Tight Financial Market

 - November 14, 2007, 9:43 AM

It is AIN’s normal approach to report the news without comment. However, it has often disturbed me, as well as other editors at AIN, that information sometimes told to us by new aircraft developers is not always the truth, the whole truth and nothing but the truth, and that in our reporting of this information we unintentionally bestow upon it the appearance of “fact.” Having covered numerous aircraft development programs in the years preceding and after the introduction of “In the Works” in March 1997, I have observed certain recurring patterns. This special analysis, therefore, blends both company information and my own opinions, based on experience. As publicly traded companies write on the bottom of their press releases, this report “may contain forward-looking statements and assumptions that involve a number of risks and uncertainties. [A] company’s actual results could differ materially from those indicated.” This statement applies in particular to the chart on page 58, “AIN’s Crystal Ball.”

As the general economy bumps along the runway looking for that tenuous “soft landing”–the expectation of which was made even more tenuous by the horrific events of September 11–startup airplane manufacturers are beginning to fold their wings or stretch their development programs for lack of financial resources.

Just this year, Century Aerospace and Ayres Corp. have closed their doors, the Century Jet and Loadmaster programs relegated to purgatory for an indefinite time. Eclipse Aviation, Safire Aircraft, Aerostar Aircraft and Farnborough-Aircraft.com all announced delays in the development programs for their respective aircraft, citing “the current financial environment,” in the words of Eclipse president and CEO Vern Raburn. AASI, VisionAire, Phoenix Fanjet and Soloy are limping along, unable to raise any new money at all for their programs. Sino Swearingen, after laying off 100 workers in April, gained a reprieve in the form of an additional $100 million from a
consortium of Taiwanese investors, but had to push its planned certification from the end of this year to the third quarter of next year. And in a class by itself, Chichester-Miles Consultants, surviving on the wealth of owner Ian Chichester-Miles, has yet to attract investment money even though it announced a radical change to its decades-old Leopard.

Although it may seem unfair to group these diverse programs together, there is no doubt they are all suffering in various degrees from the same affliction–a shortage of funds.

Dot-com Boom and Bust Hurt
The nearly decade-long economic boom that began to falter after last year’s dot-com crash had, and continues to have, curious and unfortunate consequences for airplane OEM startups looking for financing. During the boom, strangely enough, the aviation companies had trouble finding investors to fund their programs.

According to insiders, the projected rates of return of budding aviation companies were just not high enough for the New Age venture capitalists, enamored as they were with sexy dot-coms. But the dot-com meltdown made things even worse. To the chagrin of anyone wanting to fund a new company (not just aviation startups), both private and institutional investors now have become very cautious with the money they have left after the meltdown. That makes sense. But what doesn’t make sense is that the struggling aviation OEMs, instead of looking like old-time
conservative investment opportunities, suddenly appear all too risky to the newly forged, ultra-conservative venture capitalists.

The financial dilemma faced by the airplane OEM hopefuls is a tough one. Basically, there are two ways to fund a project, assuming you don’t have enough money of your own: borrow the money or sell shares in your company. All other financing schemes are just variations of these two. When they can, company owners prefer to borrow the money–hopefully at low interest rates for many years–because that allows them to retain control of their company and take as much benefit as possible from projected future profits. The downside of borrowing is, of course, that you have to pay the money back.

If a company cannot convince a lending institution to give it a loan or one with a reasonable lending rate, the only option left is to sell equity in the firm. This can be done through private placement offers, initial public offerings (IPOs) and venture capitalists, to name a few. All of these are scrutinized carefully by regulatory agencies and are not cheap to obtain.
An IPO, for example, can set a firm back half a million dollars in expenses, commissions and fees. The downside of these solutions is the same: loss of equity, profit potential and control, sometimes complete control (venture capitalists demand the highest percentage they can get, 80 percent and more not being unusual). The upside is, of course, the money, not to mention that the old owners don’t have to pay it back to the new owners. If the company goes bankrupt, the investors lose, too.
Aviation Triathlon
Unlike new firms in other industries, new airplane startups face three major challenges: development, certification and production. Like a triathlon, none of these challenges is easy and a stumble in any one of them can lead to failure. Deceptively, the early stages of the development phase are the easiest and least expensive. With even basic computer-aided-design software and not a whole lot of money, it’s not unduly hard to get a plausible design in front of the public and potential investors.
With $15 million or so, a company could even build a proof-of concept (POC) airplane and get it flying. A flying airplane is convincing to many potential buyers and investors. It’s hardware and it flies. But often all the POC proves is that the company can build a custom-made airplane. Building a certifiable aircraft and putting it into production are other matters entirely.

The big OEMs–Airbus, Boeing, Bombardier, Cessna, Gulfstream, Raytheon and so on–don’t bother with POC aircraft anymore. They go right to conforming prototypes, meaning that the prototypes conform to the design that the company plans to certify and eventually manufacture. This requires more detailed design work, extensive computational fluid dynamics analyses, much wind-tunnel testing and a lot more money on the front end of the program. Theoretically, this approach saves money on the back end and avoids unpleasant surprises and delays during certification.

The procedure works better on some programs than on others, but, without a doubt, the more aircraft programs a company completes, the better it becomes at taking an airplane from the back of a napkin to the ramp. Look at the records of the major OEMs in this regard.

Some startup OEMs are trying to emulate this method, but none has done it yet. Century Aerospace intended to take this route, but owner Bill Northrup ran out of money after spending about $8.5 million. Eclipse is using this method, but is still a year from first flight and has added six months to its certification schedule because “the current financial environment” made this prudent. VisionAire, which flew a POC Vantage in November 1996, later had to make extensive modifications to the design and is now stymied in its efforts to raise enough money to finish building and begin testing a conforming prototype.

AASI actually certified its Jetcruzer 450 in 1994, but never put it into production because, being unpressurized, it was considered unmarketable. The company is now scratching for funds to complete testing and certification of its Jetcruzer 500. Soloy can’t find any buyers or investors for its Pathfinder 21 twin-engine/single-prop mod for the Cessna 208, which it first flew in 1995 but has been on hold since February 1999. Phoenix FanJet has been planning to launch an IPO since last summer, but the dot-com meltdown seriously reduced the probability of it being successful. This year’s IPO market looks even worse.

In aviation, it’s not enough just building a better mousetrap anymore. You need money– lots of it. Estimates vary. Ian Chichester-Miles gives a rule of thumb that says you need about $30,000 per pound of the airplane’s empty weight to bring it to certification, production not included. Bill Northrup estimates he would have needed as much as $200 million to certify the Century Jet. Using Chichester-Miles’ formula, the Century Jet, with an estimated empty weight 3,500 lb, would have cost up to $57,142 per pound. Charles Taylor of Cessna estimated it would cost $100 million to develop and certify a light jet and $500 million to do the same with a heavy jet. These figures yield cost per pound of empty weight estimates well below $30,000 for most bizjets, but Taylor based his total estimates on his experience with a major OEM. In spite of bigger overheads, well run OEMs gain economies of scale with their bigness.

The Bottom Line
So where does this leave the OEM startups now scrounging for money? Where does it leave buyers and investors? Should you as a buyer consider putting down a deposit on a paper airplane offered by a company that has yet to manufacture any airplanes? Should you as a potential investor consider risking your money on such a company?

As with all things monetary, caveat emptor–the buyer beware–applies. Do your own thorough due diligence before making any deposit for any aircraft or before investing in that “sure-fire investment opportunity” with your kid’s college fund. To help evaluate the viability of the current crop of new airplane opportunities, see the boxes “Clues That May Indicate an Airplane Company Is Having Problems” and “AIN’s Crystal Ball.”