomplish this goal, they have obtained some financial backing from Mubadala, a United Arab Emirates investment fund.
Socata, which is interested in creating a business jet family to sell alongside its TBM 850 turboprop, was sold to DAHER in late 2008. DAHER, an industrial conglomerate looking to get into general aviation, is more likely to fund new aircraft development than Socata’s previous owner, the European Aeronautical, Defense, and Space Co. (EADS), which remains focused on Airbus jetliners and military equipment.
FEWER NEW PRODUCTS
Despite hopes for outside cash to fund new products, the unfortunate reality is that most business jet manufacturers are not in sufficiently strong shape to develop new jets. As revenue falls at all of the business jet manufacturers, there will be fewer resources available to commit to new product development.
Independent research and development (IR&D) spending tends to fall in tandem with sales. This market decline will not only affect new jet introduction; suppliers will likely reduce their development spending too, implying slower introductions of new innovative engines, avionics, and other components.
There have been several notable new product development casualties. Dassault was widely expected to launch its Falcon SMS (Super Mid Size) model late last year, but this has been deferred. Rolls-Royce, whose engine is the only known supplier contract awarded for the SMS program, has argued that Dassault should continue to defer this new $22-25 million model.
Hawker Beechcraft has shelved its Hawker 450XP, an update of its Hawker 400XP, and has also reportedly deferred its Premier II derivative of the Premier I. But the biggest casualty of all has been Cessna’s highest priority - its Citation Columbus. With an $800 million development bill the new large cabin jet hasn’t been able to withstand budget cuts. In March, Cessna announced that it was stretching out development by six months. In April, Cessna announced that it would shelve the design, and returned deposits to customers. This means that the company is abandoning what looked like a very attractive program, one that would help it enter the top half of the business jet market.
On the positive side, Bombardier has confirmed that it will continue to develop its Learjet 85, a composite design. And once again, defense revenue will play a role in this industry. Gulfstream’s two new programs, the G650 and G250, are proceeding as planned. Notably, the G650 will be the biggest, heaviest, and most expensive traditional business jet built yet, and thanks to General Dynamics’ military business, Gulfstream will have the resources needed to bring its highest priority to market.
When the business jet market recovers after 2011/2012, it will enjoy revenue from the Lear 85, G650, G250, and hopefully the Falcon SMS. However, there will likely be a new product development drought after these new products arrive. The market’s rapid deflation means it will be worth billions of dollars less than anticipated in the coming years.
In addition to reduced resources for new designs, this market drop implies a reduced incentive to spend on new products. For example, if business jet deliveries had kept ramping up above $30 billion annually, there would have been an ironclad case to develop a long-awaited supersonic business jet (SSBJ).
While Gulfstream and other established companies continue to research the basic engineering behind an SSBJ, an actual program launch has moved further out, almost certainly beyond 2020. Two niche companies that offered their own SSBJ designs, Aerion and Supersonic Aerospace International (SAI), will likely need to put their business plans back on the shelf for a few more years.
Recent product launch decisions by Bombardier and Embraer provide the best illustrations of the diminished prospects for new business jets. In July 2008 business jet market leader Bombardier launched its 100/130-seat CSeries jetliner family. This represents an enormous commitment for the company, and basically rules out any kind of direct response to Gulfstream’s G650.
Today, Bombardier’s Global Express XRS and Gulfstream’s G550 are similarly priced and compete for the same customer base—corporations and wealthy individuals that want the largest and most capable traditional business jet. But now that the G650 is poised to establish a new high end, the Global Express has been left behind (along with the G550) as just another price point in a broad market spectrum.
With the CSeries launch decision, Bombardier will need to continue to rely on upgrades of its Global Express product, and accept a gradual loss of business jet market share in order to fund a move into the large jet transport market. Meanwhile, Embraer, whose highest priority over the past five years has been the development of its Phenom and Legacy business jet product lines, has launched its KC-390 military transport. The company made a firm decision to proceed with this long-mooted product in April 2009.
There’s a certain logic to both of these moves. Bombardier finds the CSeries target market attractive because even though airliners typically enjoy lower profit margins than business jets, jetliners offer almost guaranteed long-term growth. Embraer finds the KC-390 market attractive because it’s a relatively secure place—it’s a small niche, but a home market customer (the Brazilian Air Force) will help pay for much of the aircraft’s development costs. In short, the CSeries and KC-390 product launches reflect a wavering of confidence in the business jet market’s future. This lack of confidence will persist until we see firm signs that the market is growing again.
Clearly, a market downturn of this severity has profound consequences for the evolution of the business jet industry. Fewer new players, fewer new products, and reduced innovation are all likely unfortunate side effects of the market’s sudden and painful fall from grace.
The detailed forecast numbers can be purchased from Teal Group. Mr Aboulafia can be contacted at email@example.com, www.tealgroup.com