The inside track on acquisition planning
With so many choices available to companies and individuals contemplating alternatives to airline travel, what’s a business owner or prospective flight department manager to do? Speakers at the fourth annual Conklin & de Decker Aircraft Acquisition Planning Seminar, held recently in Scottsdale, Ariz., sought to provide some answers to those questions.
The speakers addressed a number of issues for prospective buyers and providers of business aviation services, including analyzing the issues surrounding aircraft acquisition and meeting the challenges that ownership and operation pose. Topics at the two-day seminar included financing acquisitions, aircraft life-cycle costs, insurance and the tax and regulatory implications of Part 91 and Part 135 operations.
To Own or Not To Own
Nel Sanders-Stubbs, owner-operator of Conklin & de Decker’s aviation information office at the Scottsdale Airport, reviewed the pros and cons of the options for business transportation, comparing airline and general aviation alternatives and emphasizing the importance of determining the full costs of each, particularly the time versus dollars equation. Sanders- Stubbs said NBAA’s Travel$ense program is useful in showing a company considering the purchase of a business airplane the value of corporate aviation versus airline travel.
Sanders-Stubbs then discussed business aviation options, including charter and shared-aircraft or whole-aircraft ownership. She described factors to consider in determining whether to operate with an internal or company-affiliated external flight department, or through an aviation management company. She observed that placing the aircraft with a management company offers the advantages of schedule flexibility and available backup aircraft while allowing the owner to share liability with the management firm.
While having an internal flight department operate the company airplane provides no backup aircraft and places total liability upon the company, it can have financial benefits. If the owner acquires a Part 135 operating certificate it can offer charter flights to offset fixed ownership costs.
After noting that a beginning business aviation user should examine travel needs and mission profiles as a basis for selecting the type and model of aircraft to be used, she discussed the charter option and explained that if liability is a major issue, “charter may be your best option.”
She said charter may be the least costly alternative to the airlines, depending on frequency and volume of use, and offers a choice among aircraft. The user is automatically assured of backup aircraft, with no administrative overhead or financial commitment. However, he has no control over the aircraft, no say in crew selection and must place complete trust in the charter operator, among other disadvantages.
Once a company has decided to acquire an airplane for business use, it must keep up with regulations so it does not run afoul of the law. Eileen Gleimer, an aviation lawyer with the Washington, D.C., aviation law firm Crowell and Moring, discussed the regulatory ramifications of different aircraft uses and types of operations.
Gleimer said a critical issue is whether the company will use the aircraft primarily for business or personal trips, with the emphasis on “primarily.” She addressed the definition of commercial versus non-commercial operations, distinguished by the factor of compensation, which Gleimer said is defined very broadly as “anything of value.” A key issue here, she added, is whether the operator is engaging in “common carriage,” that is, the holding out to the public of transportation from place to place for compensation, or if the operation is incidental to another primary business of the company, and not a major enterprise for profit.
Gleimer explained how a decision to operate a company aircraft under a Part 135 certificate to offset acquisition and operational costs with charter revenue will affect expenses and may influence the structure of ownership. So-called “managed charter” is often done under the certificate of an aviation management company. Such a firm typically maintains the aircraft for the owner, schedules charter flights and supplies the crew.
Gleimer cautioned that if a company has its own flight crew fly a charter it may run afoul of the FAA. She added the caveat, “Make sure your insurance carrier knows and approves of what you’re doing, and that you have adequate and appropriate coverage.”
The aviation lawyer noted that FAR Part 91 Subpart K marks the first appearance of fractional operations in the FARs. It spells out responsibilities and owner definitions in what she called “an enforced education program about what existed before but what a lot of owners didn’t know.”
Key elements of Subpart K provide for co-ownership, dry-lease exchanges and common aircraft management. The new language imposes on Part 91 fractional operators minimum runway requirements, crew qualifications and flight duty time restrictions found under Part 135, she added.
Making the Right Aircraft Decision
David Wyndham, who manages and updates the aircraft cost and performance databases that make up a major portion of Conklin & de Decker’s service products, outlined the factors that affect a company’s choice of aircraft and offered guidance to existing flight departments on coping with change.
For first-timers, he emphasized the need to identify key missions and accurately quantify all requirements for the aircraft to be acquired. He defined key missions as “the ones that define success for the organization’s use of the aircraft.”
Wyndham urged those evaluating aircraft options to distinguish “needs” from “wants.” Needs, he explained, include range, passenger seating and baggage capacity as well as the ability to operate at specific airports. Wyndham placed in the “wants” category items such as extra seating, greater range and/or payload and optional equipment.
He said it is essential to compare performance and cost parameters within the context of the organization’s defined mission or missions. He noted that the Conklin & de Decker aircraft cost evaluator and performance comparator software programs provide resources to help buyers compile and analyze the data about how the aircraft they are looking to buy fits their mission profile.
A Look at the Market
Joe Dini, of Merrill Lynch Capital, offered a survey of the aircraft financing market from the lender’s investment viewpoint. He described financing and leasing alternatives along with currently available aircraft and their price ranges. Citing his company’s data, Dini noted that 15,000 of the world’s more than 22,000 turbine-powered aircraft are U.S.-based, and that 75 percent of the Fortune 500 companies fly 1,538 aircraft valued at $17.75 billion. Wealthy individuals and 9,600 smaller companies operate another 13,000 aircraft.
Merrill Lynch’s near-term outlook for jet sales is positive, with deliveries forecast to rebound to 7,700 aircraft worth $115 billion over the next 10 years.
In addition to discussing the new aircraft offerings from Bombardier, Cessna, Dassault Falcon Jet, Gulfstream and Raytheon, Dini highlighted the $5 million Piaggio Avanti twin turboprop, which he called a significant new player in the mid-range market, offering an attractive combination of speed and low noise signature. He added that the Embraer Legacy “all of a sudden is getting decent market acceptance,” aided by a price reflecting “very low” development costs for the corporate adaptation of an existing regional airliner.
Dini described and compared the benefits and pitfalls of aircraft acquisition through outright purchase, leasing and loans. Outright purchase provides all the tax benefits of ownership, with no insurance coverage limitations on area or amount of use. It allows changing the type of operation and receiving full after-tax benefit of residual value.
On the minus side, a company that purchases an aircraft through a one-time payment reduces its cash available for other purchases, is liable for full up-front payment of sales tax and risks a poor return on its investment from a used aircraft market slump.
Leasing offers a small initial cash outlay with full deductibility of payments, but denies the lessee the tax benefits of ownership. Other disadvantages include limited flexibility to sell the asset as well as insurance requirements dictated by the lessor along with operational limitations and mandated maintenance programs.
Dini observed that business use of piston-engine aircraft by both corporations and individuals is wider than commonly believed. A recent market entrant, Cirrus, is selling equity shares and appears likely to deliver 700 to 800 units a year. Used turbine sales have been averaging 1,900 aircraft a year, with annual dollar volume of more than $8 billion. Dini predicted that sales of small turboprops will overtake those of full-size turboprop aircraft in the near future.
Dini said lenders are now doing more thorough credit research and otherwise vetting prospective borrowers due to the Patriot Act and other security-based requirements. He discussed the benefits and pitfalls of aircraft ownership through leasing as opposed to financing through loans. He also explained typical financing structures, including tax leases, single-investor operating leases and finance leases, all involving early buy-out options.
Dini said lenders will take into account an assumed 4 percent annual depreciation, which roughly offsets inflation and maintains a near-level fair market value for the life of the lease. He said end-of-lease residual values range from 75 to 50 percent of the acquisition price for instruments of from four- to 10-year terms.
Conklin & de Decker’s Brandon Battles addressed a wider view of operating costs than is commonly perceived. Looking at the company aircraft through the eyes of a chief financial officer, Battles said the expenses charged to the aviation department might come as a surprise to some managers.
His presentation, aimed at flight department heads, pointed out ways to determine, analyze and present more accurately the actual cost of a corporate flight operation.
He cited overlooked costs that might be assigned to aviation, including secondary acquisition expenses such as lien and title searches, demonstration flights, broker fees and legal costs. In addition to financing costs, depreciation and taxes, Battles said a corporation’s internal rate of return on capital is likely to be included.
He discussed acquisition costs, both aircraft purchase price and depreciation, in terms of asset value. Financial depreciation is a more “common sense” procedure than tax depreciation in estimating what the asset will return upon disposal, he advised. “You have to ask yourself, ‘How long will we keep it?’ and ‘How much residual value will it have when we dispose of it?’”
Battles offered tips on how to make the flight department look good to the chief financial offer and how to justify expenditures–but only after determining that they are really necessary. He gave an example of an operation that does its own maintenance that, before collecting and analyzing all of its maintenance costs, might conclude, “We need another mechanic.”
However, after categorizing and quantifying costs at every level, “We may find that what we really need is an inventory clerk to better manage the maintenance operation so the mechanics won’t have to spend a lot of time chasing down parts.”
For total flight department costs, “It’s not enough to know you spent $1 million in the past year, and that your cost per hour was $900. You should not only be able to organize and label costs by category–maintenance, training, insurance, fuel, flight crew and so on–but to quantify the value added by the flight department to the organization,” Battles noted. This will give a manager a tool to justify outlays and requests for equipment upgrades, for example, to a finance department whose accounting system is oriented to producing a good looking corporate annual report.
Tony Kioussis of Jet Support Services (JSSI) described the prepaid hourly maintenance programs for airframes and engines that his company and the OEMs provide. Such a program, he said, can eliminate spikes in annual flight department costs, often the result of major maintenance events, that may alarm a company finance department. The programs vary widely in coverages but have a common benefit of budget predictability by ensuring that reserves are available for known events at guaranteed costs outside the budgetary process.
William “Bill” Quinn, founder and CEO of Aviation Management Systems of Portsmouth, N.H., provided advice on how an aircraft buyer can ensure receiving full value when selling the aircraft. He covered the acquisition waterfront from valuation and appraisal to pre-purchase inspections and, in the case of new aircraft, OEM completion management.
Quinn defined the various indices in a valuation process: fair market value, orderly liquidation value, forced liquidation value and market value, generally accepted as the most probable selling price, or what the asset can be sold for on a certain date under specific conditions as agreed by knowledgeable, uncoerced parties. The valuation process is a comparison, not a complete appraisal, intended to establish fair market value or reasonable asking price, to provide guidance for the buyer, seller, lender and insurer.
He noted that those involved in the valuation must understand the implications of technical, operational and regulatory issues that could affect aircraft values. As an example, Quinn cited early Cessna Citations, Learjets and Sabreliners that will more than likely leave the corporate fleet due to the implementation of domestic reduced vertical separation minimums (DRVSM) and other regulatory requirements, such as airworthiness directives, Service Bulletins, domestic and international noise mandates and minimum navigation performance standards.
Quinn said the scope of an appraisal is limited only by the amount of information available. If the seller provides complete, verifiable data that alone may be all that is required. Only “about 60 percent of the appraisals we do are those where we actually look at the aircraft’s records,” he noted.
The appraisal will take into account whether the aircraft is covered by engine and/or airframe maintenance and warranty programs such as those offered by OEMs and JSSI. He said appraisals vary from a simple opinion of value to the “desktop appraisal,” a five- to six-page summary of documentation, a comprehensive appraisal and value analysis, to a complete audit and appraisal, which will consist of 25 to 35 pages, depending on damage history and completeness of records. These must be done by professional appraisers to pass IRS scrutiny, Quinn noted.
He added that if an aircraft sale process is prolonged, “You should update the appraisal frequently. If it’s 90 days old it’s probably not valid today, because market values are moving upward.”
Aircraft pre-purchase inspections fall into two categories, the preliminary and a full pre-buy. The first is to answer the question, “Do I really want to consider buying this aircraft?” The latter, if results are satisfactory, “lets me know it’s time to tell my boss to spend the big bucks!” said Quinn. He noted that the appraisal parameters and overall scope of any aircraft inspection should be determined by terms and conditions of either an offer letter or purchase and sale agreement.
Quinn emphasized that any damage history, especially if damage is visible, warrants further inquiry. An entry stating merely structural damage “repaired” may diminish value if it is recent, whereas certification that a “return to production standard” was achieved is unlikely to affect value.
Company co-founder Bill de Decker stated in a presentation on total asset management that “maintenance records have a profound effect on saleability and value of aircraft and parts.” He emphasized that logs and related documentation must have, in addition to completeness and accuracy, traceability. Regarding part and component life history, de Decker noted, “The FAA has become rather anal about a record from birth to death of everything that has a part or a serial number on it.”
This, he said, often becomes a problem when parts or accessories are swapped between aircraft in a fleet, and during upgrades for which FAA-specified paperwork is mandatory. On the effect of documentation discrepancies, he cautioned that while “good looking maintenance records” can add between $50,000 and $250,000 to the value of a midsize bizjet, incomplete logs and records may make an airplane extremely difficult to sell at any price. Missing documentation of equipment upgrades will prevent an increase in the aircraft’s value, he added.
“Undocumented components have basically only core value,” de Decker cautioned. “Training is the most important thing in getting maintenance records properly filled out. We need to encourage a mindset of making maintenance documentation as good as the maintenance itself. The goal must be to make every (maintenance log) entry as if the aircraft would be sold tomorrow.”