Forecast paints bleak picture for bizav market

 - October 9, 2007, 11:19 AM

And you thought the dot.com bubble-burst was bad.

After a spectacular ascendancy in the late 1990s, the business aviation industry has taken a dive and continues to lose altitude. The excesses of fractional-ownership provi- ders and an overly exuberant high-technology sector in the second half of the last decade, coupled with an economy that is stuck in the mud, have conspired to throw the market for new business airplanes into a profound downturn. Sales of new business jets, which had reached record levels between 1998 and 2001, have slowed. Prices for used airplanes, meanwhile, have fallen as inventory levels continue to climb. Add to all of this a number of serious questions about the industry’s long-term direction and it’s no wonder that top executives for the five major business jet producers are anxiously scanning the horizon for any spot of sunshine.

The Teal Group, in its 13th annual Business Jet Overview, scheduled for release later this month at the Paris Air Show, calls the current environment the first downturn of a transformed market, part bubble burst and part momentary down cycle.

Teal’s unvarnished look at the health of the market for new turbine-powered business airplanes and a forecast of where the industry may be headed in the next 10 years makes for fascinating reading. Richard Aboulafia, vice president of analysis for Teal and the forecast’s lead author, begins by pointing out that despite these tough times some perspective is useful in trying to understand just what has been going on in the market. The worst years of the current downturn, projected by Teal to occur in the 2004 to 2006 timeframe, for instance, are still better than any year before 1998, the forecast said. Beyond 2006 the market will resume its long-term growth, although Teal does not predict a return to the heady peak levels of a few years ago until after 2013.

The most encouraging news from Teal’s forecast is the prediction that the industry as a whole will manufacture 6,075 business jets worth $89 billion (2003 dollars) in the next 10 years. Gulfstream will be number one in market share, at an average of 27.9 percent, thanks to its acquisition of Galaxy Aerospace and rival Bombardier’s need to focus on profit.

But a loss of market share isn’t necessarily a bad omen for the Canadian company, said Teal. Bombardier spent much of the upturn obsessed with market share, with the result being lots of excess production and mediocre pricing. The company’s new CEO, Paul Tellier, comes from the railway industry and should be able to recognize a commodity business when he sees one, said Teal’s forecasters. Bombardier’s share of the market is expected to dip to an average of 22.4 percent in the forecast period, from 25.5 percent in the last 10 years.

Dassault’s market presence should grow slightly in the next decade, allowing the French manufacturer to surpass Cessna and take over the number-three spot among producers. Its slice of the pie will comprise just under 20 percent of the total. Yet thanks to its ability to mix and match airframes, wings and engines, Cessna will have a good 10 years ahead, said Teal. The Wichita manufacturer’s average market share should stay even at 19.4 percent.

Raytheon Weakest Player

Raytheon Aircraft is the weakest of the major players, and for good reason, the Teal overview stated. Deliveries last year gave Raytheon just 9 percent of the total market. Development costs related to the Premier I and now Hawker Horizon have hurt the business. An order by NetJets for 50 Horizons at the 1999 Paris Air Show seemed to establish that airplane as the dominant model in the super-midsize segment, “although there have been serious technical problems with the design,” said Teal.

(When pressed by AIN, Aboulafia was unable to be specific about the “problems,” conceding he inferred them on the basis that technical issues encountered in the delayed Premier I program may have “translated over to the [delayed] Horizon [program]. But we can’t tell you. We believe there was something more substantial than just bad management.” Raytheon insists the program is technically on track. “There are no technical problems with the airplane,” according to a Raytheon spokesperson. “We are very pleased with the Horizon.”)

Raytheon Aircraft, Teal added, is very much on the market, but so far its asking price has been unrealistic. Unless it finds a way to pull itself out of its current tailspin, Raytheon Aircraft could soon find itself sold off in pieces, said Teal.

In the so-called very light jet segment, Teal predicts the Cessna Citation Mustang and Eclipse 500 are the only designs that have realistic chances of showing any promise. Most other proposals have foundered or stagnated, and even with new jets in the pipeline–Teal mentioned a Honda HFX-powered airplane in the contemplation phase at Learjet, an all-new Premier I-size airplane from Fuji and a New Piper design that would use the Williams FJX as possible contenders–airplanes in the sub-Mustang class won’t have much of an impact, it predicts.

Dominance by the large, established players will continue, as will the bias against startup companies, said Teal. The larger companies have the resources to develop new models and withstand cyclical downturns. The deck seems completely stacked against new market entrants, and conditions look to stay this way for the predictable future. After all, Teal points out, only one all-new market player–Embraer–has succeeded in delivering more than one jet-powered airplane per month on a sustained basis in the last 40 years.

The most vulnerable of the established market segments is the super-midsize category, Teal said. The Raytheon Hawker Horizon, Bombardier Challenger 300, Cessna Citation Sovereign and Gulfstream 200 all face high levels of risk and uncertainty, owing to a crowded market, which makes this category all the more vulnerable during a downturn. Super-midsize airplanes also face pressure from a number of current, past and future models in similar price/capability ranges, namely the Dassault Falcon 50, Citation X, Hawker 1000 and Gulfstream 300.

Is It the Time for an SSBJ?
In the long term, the upper echelon of the business jet market should experience the introduction of an entirely new class of airplane–the supersonic business jet (SSBJ). Teal’s prognosticators believe it is more than likely that an SSBJ design will be unveiled sometime in the next 20 years. The very highest end of the market–those individuals, businesses and governments who would presumably buy SSBJs–seem willing to pay any price. “So a $70 to $80 million supersonic bizjet becomes a reasonable proposition,” said Teal.

Dassault has the most skill to lead an SSBJ project, noted Teal, but in March 1999 it shelved such plans. “This is unfortunate,” wrote the authors, “as it would have been a great way to crush the G500/Global Express market segment, from which Dassault found itself largely excluded.” In conclusion, Teal predicted a 60-percent chance of an SSBJ program launch in the next 15 years and an 85-percent chance by 2020.

Teal lays much of the blame for the current downturn at the feet of fractional providers, which were responsible for fueling growth in the last several years and are the ones canceling orders now. An unprecedented 15 new aircraft models arrived between 1995 and 1999, just in time for the industry’s growth spurt. And while fractional providers during the flush years grew, the number of customers grew even faster. According to Wichita-based AvData, the total number of fractional shares held by shareholders increased from three in 1986–the year Richard Santulli founded his NetJets program–to 4,731 in 2001.

The demise of United Airlines’ Avolar fractional arm in March last year came as a “profound disappointment” for the industry, said Teal, because airline fractional business jet operations were supposed to be the next big growth opportunity. Instead, the major airlines saw a loss of about 8 percent of their first-class and business-class passengers to private aviation, a phenomenon that Teal said had a strong negative effect on airline finances. British Airways and Virgin Atlantic soon shelved their plans for corporate jet services, leaving the market to the established companies, namely NetJets, Bombardier’s Flexjet and the now-merged Raytheon Travel Air/ Flight Options.

The unsettling reality in the fractional industry, said Teal, centers on long-term profitability. While the Avolar startup venture was withering on the vine, billionaire Warren Buffett admitted that NetJets was losing money. He also doubted that the other fractional providers had turned a profit.

“Obviously, making money with fractional providers is difficult,” said Teal. “Unless a provider has a tremendous market presence in terms of bases and airplanes, it will need to fly a large number of non-revenue producing flights. After all, airplanes will often need to fly empty somewhere to pick up a customer. They might also need to fly empty after dropping off a customer.” This hobbles fractional providers with aircraft that at times produce no revenue but still have capital and operating costs attached.

In the next year, at least, the economy will barely inch along. Once the stock market comes back and happy days can be said to have returned, there will be the traditional spool-up time before high emotions translate into new airplane deliveries. But despite the difficulties in making money in the fractional industry, providers have big plans. They now operate more than 750 business jets and have about 1,000 more on order.

Yet Teal’s most troubling prediction is that fractional ownership may have more in common with the dot.com business model than nearly anyone has realized.

If fractional providers continue to lose money, said Teal, “their financial backers may decide to cut their losses, the way Raytheon tried to do with Travel Air. It is possible that this industry will follow the traditional pattern of new-technology market development: a new idea leads to many players, who suddenly discover that they need to make money. The industry then experiences a painful shakeout, followed by a mature market,” which is often controlled by just two dominant players.

Further muddying the waters is the fact that airplane orders from fractional providers may be less “firm” than sales to traditional buyers. “Clearly, the future of the business jet industry is closely linked to the success or failure of fractional ownership,” said Teal. This segment of the industry will also have an effect on market ups and downs. But, warned Teal, “we don’t know enough about how the mature [fractional] industry will behave during inevitable market cycles.”

With demand slack, the rebound may come too late and fall flat for some.